The Fed recently announced it will buy up $300 billion in long-term Treasury bonds and spend $750 billion more buying sub-prime mortgages from big banks. Given the $3.6 trillion budget President Obama plans, the $1.8 trillion in deficits he will run and the trillions the Fed is pumping into the economy, there is real risk we will have an inflationary spike in the future.
It is important to understand that what the Federal Reserve is currently doing does not involve literally printing money but extending credit, and that credit can eventually be withdrawn. If at some point the Federal Reserve reduces the money supply by withdrawing that credit or raising interest rates, and if they do that with opportune timing, inflation would be contained. But if they do not handle this delicate assignment correctly, we will not be able to save ourselves from inflation's devastating effects.
Inflation, described as too much money chasing too few goods, edaciously consumes capital and erodes the value of cash, savings, stocks and bonds. By eating away at the value of a currency, inflation punishes savers and creditors and rewards debtors. It is a de facto tax.
But it is a far more devastating tax than anything enacted by Congress, because it does not need approval from legislators. A man with a 5% saving account is going to be in exactly the same financial position if he pays 100% tax on his interest income with zero inflation, as if he pays no income taxes with 5% inflation. A tax rate of 100% on interest income will drive people to violent protests and be considered outrageous, but people would usually not complain about 5% inflation. Yet the truth is, either way they are taxed in a way that leaves them no real income.
Indeed, debasing the currency is the best way to destroy a capitalist system. Unfortunately, as the world's biggest debtor, the US has plenty of incentive to debase its currency and pay off the debts in cheaper dollars. Gold prices more than tripled over the last decade. This is already telling us the market thinks the dollar has been abandoned by the Fed.
It is no wonder therefore, that the Chinese are worried about the Dollar as the world's reserve currency. Rather than endure the pain and accept the sacrifices to cure us of our addiction to leverage and excess spending, we are going back to the same infernal behavior that brought us to the precipice of this financial crisis.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.
Devaluing the currency would cause wages and prices to rise but would also allow people in this group to pay back their loans in cheaper dollars. Since this group would be newer entries to the work force , they would be in position to benefit the most from rising salaries both from inflation and career advancement. Currency devaluation would also spare th Obama administration from having to propose legislation to provide debt relief for this group.
I am afraid the political logistics in favor of currency devaluation will be too much for the Obama administration to resist especially since currency devaluation would also help US export industries.
the Fed has rapidly increased the money and has the job of withdrawing this credit before it cause inflation. This is hard enough without the above political roadblocks. Given these considerations , it is likely the Obama administration will block any attempt by the Fed to reduce the money supply. especially if rising salaries means that more people will ear 250K_ category which be paying a higher tax rate.
Very interesting article. When you say "if they do not handle this delicate assignment correctly," you know that they won't and can't: when the economy starts turning, interest rates will be kept low until a recovery is firmly under way and unemployment (which tends to linger quite a bit after economic growth resumes) begins ebbing. So, it's clear that we would face inflationary pressures.
As it were right now, the government's concern is clearly deflation - hence the purchases of Treasuries and GSE mortgages/securities, precisely to prop up prices.
As for the Chinese being concerned about the dollar, I think they are also worried about Treasuries remaining sterling solid - I interpreted their comments before the G20 meetings as telegraphing that they worried the Fed might be compromising its balance sheet with lower quality collateral.
As for "addiiction to leverage, " I thought you might be interested in p 45 of our paper
http://big.assets.huffingtonpost.com/GuideToTheCreditCrisis.pdf
Best, Michael
And 5% is not hyperinflation, but the way.
And why is the HP running this series of incredibly arch, misleading and patronizing opinions that hyperinflation is around the corner, giving us infantile descriptions like this:
"A man with a 5% saving account is going to be in exactly the same financial position if he pays 100% tax on his interest income with zero inflation, as if he pays no income taxes with 5% inflation."
You'd think deflation was the normal course of things, and that we have to be taught the most rudimentary, nursery school facts about inflation. The opposite is true. In this world, you can either have inflation or you can have deflation, you cannot have neither.
And when you say, "But if they do not handle this delicate assignment correctly, we will not be able to save ourselves from inflation's devastating effects." you are talking absolute nonsense; the opposite is true, if they do not handle this delicate assignment correctly, you will not be able to save yourselves from deflation's devastating effects.
There are multiple causes of inflation, but 'stable' (exponentially growing) inflation is an unavoidable consequence of the present debt-money and price systems.
Deflation is usually a result of the actions (or inactions) of the commercial/clearing banks, who create and issue 97% of the money supply as a debt owing to themselves (their 'assets', to be called-in at their pleasure).
Hyper-inflation is usually a result of the action of a central bank, and in almost all historical cases of hyper-inflation, the central bank was privately-owned/controlled by commercial/clearing banks (e.g. the Reichsbank in Germany in 1923 was a privately-owned/controlled central bank - so this was NOT a case of "the government going wild and printing too much money", it was a deliberate policy of the bank).
To learn the actual history, please read "The Lost Science of Money" by Stephen Zarlenga.
http://www.financialarmageddon.com/
http://dieoff.org/page88.htm
Steady State, instead of Growth. Saving instead of Spending. Let the government manage the money supply and own the banks. Claw back the ill gotten gains. Prosecute the fraudsters and the merely negligent violators of trust.
Thanks for listening.
who get twice as much and actually can live off it. Try that here and good luck. Social Security
presently is running a surplus, just keep the government's hands out of it and it will do just fine.
Too bad they made it a fund for everything but for what it was intended.
This assault on The People, began with the offshoring of jobs under Reagan, reached into all of our pockets with the contrived tech bubble and its subsequent manipulated burst, hit new peaks of destructiveness with the FED and Wall Street orchestrated mortgage-junk bond rip off that has turned millions into the streets, and continues with the threat to our 401ks and bank savings accounts as the FDIC overreaches to become the insurance of last resort for the criminal banks.
Rampant inflation would help to finish the work of those other programs by ensuring that even those who once enjoyed comfortable, if not luxurious lives, were brought to the edge of poverty with what amounts to a new tax on living! When you add it up--No job, no income, no house, no retirement or savings, we get to the point where it can only be called one thing--Class Warfare.
Ever since then, the Fed has been creating money backed by debt to finance both our import based economy and growing government. Did Wall Street make mistakes in the past thirty years? Yes. But would those mistakes have been made if it weren't for Fed credit expansion? Highly unlikely; there is no incentive in a free market for entrepreneurs to stand next to a cliff and hold hands unless someone is pushing them that way.
Base your currency on a commodity, today, and your currency will fail, whatever commodity you choose.
Our economy has outgrown the market for any particular commodity. To tie our economy back into a commodity would not bring stability, it would bring disaster.
In fact, it would bring the disaster that was avoided in 1971. Everything you cite as disaster was in fact a glancing blow, the disaster was averted by breaking the very last reference, however artificial and theoretical, to commodity currency, after a good long notice in Bretton Woods, where you know, the world went off the gold standard, using the US Dollar instead.
Commodity currency money is debt. You can pay back the loan in the commodity.
Money is debt. Always has been, from the very beginning.
The middle class benefits from inflation.
Here is how it works:
The poor, particularly those without opportunity to increase their income, dependent on welfare, disability or a pension, or just dealt an unfair hand, in sheltered work, etc., fare badly when it comes to inflation. Society can be parsimonious when granting inflation relief to this group.
The very rich would much prefer deflation. The curse of being very rich is not only that you have money, but money has you. If there is inflation, you must take risk, put your money into the economy and make it work, otherwise you lose money to inflation. If you take your money out of the economy, it shrinks. But, the opposite is true in deflation; you can just sit on a pile of money, and it grows more valuable the longer you hoard it. You could have your cake and eat it too; you can have money, but money would not have you.
The middle class keep up with inflation, and more, in their incomes, and see their own middle class debts, mortgages, old school fees, shrink.
Oh, and everybody except the very rich, are devastated by deflation in a way that not even the very poor are devastated by inflation. They are left homeless, hungry, destitute, as the rich hoard all the money, and the economy collapses.
The Weimar Republic only lasted about 14 years and collapsed during the Great Depression. If the victims of the Madoff ponzi scheme think they have it bad now, things could become much worse for them.
In the meantime our government keeps spending tens of billions of dollars a month that it does not have on a bloated defense establishment with military bases around the world. Then there are the endless costs associated with the War on Terror.
The people who benefit from inflation are those who are in debt, because the money creation makes it easier to pay off debt in the long run, with newly created money.
The middle class always suffers under inflation, in the long run. Look at the period from the 1970's to today. The nominal standard of living might have increased, but debt and prices on everything have outpaced the increase in wages.
We have people who are short on banks, talking banks down...
What if he is short the dollar and the dollars is rising.. well he wants it to go down by citing inflation worries.
Secondly the greatest threat to capitalism is not inflation... but deflation of assets which is what we have now... everyone waits to buy hoping prices will fall further... some inflation is thus required in a capitalist system.
We must restart inflation to restart the economy. Thats the reason for increasing the money supply. No Option.
The more assets drop, the greater the hole to dig out of...
Regards