THE BLOG
08/08/2011 04:13 pm ET | Updated Oct 08, 2011

Inflation: Where Cronyism Meets Poverty

Inflation is built into a monetary system that is designed, so it seems, to help political and financial classes exercise power over ordinary citizens, and to make us pay for the privilege.
As Sir Josiah Stamp, Director of Bank of England (1928 - 1941), said,

If you want to continue to be slaves of the banks and pay the cost of your own slavery, then let bankers continue to create money and control credit.

A while ago, I wrote the following.

This creation of money by bankers, including central bankers, is inflation. The steady erosion of the value of money transfers wealth to those that create it, impoverishing those who do not hold significant assets. Those asset-poor people are the lower 90% of our nation. Over time, the rich get richer, and the poor get poorer, and those in the middle tend to join the latter group. The skilled American householder today earns less than he earned in 1973. And whereas it used to take one income to raise a family, it now takes two.

To keep the system running without riots in the street, the same government officials who license the banks to print money pass welfare laws, which keep the disenfranchised at the bottom, but off the streets.

Therefore, there is no welfarism, beloved of the old Left, without crony capitalism (which pays for it). And there is no crony capitalism, beloved of the old Right, without welfarism (which maintains the political stability that protects it).

In response to the article in which this appeared, one reader asked,

Is the middle class really so helpless in all of this? As a member of that group, I feel we can extricate ourselves from the left-right power games, and we can pursue our lives in a way that makes the power-mongers far less relevant. This article focused on the state and the banks' manipulation of money-but do we have to play that game? If we refuse to go into debt, if we live within our means-then doesn't that undermine the power of the banks?

This is an excellent point, but the odds are stacked infinitely against us.

As any supporter of Ron Paul will tell you, Federal Reserve Notes (a.k.a. dollars) represent no physical thing of value. Before Nixon took the USA off the gold standard in 1971, a dollar bill could theoretically be redeemed for a chunk of silver from the Treasury. In other words, a dollar had actual value as an entitlement to receive a certain amount of some physical asset.

Nowadays, the federal reserve note has no intrinsic value. Its only value is practical -- in that the government decrees that it shall be used to settle all debts, public and private. In other words, if you refuse to take it in an economic transaction, you can be put in prison. That is the meaning of fiat currency. Ultimately, the demand for these notes is created by the requirement to pay taxes in these notes.

The government that decrees the use of this "money" licenses banks to create it. The only other way money is created is when it is spent into the private sector directly by government. On the first mechanism rests the systematic transfer of wealth from productive participants in a free market (workers and entrepreneurs) to financiers, and on the second rests the ability of the government to spend what it has not raised in revenue.

The economist John Kenneth Galbraith provided the best introduction to the creation of money by banks when he said,

The process by which banks create money is so simple that the mind is repelled.

It works like this.

A man walks into a bank. He asks to borrow money. Let's call the amount requested P (for principal.) The bank creates the money by typing some numbers into a computer to add the funds to the bank account. The money has now been created out of nothing. At the same time, however, a legal obligation is created: the man must pay the bank back an amount P plus some interest. We'll call that amount I. So P dollars have been created by the bank and P plus I dollars are owed to it.

The interest, I, will of course be profit to the bank. For this profit, the bank had to produce nothing. The borrower, though, will have to work to earn the amount P plus I to pay the bank back. In other words, the wage earned by the borrower as he works to create some tangible product or service of value will be transferred to the bank that has produced nothing.

Bad enough, but here's the catch: when the bank lends the money to the borrower, only money in the amount of the principal is created. The interest on that principal is not. Therefore, in aggregate, people owe banks more money than has yet been created!

It is only the time lag between the taking out of a loan and the interest payments that allows time for the money to cover the interest to be created by someone else's taking out a loan with a bank somewhere else. In other words, the inflation is built into the system. If everyone stopped borrowing from banks, the creation of money would stop. If everyone then tried to paid back their bank-loans, all the money in the economy would go back to the banks but people would not be able to pay back their interest because the money would not yet exist to pay it. To put it another way, money is debt and the only thing that stops the economy from collapsing over night is people's choosing to go into debt. The next time you look at a dollar bill, know that you're probably holding in your hand a bit of your neighbor's debt. Put yet another way, practically all money belongs to the banks.

Of this situation, Robert Hemphill, former credit manager of the Federal Reserve Bank in Georgia, said simply,

When ones gets a complete grasp of the picture, the tragic absurdity of our hopeless situation is almost incredible, but there it is.

Indeed.

The banks are allowed to do this only because the government gives them a special license to do so. When you or I create money, we have committed a crime. When the banks do exactly the same thing, they have not committed a crime. Not only that: they get to make a profit off the money that they create. It is the ultimate risk-free business.

As money is created without the production of goods, prices rise, and so we can all buy less with the same number of dollars.

What about when the government creates money to purchase goods and services of the private sector? As the creator of the dollars, it gets to spend them at today's prices, but once the money gets into the economy, prices go up and everyone else has to pay more for everything. In this way, the government gets to spend money without taxing us. In so doing, the government leaves untouched the bank balances of the citizenry, but transfers away their buying power to itself. We don't notice the effect until it's too late, so we don't riot.

In each case, inflation is government-sponsored, and makes poorer those at the bottom of the economic scale who have no assets. Not only do the poor not realize that the government and monetary/banking system are causing the problem by making their earnings worth less (on the one hand) and transferring wealth systematically to the creators of money (on the other), but worse than that, the beneficiaries of these transfers actually think the government is helping them through welfare programs etc. - and vote for the politicians who promise to maintain them. All the while, they don't realize that the same politicians that are helping them in their poverty are contributing to the poverty by this system of debt-money and inflation.

For this reason, the fact that JP Morgan has a profitable business administering food stamp debit cards is the perfect metaphor for the entire American economy, which depends on simultaneous distribution from the middle to both "the top" and "the bottom."

To make this a little less abstract and a little more specific, I ran some numbers.

Consider a worker who started his career in 1971, when Nixon took us off the gold standard, and the inflationary regime described above was freed of any real constraints. That worker, earning $40,000 in today's money, would have been paying an average of about 17% in taxes out of his paycheck (including income tax and Social Security, etc.). If he is being conscientious, like the person imagined by the questioner who responded to my previous article rightly suggests we should all be, and if he therefore tries to minimize his participation in the money-debt system, say, by taking on no debt but saving 15% of his after-tax paycheck every month, then the loss of value of his savings over forty years due to government-sponsored inflation alone would be equivalent to an extra income tax of 9.1% -- or more than half the tax he was paying on his income! (Note that this number is much higher than inflation, because of the effects of compounding over time.)

And so, as I suggested in my original article, wealth is concentrated in the hands of the financiers and power is concentrated in the hands of their political sponsors, at the expense of the working middle.

Lest you think that this edifice is anything other than an insidious evil, hear the repentant words of the very president who was more responsible than any for setting up this system, Woodrow Wilson:

I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit.

But heed the words of a philosopher:

None are more hopelessly enslaved than those who falsely believe they are free.

Johann W. von Goethe

(If you are interested in these ideas and others I've written about , and can get to the University of Colorado in Boulder, visit the Blue Republican page on Facebook for updates about upcoming seminars there.)

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