Friday, April 11, 2014

My View

Random ruminations from your resident curmudgeon...

If you have listened to new Federal Reserve Chairman Janet Yellen speak, she has consistently voiced a concern over a lack of inflation. She has said that increasing inflation to around 2% is the goal of the Federal Reserve.

That same sentiment is echoed by Christina LaGarde, the Director of the International Monetary Fund. LaGarde, in a news conference this week, said that one of the primary financial problems across the globe was "low-flation" (her term), meaning that inflation was not increasing fast enough.

Now friends, I have to ask you, why would such important monetary bodies want to increase inflation? Why is inflation so important to the Fed and the IMF?

First off, let's define inflation.

In simplest terms, it is the rate at which prices for goods or services are rising AND the purchasing power of the currency is diminishing.

For inflation to take effect, both conditions must exist. Understanding this is critical for you, me, and especially policy makers. Sometimes prices rise because there is so much demand for a product or a service. This is the fundamental economic principal of scarcity, and when there is less of a good, prices will rise until either more of the good is produced or buyers find a substitute.

Rising prices in that instance aren't necessarily bad. That shows a growth in demand and the capacity to pay what the market will bear for the price, generally signs of a healthy economy.

Inflation, however, occurs when prices begin to rise and the value of the currency- it's buying power- is being diminished.

If a soft drink costs $1 and inflation is running at 2% per annum, then next year, it will cost $1.02 (this is a sterile example just to prove the point).

So...back to the question:

Why does the Fed and the IMF want inflation?

There are a number of reasons, but I will offer my take on this.

Inflation raises the Gross Domestic Product (GDP) because it raises prices on everything. When prices rise, so does the GDP of a country, and this eventually leads to more tax revenue for the government. A company could sell $1 million worth of product in a zero inflation environment and their taxes would be assessed on that $1 million.

Let inflation rise 5% the next year, and although the company sold the same amount of product, their revenue in now $1,000,050. That extra $50,000 in revenue (artificially created by inflation) is now subject to tax.

Another aspect of this is that the value of the dollar based on purchasing power is declining.

Think about this: if you borrow $1,000 from your bank, you want that money to buy $1,000 worth of stuff. Now say inflation is rapidly increasing, rising by 10% before you make your first payment. You bought stuff with you money where each dollar you borrowed bought $1, but since inflation is rapidly rising to 10%, you are paying back your debt with dollars that are only worth .90.

As a borrower, you won.

Now look at the U.S.

We have printed $4 TRILLION new dollars over the past 5 years. We have sold those to investors (in essence, we borrowed their dollars from them), and we will begin to pay back those debts in the near future.

Think the U.S. wants to pay off their massive amount of indebtedness with dollars that are worth less than what was borrowed?

So do I.

And it is not just the U.S. that has engaged in this practice, but just about every other nation in the world.

Now this all sounds abstract and quite possibly dull, but here is how this impacts you and me.

As prices rise and the purchasing power of our currency falls, it takes more of those cheaper dollars (because of inflation) to maintain our standard of living.

Not increase.

Just maintain.

Now couple decreased buying power with an economy that is not producing quality jobs and one wherein real incomes have fallen nearly 10% since 2008, and you have a formula for an economy that is stagnating and families are struggling to make ends meet financially.

You have the United States.

So now when you hear the Fed's spokesmen speak about raising the level of inflation, know this simple fact: they are taking away your purchasing power and negatively impacting your standard of living.

Now, I fail to see how this policy objective benefits the majority of Americans. In fact, if the officials at the Fed were honest, they would tell you that it doesn't.

Instead, it is the only way out of a financial mess of their own creation, and even that may not work.

Keep this in mind as you struggle to make ends meet and the next time that you are told increasing inflation is a good thing.

Because it is certainly not.

And that, my friends, is my view.


  1. The reason you want a modest (2% ain't much in perspective) inflation rate is that the alternatives hold terrifying consequences. A too-high inflation rate can cause interest rates to skyrocket and devastates consumers, while the prospect of deflation throws the brakes on consumption activity as well (why buy something now when prices are trending down).

    If the government really wanted to monetize the debt and pay it back with cheaper dollars than are being borrowed, they'd target something much higher than 2%.

  2. You are exactly right, Dirk, and as I pointed out in my 3/24 blog, inflation is significantly higher than the targeted 2%. It is estimated by some economists that the real rate if inflation is 6-7%. That results in a severe erosion of purchasing power.