The Economy Guy

Inflation – that is the topic for today, and is my long promised, overdue topic for you to think about, and how it could (or will?) affect your personal future.

The question I want to answer today is “Why would the government want to inflate the Dollar?”

First of all, politicians don’t want to create inflation.  They know that inflation is a vote killer, and they would be thrown out of office if it got around that they wanted it to happen, and it indeed did happen.  So, you won’t hear politicians talking about inflation as a solution to the financial mess we are in.

However, the FED has the job of protecting the banking system.  They are the bank of last resort, and they are being called up to shore up the finances of the financial sector in the US, and as we now find out, they shored up the financial system across the world in 2008.  The FED’s (or any country’s central bank) charter is to come into the market with liquidity (a fancy word for money that is printed out of no where) and LIBERALLY spread that money around where it’s needed.  Along with that charter are two more requirements:

1. to take good collateral for the money (loans) it spreads around liberally, and
2. to charge a painful interest rate for the money.
   

Our FED did spread money around liberally.  But it totally failed in the last two requirements of central banking.  We know that it took junk collateral for some of its loans (and the FED is stonewalling on giving the FOIA request for all the collateral received).  We also know that they didn’t charge onerous interest rates for the loans given out – the money was “free” in effect as the interest rate was very close to zero percent.

So, you could say that one of three ain’t bad…..  But, I would say that the FED has lost its way and unnecessarily jeopardized the citizens of our great nation by bailing out the financial institutions and sticking it to the people of the nation – by causing the high unemployment and low growth rate we are currently suffering.  They risked “all” by not taking the collateral needed to secure the loans.  They were lucky that the disastrous liquidity crisis (and I believe it was an insolvency crisis, rather than a liquidity crisis) was resolved and most of the money was repaid to it.  That’s just dumb luck –well, maybe informed luck, but luck just the same.  Why didn’t they take good collateral?  My bet is that it didn’t exist.  Take Citigroup for example – please.  They had CCC rated bonds that were given to the FED, and they were valued at face value.  Give me a break.  That means the FED took that junk as collateral.  A better question was “If a needy institution didn’t have the necessary collateral, why didn’t the FED just let them fail?”  My opinion is that the FED has been taken over by the same bankers who run those big banks that got all the money, and created the crisis in the first place (in conjunction with Congress, the President (as a Senator), Mortgage Lenders, Appraisers, Realtors, just about everyone.)

So, the FED has announced Quantitative Easing 2, and will be printing about $100B per month for the next 6 months, but the FED Chairman stated very clearly this weekend that he was misinterpreted, and that QE2 would NOT end in 6 months, but will continue as long as it’s needed in the opinion of Ben Bernanke.

Inflation is caused by printing money.  I don’t see any need to defend that statement, so I won’t.

So, back to the original question.  Why would the government want to inflate its way out of our situation?  Here are the reasons I can think of, and I bet you can think of more as you get your head around it.

First let’s start with the problem.  We owe a ton of money to all the holders of US Treasuries.  Our Federal Government (and most state and local governments) is spending more than they are taking in with taxes.  We’re broke.

Solution —-  INFLATION.

1. If there are more Dollars printed, we can just pay off those US Treasuries with the newly printed money.
2. However, with more money printed, we get inflation.  Do remember back in the late 70’s and 80’s.  We lost 1/3 of the value of the Dollar in a 5 year period.
3. With inflation, we get increasing prices of most everything in the US.
4. Houses will start going up in value – and the housing price decline was the initiating cause of our financial crisis – remember?
5. Increased housing prices will bring people “underwater” with their mortgage back afloat.  Nice psychological move in my opinion.
6. Increased housing prices means “profits” by investors and homeowners – so the potential for more taxes for the government.
7. Stock prices will increase too – so more tax revenues on all those gains will pour into the government.
8. Bond prices are more difficult to predict.  In the short run, the FED may be crazy enough to keep interest rates low through their existing Quantitative Easing strategy.  Longer term, interest rates must explode to stop the inflation – and bond markets will dive.  The lesson here is – stay out of bonds.
9. People will feel more affluent as their home and investments start rising.  They will spend more, and the economy will go up.  Good for all.
10. Families will become more wealthy, and the “death tax” will bring much more money into the government.
11. The Alternate Minimum Tax (AMT) will hit more and more, and eventually ALL people, and more money will come into the government.
12. People sitting on cash in savings accounts, or CDs, or bonds will get wiped out – or at least they will fell very POOR after a big increase in inflation.
13. The Dollar will go DOWN, and this helps with our exports, so exporting companies will have a boom in their sales – and more corporate taxes go into the government pockets.
14. Enough money will be around for the government to pass whatever programs it wants to pass – everyone will feel wealthy.  Sounds a little to much like Christmas for my liking.
15. More Federal taxes means more State tax revenues, so states start to feel the greatness of inflation too.
16. More spending by everyone and higher property values means the local municipalities get more tax  (sales and property) money too – wow is everyone happy?
17. What can you add?
    

I think these reasons will be irresistible to any politician who thinks about it for less than 10 seconds.  It really sounds (and is) too good to be true.

However, it is really necessary to spell out some of the unintended consequences also.

1. A lot of people will become much poorer.
2. Our trading partners will protect their own export businesses with either tariffs, trade embargoes, or exchange controls – and the world export market will SHRINK over time. Just the opposite that we want to happen as this is a true precursor to a Great Depression.
3. The price of everything will rise in the US, and it will start to get silly to buy gasoline or food or an airline ticket or a present for your kids.
4. The price of thinks could explode – as it did in Germany in the 20’s.
5. The end result will be another Great Depression.
6. If the crisis becomes too great, the people could hand over control of its country to anyone who sounds like they can solve all the problems – a loss of freedom and the US Republic is possible.
   

These are dire times.  The FED isn’t protecting the citizens of the US in my opinion.  The FED is printing money and causing inflation.  The world is watching, and the markets will come to play probably sooner than later.  Are you protecting your assets today?