"With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people." -Fredrich August von Hayek
"Money, when considered as the fruit of many years' industry, as the reward of labor, sweat and toil, as the widow's dowry and children's portion, and as the means of procuring the necessaries and alleviating the afflictions of life, and making old age a scene of rest, has something in it sacred that is not to be sported with, or trusted to the airy bubble of paper currency." -Thomas Paine
There are very important debates going on about inflation vs. deflation vs. hyperinflation and what role policymakers at the world's major central banks should play. I suggest you follow this development at least to some degree, as the potential to impact you and your finances is enormous. In a world of fiat currencies with countries drowning in debt where central bankers can print hundreds of billions of dollars in mere seconds, the consequences can be staggering. The always must-read John Mauldin had commentary out this week dealing with just that:
After looking at inflation across all countries and analyzing all hyperinflationary episodes, the lessons are the following:
*Metallic standards like gold or silver show no or a much smaller inflationary tendency than discretionary paper money standards.
*Paper money standards with central banks independent of political authorities are less inflation-based than those with dependent central banks.
*Currencies based on discretionary paper standards and bound by a regime of a fixed exchange rate to currencies, which either enjoy a metallic standard or, with a discretionary paper money standard, an independent central bank, show also a smaller tendency toward inflation, whether their central banks are independent or not...
It is extremely important to note Bernholz’s conclusion. Hyperinflations are not caused by aggressive central banks. They are caused by irresponsible and profligate legislatures that spend far beyond their means and by accommodative central banks that lend a helping hand to governments.
Our Congress and occupiers of the White House for the past few decades, and particularly for the past 10 years (regardless of party) clearly qualify under the "irresponsible and profligate legislatures that spend far beyond their means". But only in recent years has the Federal Reserve begun to monetize that spending with its "quantitative easing" programs (they have blown multiple massive bubbles, but that is not the point of this post). The most recent round of $600 billion of quantitative easing, also called "QE-2", started in November and is scheduled to end in June.
At this point, I think high inflation starting within the next few years is "baked in the cake". If you look at energy and food only, one could argue it's already started (this is being offset by the continued deleveraging by U.S. households). While $600 billion seems like a lot -- and it is -- I don't think that is a level that brings hyperinflation into play. But, but, but. Starting in June the federal government is going to have to sell over $1.5 trillion a year of debt to fund our massive deficits, plus roll over a few trillion a year in looming maturities, without the Federal Reserve as a buyer. The question is what happens if the Treasury has difficulty selling bonds at favorable rates and/or we hit another economic rough patch (inevitable) and there is pressure on the Fed to act? Is our Federal Reserve independent and responsible enough to pull in the reigns of monetizing? I have serious doubts, as it seems like Tim Geithner and the Treasury and Ben Bernanke and the Fed have been working hand-in-hand for years now. There is no reason to think they won't going forward. And events like the riots in the Middle East, the European debt problems, and now the tsunami in Japan will certainly give the Fed cover to do QE-3 if they feel like it.
Two anecdotal stories jumped out at me this week that highlights what makes me nervous about this potentially dangerous relationship. First, William Dudley, President of the Federal Reserve Bank of New York (and former chief economist at none other than Goldman Sachs!) ran into a "let them eat cake" moment during a speech in Queens. Reuters reports:
The president of the New York Federal Reserve Bank doesn't normally face a raucous crowd.
But in Queens, New York, on Friday, William Dudley was bombarded with questions about food inflation, and his attempt to put rising commodity prices into a broader economic context only made things worse.
"When was the last time, sir, that you went grocery shopping?" one audience member asked.
Dudley tried to explain how the Fed sees things: Yes, food prices may be rising, but at the same time, other prices are declining. The Fed looks at core inflation, which strips out volatile food and energy costs, to get a better sense of where inflation may actually be heading.
So, Dudley sought an everyday example of a price that is falling.
"Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful," he said referring to Apple Inc's latest handheld tablet computer hitting stories on Friday.
"You have to look at the prices of all things," he said.
This prompted guffaws and widespread murmuring from the audience, with one audience member calling the comment "tone deaf."
"I can't eat an iPad," another quipped.
See, who cares if you can't feed your family because food and energy prices are skyrocketing due largely to Fed policies, go to the mall and buy a fu&%$ng iPad to offset it! What a world these clowns live in! If inflation is higher than they want or would thwart inflation-generating policies they want to enact, well then, just change the definition of inflation to exclude food and energy. Full steam ahead. Nevermind that food and energy hits people harder the further down the socio-economic chain you go. And seniors on fixed incomes and savers getting horrible investment returns? Necessary casualties of the Fed's inflation war. The ivory tower must be higher than I thought.
It is widely believed by many (including me) that the Fed's current monetizing has been a catalyst for higher oil and fool prices, both directly with a depreciating dollar and indirectly as speculators try to anticipate the inflationary effects of money-printing and as individuals horde goods in anticipation of an inflationary future. Besides hurting the average American consumer, some of the other knock-on effects include riots and overthrown governments in the Middle East and Africa ("Other than that, Mrs. Lincoln, how was the play?"). The Fed's cluelessness continued with Atlanta Fed President Dennis Lockhart noting the following:
Fed's Lockhart: Oil shock could lead to QE3
If oil prices continue to climb, it could force the Federal Reserve to make a new round of asset purchases, according to Atlanta Fed President Dennis Lockhart.
Appearing at the National Association of Business Economics in Arlington, Va., Lockhart said that while he doesn't think additional purchases are currently warranted, more stimulus could be needed if oil prices continue to climb.
"If [the rising price of oil] plays through to the broad economy in a way that portends a recession, I would take a position we would respond with more accommodation," Lockhart said at the conference.
This is the circle of doom. The Fed prints money, which causes prices to rise (or really, the dollar to depreciate in value vs. real goods), which negatively impacts the economy as consumers spend more on food and energy and less on other goods, and so the Fed tries to further stimulate with easy-money policies. Wash, rinse, and repeat.
While it will go in fits and starts, there is no question that we have started down the slippery slope of monetizing government debt that is leading to inflation. QE-2 ends in June. What will the Fed do then if the economy isn't self-sustaining (which, as noted most recently HERE, I believe it is not)?
I don't know what will happen. But there is one question you need to ask yourself: Do you trust your government and Ben Bernanke and the Federal Reserve to do the right thing? I, personally, have grave doubts.
We're Going the Wrong Way
Neal: He says we're going the wrong way...
Del: Oh, he's drunk. How would he know where we're going?
-Planes, Trains, & Automobiles
Exploding deficits per capita with stagnant economic output per capita. I would say this is scary to quite scary. Ironically, our debt to GDP is expected to hit 100% on...Halloween. Boo!
October 19, 2011 in Current News Commentary, Economy | Permalink | Comments (1) | TrackBack (0)