Self-Fulfilling Fantasies: US Treasury Bonds

Number one on my list of fantasies is the US Treasury Bond. (Just for the record, in this context I mean nightmares. I do have good fantasies!) People feel US Treasury Bonds are safe. Are they?

The usual reason given for the safety of US Treasurys is that they are backed by the ability of the US government to dip into the pocket of the most-wealthy nation on earth to meet interest payments and redeem the bond upon maturity. Well, yes, that is true, still true. But that proposition does have limits, limits that have not been stated or acknowledged before, but need to be seriously considered, soon. (Notice that the wakeup call of the S&P downgrade of US Treasury Bonds has not resulted in honest reconsideration of the path of the Obama administration, but has caused several loud calls for destroying the remaining limited independence of the credit rating companies.)

There is also another issue that isn’t addressed in the basic reasons for the safety of the US Treasury Bond, prices. You see (and I am sure that many of you do see) the price of the bond is related to the interest rate that it pays, which in turn is related to the interest rates paid on other bonds around the world. If interest rates begin to climb, and the secondary market for Treasury Bonds (where bonds purchased from the Treasury are resold), even the Treasury itself, need to compete for funds, the interest rates for the bonds will climb. The consequence will be that the price of the bonds will fall. So Treasury Bond prices do change. If interest rates move, say, a whole percentage point upward what happens to the price? The current benchmark 10 year Treasury Bond has a yield (interest rate) of about 2.4% (the date of my first draft being somewhat different from my publishing date). So I am suggesting that it went from 2.4% over time, however long you want, to 3.4%. The latter interest rate is still very low. Historically, this bond has been much closer to 5%. Even at 3.4%, with taxes at roughly 25% and inflation around 2%, the bond isn’t making you any money (at 2.4% you are taking a loss). (Of course, foreign governments aren’t paying taxes!) But, a bond purchased originally at 2.4% will not yield the new market rate and can’t be sold for the original purchase price (nominally $10,000). Instead it must be sold for the amount that will bring the current market rate of 3.4%. (or $240 – the actual dollars paid in interest – divided by the new interest rate) which is close to $7058 ( there are issues of time to maturity, when you receive back your $10,000 that will adjust the actual sell price). You have lost roughly 29% of your principal. You see, relatively small moves in interest rates will have significant effects on the market value of your bond.

This example demonstrates that bonds are no safer in terms of maintaining your principal than any other asset, unless you hold to maturity. How safe is that? Depends upon the inflation rate doesn’t it. When thinking of long-term monetary values, don’t think in terms of currency, that is, fiat currency. Think in terms of some real, basic thing that you use in daily life, like a loaf of bread, or a pound of ground beef, or a latte in Paris, whatever. You will connect the rate of inflation to your currency denominated assets and be able to better realize what is happening to your capital. The bottom line is that US Treasury Bonds are very risky. (I won’t even go into the fact that you have put your savings into the hands of people like Obama, Bernanke, and Geithner.)

Many, if not most investors know these facts, so why are they still running to US Treasuries? Context. Or, a perhaps better way of putting it, where else are they going to put their money? There are a couple currencies that are considered strong, i.e., the Yen and the Swiss Franc. Both of these have been bid up sky high (much to the dismay and panic of the authorities and business people in those countries). There isn’t any real room there for more money. Other currencies are not considered safe by the populations of those countries. The best current example of that is the eurozone. This group of “developed countries” have people making decisions who are more concerned about voters than solvency. People who wish to protect the value of their liquid assets are scared of what these politicians will do (not to mention the so-called economists who do not think stability or production as important to economic health). The person holding liquid assets wants to put his property somewhere that the whims of the politicians can’t destroy it.

The bond markets for stronger countries, such as German and Austrailia, are small, very small in comparison to that of the US, and can realistically take only a small portion of the available funds. So for anyone wanting to get out of their home market, out of their currency, out away from their authorities, the US is still a better place. It just gives you a good idea of how bad it is elsewhere that the US dollar and the US Treasury Bond are about as good as it gets.

The result is that Obama, Bernanke, and Geithner feel pretty strong and confident, in spite of the downgrade of US government bonds by S&P. Again, isn’t it amazing that the politicians in other countries scare their populations more than the US trio of idiots.

The above discussion also gives you some idea of what could be the future for the cost of gold in fiat currencies. The gold market is smaller than the market for the Yen or even the Swiss Franc.

At this point I should explain how the bid/asked market functions: it is the margin that moves a market, especially a auction market like stocks, bonds, currencies, commodities. It is not the total demand or ownership. It is the most recent orders, their size, their volume, and which side of the transaction they are on, buy or sell, that moves the market. The traders do what they can to meet the reqirements of the open orders, moving the price as required to elicit corresponding orders (a buy order to match the existing sell order) to clear the market. Higher volumes of demand for a item, like gold, will send the price up. The higher the volume, the faster and larger the price movement.

So if people really begin to consider gold as safe and a real alternative to fiat currencies, the current price will be considered very low. Any kind of movement into gold from these other markets will send the gold price to astounding heights and will really scare a lot of people.

What will be interesting to watch (but not to live through) will be the point at which people begin to doubt that US government assets are a good idea, including the dollar. We don’t even have to worry about China or Japan for things to get ugly. If just foreign banks, businesses, and individuals begin to sour on our debt, its yield will move strongly upward and its market price downward. The budget deal and all of the carefully crafted, make-believe scenarios will be revealed as so much fantasy. These scenarios (models) are also among my favorite nightmare fantasies.

Debt, Ceiling, and The Issue

So many people are reacting to the recent bill to raise the debt ceiling as if it meant anything. It did mean something, but not what people are whining about and not what the Dems or the Republicans are suggesting.

You should have expected that the debt ceiling would be raised, and probably by the arbitrary date that had been set. If anyone in Congress had suggested that the US go into even partial default, they weren’t being taken seriously. When the government has been shut down before, the Republicans have taken the blame and felt the pain on election-day. They weren’t going to do that again. No, they were going to raise the debt ceiling.

I am a little surprised that they raised it as much as they did, although the actual number was rarely mentioned in the press. No wonder, since the increase was about the same amount as the announced reduction in spending – that is suppose to occur over ten years.

Add in the fact that actually less than a trillion dollars of spending reduction was identified in the bill that was passed and the remainder is suppose to be selected in a special legislative committee, we have a bill that doesn’t mean much. Nor are the effects to begin for the next two years, except to raise the debt ceiling by over $2T.

The “reasoning” behind not having any cuts in the next two years is strictly Keynesian economics. It is accepted by both sides that government spending is a good thing for an economy that is not growing sufficiently (if at all). No one questioned this claim. The Republicans went right along with it. If you think about it, it makes even less sense in this case. I mean they are accepting the idea that not reducing the spending that BO wants in 2012 means that the economy then will do better than if his budget was reduced. This is just amazing. It this thinking is correct, the correct thing for Republicans to do would be to push for more spending, regardless of the deficit, to have even better economic performance. Well, of course, we are now talking Ben Bernanke’s language.

Many people are claiming that the loser was BO. They say that he didn’t get the increased taxes on the wealthy that he insisted upon. Maybe. There is always tomorrow, of course, or after the next election. The way the Republicans are going, BO will look great. I am sure that he hasn’t given up on raising taxes on the most productive members of our nation, he will find another time to push this through.

The bill hasn’t made our immediate situation any worse. If you understand that the debt limit was going to be increased and the whole thing was a game (a game that was taken very seriously by all participants), then you just hoped they didn’t do anything more stupid than normal. There are no new immediate taxes, no new spending, no explicit attacks on our freedom.

There is one bright spot, I think. It is that the very issue of the debt was brought forward and made a big deal. It gained the attention of the media and many people in the country for a couple weeks. It also seems that the Republicans did latch on to this issue and maybe they will try to keep it in the forefront of their public comments. That is a good thing.

Yet, as I say that I also remind myself that they did not make clear to the American public that Social Security and Medicare are doomed, no matter what the Dems do about it. Those programs have a cost that no nation could pay, and certainly not one as encumbered and regulated as this one.

The Republicans also undercut their case when they fought for such small potatoes. Cuts of $2.7T (or whatever the final advertised number was) spread over ten years do very little to impact annual deficits of over $1T a year. It was such a big fight over so little.

But actually, it is even worse because what they were fighting over weren’t cuts at all. The Congress uses terms differently than us common folk, and the “Tea Partiers” fell right into it. The budget projection process assumes that most programs will continue to expand over the years. What Congress fought over was the rate of increase of those programs. They weren’t cutting anything at all.

The expectation that reducing the increase will make a difference assumes that the income side of the budget would grow at a certain rate, meaning that if income continues to climb, and we reduce the increase in spending, we will see a reduction in the deficit and we will borrow less. But, where is this increase of revenue coming from? Well, two options: price inflation or actual growth. Along with price inflation often means increases in income as well and thus increases in tax revenue. Historically, however, income lags, meaning that our standard of living lags, and tax revenue lags. So, price inflation would only partially support a decrease in the growth of the debt.

Really, Congress is assuming that the economy will grow. I do not know what growth rate was used to figure out that their numbers would work and the deficit would not grow as fast as it has. I expect that it had some relation to our history since WW2. The growth rate over the last ten years has been much lower, however. We may not expect our growth rate to achieve the historical average any time soon, since we really haven’t recovered from the last recession. There are lots of reasons to think that the last recession is continuing and tending downward. You can be certain that the framework of this “Deal” didn’t assume a recession in the ten-year timeframe. The entire underpinning of the “Deal” is flawed.

The bottom line is that the “Deal” that was suppose to cut spending will have little effect on what will happen in the economy over the next ten years. It is a nothing. It has many fraudulent characteristics. Worse, it may make some people relax and think that things are in better shape.

That is one reason why I don’t understand the people who were so disappointed that the “Deal” was done. The bottom line was that the Republicans were fighting for show, not for real results, and not passing the debt ceiling was just too real for them (as a group, anyway).

And now (have to write more cuz stuff is happin’), S&P has actually shown up. I think that their explanation is pretty good, except that they should have mentioned that the politicians got us into this fix in the first place. I have seen two different kinds of responses, well, three, but the third, “It’s about time!”, is a very small minority.

One response is surprise that the downgrade is occurring now since the US government can meet its obligations of paying interest and paying back bonds. This is as short-sighted a view as we see from the Congress. The issue isn’t about today’s payments, but the payments during the life of the bond, which is in doubt, really.

The other response is from the Administration and the Democratic members of Congress. They apparently believe that anyone who disagrees with their view, their very subjective view that whatever they want to do is good, is at best mistaken and probably evil. Don’t be surprised to see the FBI visit S&P headquarters. If Obama actually realizes what the meaning of the downgrade means, he will look for ways to use the power of the government to change the rating of his debt.

Many of the supposed financial experts interviewed that I have seen have been unwilling to predict what we will see tomorrow when trading restarts around the world. I certainly don’t know. We may see some pause as people try to come to grips with the revised situation. Many of the organizations that currently hold Treasuries as assets that must be AAA rated may be calling their attorneys to find out what they must do. Prudence would require that they change their assets in an orderly manner and not wildly sell. But then, we could see some panic selling. Either way, a lowering of the rating of US government bonds should see an increase in the interest rate being demanded in the market. How much is very much open to question. The Treasuries will still be a major holding by many different international and domestic organizations.

But think what the downgrade does for the “Deal”. The whole plan did assume a certain cost of borrowing. That is, paying the interest on the debt is a large portion of the federal budget. That portion has just gotten larger. I bet that the projection of future spending used in shaping the “Deal” assumed pretty much the same interest rate on bonds for the entire 10 years. It certainly assumed a continued AAA rating. Now that rating is gone at the very beginning of the 10 year timeframe, and it is unlikely that the Administration or the Democratic members of Congress will do anything that will provide reasons to change the downgrade. The supposed cuts will be off set by the higher cost of paying the interest on the debt. So much for the entire hoopla and the “Deal”.

We need to focus on the primary thing, which is the education of the American people. If a sufficient number (say 20%) understand the situation, their voice concern will cause Congress to move in the correct direction. As long as the American people believe that, for example, Social Security and Medicare can be viable over the long term, nothing will be done.

As we move into the forth year since the bust of 2008 and there is no real recovery, we do have an opportunity to point out the reality of the Keynesian policies of the government. The American people do not want to live this way. I think that even the ones receiving government payouts may be willing to listen more than their counterparts in other countries because they are still Americans. In any event, we have our opportunity. Let’s make the most of it.

Outlook: The Economy and Inflation

If I haven’t mentioned this before, let me do so now: keep an eye on “business news”. So many people are focused on the political issues that they don’t take time to look at the business pages. People also tend to consider business news as very specialized, I think. I mean that the stories involve finance and accounting concepts that are not sufficiently understood by the average, intelligent person. I would agree if the articles on the business pages in the normal daily newspaper or news web site were about actual businesses and markets, etc. Most articles, unfortunately, are actually about the government and its activities. What would pass as actual news in the business world is ignored there just as real news is ignored in the other sections. Further, the “reporters” in the business section are not people with an education in business, finance, or economics. Nor do they have business backgrounds or even a history of intelligent investing. They are people with journalism degrees who could not make it to the front pages. Years ago someone did a survey of the people writing for Money Magazine. They found that few of the writers had any investment background. The writers for Money Magazine were young, inexperienced, and had bought into the Money Magazine “philosophy” (and advertising strategy) without question.

So it would seem that I have just given you good reasons to ignore the business pages. Well, even so, it is the reports on the government that you need to look out for. A few of those reports are considered significant enough to reach the front page. Many of the others are important to know about. You need to have a broader view of the economy we live in and its prospects to better understand what could happen in the future. You need that for yourself, to better plan for yourself and your family.

For example, some people are carrying on about high inflation and you might think that inflation is raging and creating havoc. Look around you. Do you see prices in general going up? Significantly? There is some, of course, but nothing big has happened as of yet and may not for a while. People who are carrying on about inflation happening now are ignoring the actual situation. (I am not suggesting that there is no threat of inflation or hyperinflation. There is. But it is a threat, a possibility and can be avoided.) Many people are ignoring the issues of Social Security and Medicare and their impact on the budget, today. You don’t keep track of this stuff without looking at the business section (and reading this blog, of course!).

Okay, so lets talk about outlook, or what I have called the Inflation Watch in the past. This time I am broadening my focus.

In spite of all the pushing, money pumping, stimulating, and general noise making, the government, including BO and Bernanke, has been unable to get the economy functioning, producing consistently, and growing. They don’t know why. Their mental framework, the “understanding of the world” they utilize to make decisions, has not brought them to the shining success they expected. But don’t despair; they know why it didn’t work. We didn’t cooperate, we being the banks, the business, the capitalists, the consumers, all of the non-government types. It is our fault. They will just have to try harder. Don’t worry. They, BO and his gang and Bernanke and his colleagues, will not question their ideas.

In the meantime, the economy is floating along, not improving, deteriorating marginally in areas that are hidden. More houses are being foreclosed upon (funny how there are few if any news reports about foreclosures these days, which was big stuff a year or two ago). BO is considering “restructuring” Fanny Mae and Freddy Mac. You know that won’t be good.

There is more unemployment and few new jobs, relative to the available workforce. (Notice that in my area, just outside of Washington, DC, unemployment is low. Isn’t that strange. Notice also the various comparisons between federal government employee incomes and the private sector.) Industrial production rose for a while, but has now slowed, if not stopped growing. Imports are again exceeding exports significantly, and the gap is growing. The balance of payments (all money transfers as opposed to just trade) shows that foreigners are still keeping dollars (idiots).

Not to be left out, foreign governments are doing just as much to screw things up as the U.S. government. Many who are looking at the Chinese to be shining stars are ignoring the fact that their Communist government believes in doing the same thing that the U.S. government does. We are the great capitalist nation and the Chinese are emulating us.

Someone could reasonably say to me that it isn’t really today that we need to be worrying about. It is the future, maybe the intermediate future. I agree. There are certainly significant seeds of terrifying doom planted in today’s economy, i.e., the debt, the made-up money at the Fed, the lack of any savings available for investment, the flood of new regulations, etc. The list is very long. Even worse is the lack of understanding of the true nature of the situation where the decisions are being made or where the decisions are being evaluated, i.e., the press.

Nevertheless, the American economy is not just the government or the Fed. There are millions of other actors who are seeking their best interest and working to achieve their own goals. These people have learned over the last century how to work around and within the government actions to minimize the consequences of those regulations and laws. Their ability to do so is not unlimited. But they have shown amazing creativity and resilience. We aren’t necessarily doomed.

Just as the government and mainstream economists don’t question their premises, those who have cried doom often in the last decades don’t seem to question why that doom hasn’t occurred. At root, they seem to give the government a kind of power in the economy that means that the non-government population is completely helpless and their actions have no consequences. Destruction is inevitable. Consequently, these doomsayers tend to pounce upon any small indication that things are coming apart as proof to the government’s power.

We must keep perspective.

The economy today is wallowing. The people making decisions are idiots. In many respects the average American cannot be relied upon to make good decisions. Even so, there is a lot of good stuff going on in our economy and society (including us). We can make it through with only a little damage. It would help if people listened to us. It would help if the American voters put in a non-Dem house of the legislature. Unfortunately, we can’t count on those events.

So what is the “Outlook”? At best it is very uncertain. Under current conditions and leaders, the best we can look forward to is more of what we have had over the last couple of years: no growth and floundering. With some positive results in November, maybe things will move toward the early part of this decade (not really good but better than now). But the potential is there for disaster. It isn’t unavoidable, just a potential.

Deflation

As with inflation, there is a great confusion as to what deflation is. The people who steadfastly insist that inflation is raising prices are consistent in insisting the deflation is falling prices. This is why, time and time again, since the 1930s, they insist that prices need to be kept at least level when the economy hits a bad spot. They hold this position in the face of overwhelming evidence to the contrary, but that is another issue that involves considering their philosophy. Maintaining price levels has resulted in some of the most insane actions that we have seen in the free world. The classic is FDR’s requirement that crops be destroyed and land kept out of production when there were bread lines and people going hungry.


That dropping prices are not a bad thing has lots of evidence. The best I think refers to the time period from the end of the Civil War to the end of the 19C in the U.S. I have seen some suggestion that prices tended to stay level during this period, so there needs to be some more research (anyone know of some good references?) but there is also strong evidence that prices tended downward. Certainly, several important products saw sharp price declines as new technology was applied, including better business management techniques (e.g., Standard Oil managed by J.D. Rockefeller).

In today’s world we see prices dropping for many important items in spite of the continuous inflationary pressure of new made-up money being pushed into the economy. But overall, even the much maligned CPI shows some upward trend of consumer prices. The “core” inflation rate (which excludes what is considered volatile, energy and food; isn’t that really dumb) is slightly up year on year at less than a percent. Those who figure that the CPI has been manipulated for political reasons and to keep the masses from getting restless prefer the shadow statistics analysis that says we are seeing closer to 6 or 7% inflation this year, especially in food. Bottom line though is that we are definitely not seeing falling prices.

Those who are deathly afraid of falling prices would be demanding that the Fed, the White House, and the Congress do something, anything, if prices do start to fall. They fear a depression. If prices do begin to fall, we will see such a massive pumping of money, demands for price controls or supports, and really weird stuff that will take our breath away.

It was the fear of falling prices that prompted many of the actions at the beginning of the recession in 2008. The consequence of that was the prevention of the liquidations and readjustments necessary in the economy to allow it to return to productivity. It is why we are still in a mess. More actions to keep prices level would not be helpful.

Another group, to which I belong, regards deflation as a reduction of the money supply. The money supply indicator for the U.S. that I use (MZM) has dropped about 3%, but has now stabilized. The main driver of the money supply in the past 50 years has been the expansion of bank credit, primarily to businesses, but also to consumers. Bank credit has decreased almost 25% in the last 18 months. Even so, the money supply has not shrunk. Further, we are continuing to have balance of payment shortfalls, which means we are sending dollars we don’t miss out of the country.

So what? What would it mean to us, now and into the future? Remember that one issue of inflation is the entry point of new money. In the same way, in deflation, it matters where the money is being taken from. Right now, money is being injected into the economy via federal payments, i.e., stimulus, medicare, “jobs” programs, social security, and other payments. Where has money being taken from? Loans to businesses are decreasing, as I mentioned before. What isn’t? Loans to government. The Federal Budget is in massive deficit in 2010, and will be so in 2011 and thereafter unless something extreme happens. Money is not being taken out of the economy so much as savings is being diverted from any activity except government debt.

The question I keep coming back to in the discussion of deflation is how actual deflation could possibly happen. Those who argue for deflation of the money supply do not actually explain how it could come about. They merely point to certain trends and extrapolate from there. That’s fine. But the trends have not actually reached deflation. And those trends have now been going on for a while, and still no deflation.

So how could the money supply decrease? One idea given is that if we go into (further into?) recession again now, business lending will decrease further and total checking deposits will fall. Checking is ready money, which is the backbone of the money supply. So far, however, bank loans have decreased 25% and money supply has remained flat, even with the export of dollars as our balance of payments have remained in deficit. The fall in banks loans is not leading to deflation.

As I see it, the federal budget deficit and BO’s expansive spending (he wants more stimulus) is pushing on the money supply faster than any deflationary trend. If, somehow, BO were to stop spending, the budget deficit stabilized, someone figures out that we don’t need more fake jobs and production-killing regulations, and no panic response comes from Congress or the Fed, we could wonder into deflation. Yeah, that is likely to happen.

An actual deflation would do some good in that it would wipe out more made-up money. The real issue, of course, is what happens to savings and actual productive investment. It doesn’t matter that much what the money supply is doing (if the government is not actively inflating it), if there is actual savings and the savings is being put to use productively, profitably. In fact, real money supply deflation is fine if savings is invested productively. In deflation, a saved dollar is becoming more valuable, i.e., can buy more as time goes on, and, therefore, saving a dollar automatically increases one’s wealth. Putting it into the hands of someone who can turn it into a profitable endeavor makes the dollar even more valuable. All of this doesn’t happen when the government is sopping up every dollar it can find to fund its deficit.

The bottom line isn’t whether we are in deflation or not. It is what the government does. Since there is no one in position to make decisions that holds principles in ethics, politics, or economics that are connected to reality, we can be certain that what they will do will not be beneficial. But that is true whether we have inflation or deflation. They are right now taking every bit of savings, and with the recent new law increasing the regulation of the financial sector, the power and flexibility of our system for funding production is further damaged.

Deflation, then, is a fake issue. It is another way in which analysts, politicians, bureaucrats, commentators, bloggers, and journalist can feel as though they are grappling with the important economic issues and evade reality.

Inflation and Economic Update, April, 2010

This week we saw big headlines touting the growth in spending by consumers on stuff. This is big news to the “mainstream” economists and drove the stock market higher. Prosperity, economic growth, they say, is beginning.

At the same time, employment has not begun to increase, new unemployment claims continue at high levels, the government keeps extending benefits for the unemployed, production has gone up a very small amount, and bank lending of all kinds has continued to decline.

Housing in an interesting sector. Last month’s housing purchases were significantly higher, much higher than expected. The increase in home purchases, of course, was trumpeted by the administration and its media cheerleaders as a great success. Ignored by them was that the tax credits for home buying that the administration had pushed through were set to expire soon, at the end of April, a few days from now. People were rushing to take advantage of the government giveaway (i.e., the government would take less of your money in taxes). April’s figures for home sales will look good, too. Just wait until after May. Reality will set in. Without artificial support, the housing market will tend back to its original course downward in terms of sales and prices. In the meantime, foreclosures are increasing.
So, why do they say that the economy is recovering?

One of the unquestioned tenants of mainstream economics is that consumer spending is a primary driver of an economy. If “consumers” are spending, then the economy will grow and wealth will increase. I put “consumers” in quotation marks because the mainstream economists disconnect the “consumer” from any kind of productive activity. A job, they reason, is merely the process by which a consumer receives his money to spend. That is why government jobs, subsidies, handouts, dole, public works, infrastructure construction, and government money projects ad nauseum are all equated with jobs in private, productive companies. It isn’t that anything is produced, it is that people have money to spend. They don’t think that government spending per se is important, just that it gets money into the hands of consumers, who are the motive power in our economy.

Ayn Rand, in “Equalitarianism and Inflation” published in the Ayn Rand Letter in June and July, 1974, offered to bring in savages from around the world to help out in the spending.

If asked, they might say that the increased demand will elicit more production. They will suggest that the increase will come from the manufacturer bringing on unused productive capacity. Bernanke, from the Fed, would say that when production has reached full capacity, we could see some prices begin to rise, but he will also, deep down, expect to see more capacity created, somehow. It is not clear to them. It isn’t real. Most important, it isn’t production that is important, but spending.

So, since consumers last month started spending more, the mainstream economists believe that the economy is recovering.

But, you ask: Where is this money coming from? What does it really mean?

I think that there are two sources for this upsurge in spending. First, it does look as if the economy is bottoming out, and people are a little relieved that the downward spiral is not continuing. That relief, plus the government and cheerleader hype, make people feel as if they do not need to keep a lid on their plans and personal spending. Things have worn out, things are out there beckoning to be bought, people miss their old lifestyle of buying, buying, buying. Off they go and spend some money. So, some of the increase in consumer spending is coming from people who had recently been paying off loans or saving, but are now putting money into the consumer market. This isn’t necessarily bad (nor good), but if these are productive people, their spending isn’t directly harmful. I don’t think that we have a means to tell if this is a large portion of the upsurge in spending.

The rest, and an important part of the upsurge in consumer spending, comes from non-productive people, and is therefore, harmful. This is money from all of the government programs, including, but not limited to: unemployment benefits, “shovel ready” programs, graft, handouts (individual or corporate), new government employees, corporate bailouts, and on and on and………. We have more dollars chasing a limited amount of goods, and prices will tend upward.

I saw a presentation by an inflation watch group that claimed some food prices had climbed over 50% recently. The price for oil is continuing upward, especially as the large developing countries actually develop for a change and new car sales continue rising there.

Boom-bust cycles are fed by credit expansion. There is no credit expansion right now. We are not going to see asset booms for a while. Someone said we have a boom in government. We do. The government is spending. To the extent that the money is made-up stuff, we have a direct feed into prices and they will rise. When the money funding the government comes from previously exported dollars (i.e., China buying Treasury Bonds), it is made-up money, and prices will rise. To the extent that the money comes from our own economy, it is savings that is being consumed rather than invested for wealth creation, and we will continue to stagnate. Neither is good. Back to the 70’s, back to stagflation. Since BO and his gang do not look at history, we could see price controls again. We could see the FBI back in corporate offices again. We will see more attacks on capitalism and more destruction of our way of life, of our freedom.

WE CANNOT IGNORE OBAMA’S ATTACK ON BANKS

For many very good reasons Objectivists and others became very active and vocal on the issue of health care. Destroying our health care industry, in this case by attacking the health care insurance industry, gives the government more power in fundamental ways and undercuts our ability to enjoy our lives, or actually stay alive. ObamaCare needed to be stopped. It needs to be reversed.
In very much the same ways, Obama’s attack on our economy will have the same effect. With an economy hindered, we will have less time and strength to fight for our freedoms, we will have more people dependent upon the government and thus reluctant to stand up to him. We will have more lawlessness. We will have a bigger fight to wage.
Central to a modern economy is the financial industry. We have seen how important a sick financial industry is and what the results can do to not just the U.S. economy, but to the world economy. At this time, Obama’s main target is the banks. He is threatening to hamstring them, shrink them and limit their size, and place even more controls on them than any sector of our economy has seen. He is encouraging the international community to do the same.

In a recent radio speech, Obama said, "Every day we don't act, the same system that led to bailouts remains in place, with the exact same loopholes and the exact same liabilities. And if we don't change what led to the crisis, we'll doom ourselves to repeat it. Opposing reform will leave taxpayers on the hook if a crisis like this ever happens again."

All of that is true, but it isn’t the loopholes and liabilities in the banks that create the problem, but the government. This story needs to be told and distributed. We need the Tea Party people to know this, we need the population to know this.

I see two parts to our problem. One, many people see the health care fight as a universal one in which everyone has a stake. They do not see the same for the attack on the bankers. This is a case where Obama is using the standard tactic of divide and conquer. Not only that, but many people who support the resistance to ObamaCare view the bankers as villains, or view regulation of banks to be a minor, separate issue that will have little effect on themselves. It is an ignorance of economics and of how business functions.

Second, Objectivists have no better understanding of economics and the importance of finance. Generally, our understanding of economics is little better than that of the man in the street, and for basically the same reasons. Further, most have not seen a reason for looking into economics. We understand the importance of knowing something about capitalism as a political system. We also understand the importance of business creativity, production, and markets. But we know little about how it all works and how the various parts will effect our daily life. We are thus vulnerable.

Expanded bank regulation, especially the attempt to shrink the banks needs to be opposed with significant effort. We need to make clear that our ability to have freedom and prosperity depends upon strong, market-driven banks. That government interference in banking is detrimental to everything we hold dear. We cannot let Obama have a unopposed path to destroying the economy.

What to do? The same things we have done already for healthcare. Plus, learn. Ask questions.

In a recent PJTV program discussing the mid-April Tea Parties, Dr. Yaron Brook said that this is the time to stand and work for freedom. This point in time is the best opportunity that he has seen. He also said that it might be our last chance, that is, if we fail now, it will be more difficult and perhaps impossible in the future. He means that in the future we will be too busy trying to stay alive and the forces opposing us would be armed and unwilling to let us speak. One vital key to our economic health and political freedom is the financial industry. We must try to save it.

PARALLELS, NASTY ONES

My perspective is economics, not that I am unaware of or concerned about the philosophic, moral, or political issues, but other people are writing about those and doing a fine job. I don’t see a reason for duplication. I don’t see much written about the economic implications and that is more where my experience and education lies, so, with that in mind, let me ask:



Do you notice the parallels between FDR and BO? Both began office after a huge dive in the economy: the stock market dove spectacularly in both cases, unemployment has soared to similar heights, there were financial crisis in both cases, both were preceded by Republicans who are regarded as somehow pro-capitalism but aren’t, both have pushed through public works bills, both pushed for overhauls of major parts of the economy, both are presenting themselves as saviors, and both are more concerned with power than any other issue. I am sure that there are more economic parallels.


Here we are into the second year of BO’s presidency, and, in spite of what the Fed and other government economists say, we are still in the recession. Unemployment is expected to remain high for years to come. Businesses and banks are unsure as to what to do because of the uncertainty as to what BO and his Congress will do to them in the near future. Further, what BO has done recently promises to weigh down the economy with massive expenses, higher federal debt, and tighter restrictions on production.


In other words, we have no good reason to think that our future will be any different now than the people in the 1930’s experienced. (It is true that BO has not started destroying food. Don’t put it past him.) To say this correctly, we are currently headed for continued recession that could last for years. Since BO, Treasury Secretary Geithner, and the Fed’s Bernanke do not know why the economy is not recovering, and would not consider freedom as an acceptable solution to the lack of recovery, we can expect more “solutions” that will sap our savings, and drive us further into recession/depression. Last time the Great Depression lasted 16 years without any questioning of the doctrine that kept us from prosperity. Even after the economy began working again, in 1946, when FDR was dead and Truman had put in his own people, no one questioned how the economy recovered without the government’s input. Today, no one is asking why the “recover” is so slow. Instead, they are doing everything possible to prevent recovery.


Further, after 70 or so years of encroachment by anti-capitalist measures, our economy has less vitality and room to maneuver than it did in the 30’s and 40’s. The government has more tools to manipulate and degrade economic performance today than it did before.


On the other hand, in some ways current businesses are more flexible and know more about their businesses than business managers in the 1930’s. Further, American businessmen have nearly a century of experience of how to work around government regulations and manipulation. That is not to say that they can bring our economy out of the recession, but they may be able to maintain their own and be modestly profitable. The large number of businesses dependent on government handouts will be a drag, as they continue to absorb savings and made-up money. It might sound as though this paragraph contradicts the previous one, but I am looking at the problem from first the restriction side and then the victim side. I don’t know which one will dominate, but both trends exist.


Frankly, what we have is uncertainty all around. But, keep in mind that uncertainty, in this circumstance, is a better condition than outright deterioration or a further dive.


In terms of your own situation, the best advice is to keep flexible. That doesn’t mean to stay in cash, including foreign cash, because cash is a guaranteed loss in a time period longer than a year. That doesn’t mean all gold, because the gold price, as we have seen over the last year, is bounced by many factors besides being a store of value. It doesn’t mean all foreign investments, because foreign economies are being buffeted by the same factors as the U.S. economy, including their own governments and central bankers. Foreign economies are also very dependent upon the U.S., so if we are failing, the likelihood of their flourishing is low.


What I think your best position includes is diversity, more so than ever, including foreign and domestic stocks, cash, foreign cash, and etf gold (least expensive way to hold it). No bonds of any kind. You do not want to be a lender in these circumstances.


Residential real estate is risky. If the situation is that your job could be in jeopardy, trying to hold on to the house could be a major problem. Buying today, even at low rates and lower prices is no guarantee that the purchase will work out for you in the next five years. If you have owned the house for some time and have equity in it, and the payments are relatively low, and you have some reserves, you are in a decent position. The biggest problem in these times is that the mortgage payment will tie you down, reduce your flexibility, and tend to present an inducement to remain in a perilous circumstance.


More than ever, you need knowledge. You need to know how these markets work. You need to know how the dollar relates to other currencies and foreign assets. You need to know how to watch your countries inflation monitors. You need to know what sources you can trust.


How long will this uncertain-stage last? It has lasted for several months so far, since the rush to dump employees slowed. We are waiting to see what effect BO’s massive new debt will have, we are waiting to see what the Fed does with all the money it created, we are waiting to see what consequences the new wave of regulations on all parts of the economy will have, we are waiting to see if BO can carry forward his massive expansion of government, and we are waiting to see if people are actually beginning to resist BO and the Dems. Combined, all of these issues are bad for even maintaining the current lull.


Prosperity is very unlikely if even a few of these economically stressful government activities come to fruition. I do not expect prosperity without at least some movement away from the future the present government and Congress have planned. Let’s say the Republicans win significantly in November. Will that mean that they will back us off of what BO will have instituted in his two years? It is unlikely. They may just decide that it is an opportunity for their brand of fascist state.


We could also see the economy begin a slow dive, not a panic, but just a decline as businesses find that they are not able to pay their debts or payrolls. This decline will not be signaled by any specific event. It could even be hid by the government’s statistical procedures. Just keep an eye out for a lack of growth, lack of non-government hiring, government talk of some segment or other of the economy failing to do their part, and the housing sector seeing more foreclosures and lower sales.


We may end up wishing we had a John Galt to unplug the minds keeping this thing alive.


Now, my focus is our economy. But as I said at the beginning of this post, I know that there is connection between the moral, political, and the economic, i.e., without freedom we cannot have a productive, prosperous economy. Without the morality of reason, of self-interest, we cannot have freedom. I am an advocate of individual rights and lazi-faire capitalism, of the virtue of selfishness.


I am talking to those whose fight is to achieve freedom. I merely want you to protect as much of your personal wealth and wiggle room as possible.

The Question of Obama

When I look at the next few years, one of the big questions that I have is the real nature of Obama. Every time he presents another of his ideas it seems more extreme than I could have expected, more cut off from the real world, more bazaar, more like we are living in Venezuela. I am serious, Obama is envious of Chavez, just as FDR was envious of Mussolini. Therefore, I want to ask a question:



Does Obama have any sense of restraint? Can he restrain himself?


I ask because I have seen no restraint in any of his actions so far. In each of his major proposals and attempts to push forward his program, he seems to go for the full effect at once.


His health care plan was nearly full socialism. And in spite of growing resistance to his health care plan, he still seeks a way, any way, to pass the thing.

In the face of an economy that is showing no real start of a recovery, he has presented a budget that will spend outrageous amounts. Actually, I don’t have an adjective that fully expresses the audacity of the “thinking” that is behind this budget.

With no sign that his previous “stimulus” packages have provided any benefit, he is demanding a big new one.

With the Supreme Court sitting immediately in front of him, he criticizes their pro-free speech ruling.

He barges into the Republican retreat and plays gangster, and then pleads with to give him all the power he wants to do things his way.

He criticizes people for wanting to have fun and offends another Dem.

He verbally attacks anyone who he thinks the public will allow him to bludgeon, like banks or major corporations.


Practically in the same day he demonizes the banks for taking on too much risk and then for not taking risks when he wants them to do so.

I am sure that the list can go on a lot longer, but you’re saying, “yes, we know”.


What is he going to do when he becomes really frustrated? What is he going to do later in the year or next year when it is clear that the economy is not going anywhere? What is he going to do when low tax revenues are making the Treasury borrow sums of money that is causing the market to choke and long-term interest rates go soaring. And then criticism becomes more severe. Is BO going to retreat? Or is he going to become more aggressive, call on his still loyal, younger supporters and demand change. Is he going to instruct his loyal people in the administration to nationalize the businesses that are not bending to his will? Is he going to …?



What is he going to do?


I don’t know. In the past we have been confident in the willingness of politicians to follow the legal procedures of office. But we have seen actions in the last two years that completely ignore property rights and there has been no real protest within the Washington establishment. It began with Bush, and BO is quite willing to follow in Bushes footsteps and beyond. I wonder if BO has any restraint. I wonder if BO is willing to accept any significant opposition to his desires.


Do you have a feel for the man? Will he accept frustration? If, as I suspect now, that in the next election he will lose the majority he has in at least one House of Congress, will accept defeat?


What do you think he will do?

Bernanke's Confirmation: No! Err... Well....Okay

Ben S. Bernanke, the Chairman of the Federal Reserve Board, is facing some opposition in winning a confirmation for his second term as Chair. As a man who is nearly universally proclaimed as the savior of the American economy from a deep depression, it seems amazing. The mainstream press has been a cheerleader and books have been written extolling his heroics. What is happening?



My own view of the man is spread throughout this blog, especially in my comments on his speech on January 2nd. He practices a science that is tailor made to not learn of causal relationships. He gives the impression of being non-political. He appears to be the ultimate academic bureaucrat.


Bernanke always appears poised and rock solid in his pronouncements and prognostications. This is his view of how a Fed Chair should be. Unfortunately, he appears rock solid regardless of the veracity or wisdom of his statements. Here are some examples: He appeared poised and rock solid when he said that there was no problem with the rise in housing prices a couple years ago. He appeared the same when he said that the problems with foreclosures would have no impact on the economy. He appeared the same when he said that Fannie Mae and Freddy Mac were in excellent financial health. He appeared the same when he and the Treasury nationalized the failing Fannie Mae and Freddy Mac a few days later. He appeared the same when he began nationalizing banks and put a couple trillion dollars into the economy. He appeared the same when he said that events that coincided with injections of money were coincidences. He appeared the same when he said that the probable cause of the foreclosure problem was the use of risky mortgages offered to substandard credit borrowers, even though he knew that the Fed had pushed with the rest of the Federal government for lowering credit standards for mortgages for years. The guy has an appearance that does not connect to the real world.


I also think that any man who accepts the chair of the Fed has to be regarded as having a questionable psychology. This is one of the most powerful, political positions in the world. Anyone willing to accept that much power over his fellow man has problems.


At this point, there is very little suggestion in the mainstream press that the Fed is responsible for the house price bubble. As I mentioned, there is nearly universal acclaim for his leadership in keeping the U.S. economy from depression. Why then is his confirmation being opposed by several Democrats?


The good news is that several democrats are criticizing Bernanke for the bailouts. The bad news is that they are criticizing the bailouts primarily because these politicians think the companies bailed out are unpopular. It is a play of the class warfare card.


It is okay, they think for the Fed to have pumped a trillion or two into the economy. It is okay for him to have wielded the power he has, along with the Treasury.


One set of criticisms of Bernanke is that he gave too much money to AIG and did not add conditions. These criticisms aren’t that Bernanke bailed out AIG, but that he didn’t do it in a certain fashion. Somehow, in his headlong dash to dole out all the money he could create, Bernanke was suppose to make sure that the money wasn’t suppose to be used for AIG’s actual business, which, in this case, was to insure certain investments tied to mortgage backed securities. If AIG failed to meet its contractual obligations, those companies would suffer sever difficulties and many would fail. What was AIG suppose to do with the money? These congressional critics are all for the use of government money as a means of manipulating the economy, confiscate assets, and generally extend the government’s reach, but they are outraged that the money was used for contracted, normal business activities. It is just another example of the attitude of the political climate that the importance of contract is ignored and denied. The worthiness of attacking a person because their actions inadvertently helped a company that can be attacked for political gain.


One criticism that I have heard only a little is that he has lied at several stages of the bail-out. He lied to BoA on the financial health of Merrill Lynch, and then when they found out the depth of the problem he threatened the Bank’s leadership and implied that he would put someone in their place who would do what he, Bernanke, wanted. The man feels as though he may do as he pleases with his power. He lied about the AIG deal and his representatives at the New York Fed told AIG to keep quite (for which the AIG officials are blamed with the suggestion that AIG instigated the deceit, when it was obviously the Fed). He has lied about the role of the Fed in the lowering of credit standards for sub-prime mortgages, implying that it was the nefarious and evil mortgage brokers, who had only their jobs and businesses to loose. The man apparently feels that any statement he makes is acceptable because he is “saving” the country from depression. He must “do all it takes”, which means forcing people to do what is not in their best interest. At best, Bernanke believes in sacrificing others for the sake of “the greater good”. Not to psychologize, but it is just as possible that he just likes the power.


I have seen that many people are happy that Bernanke may be rejected. They are joining the chorus, albeit a small one at the moment, in calling for his confirmation to fail. Bernanke should be fired, at the very least. He should not continue in a post that he doesn’t understand and mishandled so badly. I cannot deny that I too would feel good about the Senate sending him home. But. But! BUT! There is a small, okay, a big problem.


If Bernanke, the lying, self-deluded, power craving, freedom destroying, bureaucrat loses his job on Sunday. What happens? Obama gets to appoint a new Fed Chairman. Obama. Obama gets to appoint the person who is quite possibly the most powerful person in the world economy. Obama.


I am afraid. The prospect of Obama placing a person in the Fed Chair frightens me more than Bernanke does.


I have not kept track of Obama’s appointments. But from what I can tell, his people are radical, anti-freedom socialists and fascists. I am not aware of a single competent person. The guy at the Treasury is the one who forced through much of the current economic plan as head of the New York Fed. He came to the government from Goldman Sacks, and he turns out to be a pragmatist of the first order, willing to use government power to control and manipulate. He is not a capitalist. If there are people in Obama’s administration who do not want to actively expand government power, they haven’t made an impact.


So, what can we expect from an Obama appointment that could get through the Senate confirmation process? Anyone who has paid their taxes, including their nannies taxes, who will use the Fed as the means to further corrupt, undermine, and destroy what little remains of our freedom and capitalistic system. Is that better than Bernanke? Bernanke’s one little bitty redeeming piece of character is that he is an academic, as corrupt and pragmatic as that is. He is not overtly political. He is certainly not a supporter of capitalism, and he has shown no willingness to oppose any of Obama’s drive to fascism. Nor will his policies help stabilize and strengthen the economy. But, he is not going to act as Obama’s pawn or tool in the manner that Obama’s own selection would. It is a small difference, but sufficient that I am willing to argue for Bernanke’s return for another term.


If you want to argue that putting Obama’s person into the Fed will make our current situation much worse and that people will rebel against Obama and the destruction of our freedom I am willing to listen. But, I think that it is too early for us to do that. People don’t know any more about freedom and capitalism than they did three years ago. It is still too soon. I think that we can use more time in a slowly deteriorating situation to further our efforts to save our freedom and the United States of America. I want more time.

Notes on the Jobs Data

Someone noticed that the employment figure released recently by the Federal government was actually slightly less than the number they released ten years ago. I have looked for this comparison on the web, with no luck. I heard this report on PJTV, in the weekly discussion with Yaron Brook.


It is disturbing that employment is nearly the same as ten years ago. We are not talking about percentages here. It is the actual number of people employed. It means that the steady inflation that is suppose to make us prosperous didn’t work. Bernanke’s solution to all our problems hasn’t been a solution.


But two things come to mind, mine, anyway. One thought moderates the news, the other makes it worse.


The first thing that needs to be noticed is that an exactly ten-year comparison doesn’t really give you an honest read on what the figures mean. Given that we have been forced to live through two business cycles during that time, it would be a better comparison to go from peak to peak, or trough to trough. In this case the lowest employment during the earlier period of time as a basis of comparison to today. It might not look as bad. Of course, you might still argue that the growth in the population over the same period would tend to mean that the number of people employed today should still be higher today, even if this is a trough and the earlier number was mid-lower cycle. Okay, that’s true. (Note that this is the employment number, not the unemployment number, which has other problems.)


On the other hand, today’s number is bogus, and make the comparison to the earlier, ten-year old number, much worse. This is especially true if the government included in today’s figure any of the Obama, make-work “jobs”, that just soak up money.  There are more government "jobs".  There are also a lot of jobs in private enterprise that consist of doing stuff the government requires but don’t actually produce anything. These “jobs” don’t actually add anything to the economy either. All of these new jobs combined, new government jobs, Obama make-work jobs, and jobs created outside of government just to take care of government required reporting or compliance, mean that the actual number of productive jobs today are much fewer than ten years ago!


So, if you want to look at the level of prosperity-producing employment of today vs. 10 years ago, given the misleading, arbitrary choice of dates, you would have to conclude that the economy has lost a lot of jobs and that we are experiencing as prolonged decline in our living standards.


The resource that is most scarce in any economy is people. The more people you have, the more productive you can be (another point lost on the anti-immigration folks). We actually have lots of people but our government insists on forcing us to employ them in ways that tend to be less and less productive, or not employ them at all.  When will they notice that their whole thing is not working?  Do they care?  No, they don't.

Their Plans for You

Courtesy of Lisa Doby, on Facebook, where she referred to this article. 

The government has plans for you, your money, your retirement plan.  You know that Obama and his gang are looking out for you, don't you?  So everything will be okay, right? 

Seriously, keep your eyes open, and be prepared to act.

http://market-ticker.org/archives/1830-401kIRA-Screw-Job-Coming.html

Green Jobs; Obama’s Jobs Program and Inflation

This idiot program has been discussed in other places regarding its failings as a stimulas, as a provider of real jobs, as a wealth producer, and as a drag on the economy. I want to talk about it regarding its impact on inflation.

This is a direct price inflation input into the economy.

As we know from economists, inflation affects industries and people unevenly. Its first impact is where the new money enters the economy. There are at least two sectors in our economy that have been receiving made up money for decades which are major distributors of consumer level price inflation. They are very obvious: health care and higher education (the costs of which have been raising at over 7% a year for decades).

Most of the rest of the inflation has been coming in via the expansion of bank credit, i.e., exported inflation by way of the trade deficit, and asset balloons like the tech stock bubble and the residential real estate bubble.

Here we have money to be pumped directly into the consumer economy by way of unproductive jobs. The good news is that this entry point into the economy will not cause asset bubbles or significantly increase our trade deficit. The bad news is that it will feed directly into consumer prices.

A major technical hurtle in understanding how newly made money filters through our economy is understanding why prices haven’t risen more over the past twenty years. Don’t yell at me that the government CPI under measures inflation, it doesn’t matter. My standard is real, corporate profits, which is to say, their real, ongoing costs of production. If we had significant price inflation, those costs would be causing ongoing corporate profit problems because the cost of replacing materials would be higher each cycle, and you would see problems. We don’t see cost problems to speak of. The inflation is going elsewhere.

We do have other consequences of inflation: the trade deficit, or actually, the money that leaves and doesn’t come back (yet) and asset bubbles. Some suggest that our rising productivity soaks up made up money, and thus prices don’t drop as they normally would. I don’t disagree with this suggestion. I don’t think that it’s large enough to make up the difference between the actual amount of inflation and the experienced level of price inflation. I admit that I don’t have figures (if it is actually possible to have “figures”).

We do see in front of us on a daily basis the method that made up money makes it into the economy: the federal payroll and federal retirement benefits, plus social security. To the extent that the government finances itself via inflation, the federal payroll, etc., is a dispenser of money that goes directly into consumer prices. How does the federal government do that? I mean that I am on record as saying that as long as the deficit is funded by selling bonds, then there is no inflation stemming from the deficit. No body called me on that. You see, a significant portion of the annual federal deficit is funded by foreign central banks and other foreigners buying federal bonds. All of the money coming from foreign central banks is made up money. Plus, some of the federal debt is purchased by the Fed, though not much. Therefore, a lot of the federal spending each year is in made up money, which goes directly into the consumer markets, and is a source of the rise of prices and price inflation. It’s nice to figure these things out.
So, the conclusion about Obama’s grand unproductive jobs program is that he will be adding yet another source for inflating the prices we see when we go out to the market. Thank you B.O.

What is Inflation?

In a discussion of today’s U.S. economy, a serious writer must include inflation. Yes, I am going to talking about inflation. Probably, I am going to talk about it a lot. I guess that makes me a nut, right? I mean only scaremongers and right wing fanatics talk about inflation. Besides, since the early 90’s we have had almost no inflation, I mean only about 2 to 3% a year, which the Fed (the Federal Reserve Board) thinks is close to the right range.

But here is the killer, if you loaned the government $10,000 for a 10-year bond, at a 2.5% inflation rate, you would get back $7,810 of purchasing power. A loss of 22%, guaranteed! If I told you that I was going to give you an investment in which the principle would loose 22% guaranteed, would you like that? (At best, after taxes, the interest paid on the bond would bring the total to maybe $9000. You would still have a loss.)

In addition, any plan to retire ten years later would have to take into account the rate of inflation. None of that sounds as if a “low” inflation rate is a minor deal. And we are talking here about the potential of a higher rate of price inflation in the future, maybe the near future.

Well, what is inflation? That is the question. There are two competing definitions. Actually, if you look practically anywhere on the web, in “official” government materials, or at the writings of mainstream economists, you will find that inflation is defined as “a general raising of prices”. That is, the prices of just about everything in the economy are going up.

Is this definition really helpful? Does it mean something?

Well, maybe you want to know what causes inflation. (Some would argue that a definition should include causes.) This is an area of controversy. We have a difference of opinion. You will quickly find that the sides are drawn this way.

On the side of an answer that is wide ranging and offers little in the way of a means to reduce the threat of inflation. The best statement of this side that I have found so far is:
http://www.wisegeek.com/what-causes-inflation.htm. You will note that all sorts of actors in the economy can be at fault including producers, raw material suppliers, and others, many others. It just depends. I always wanted to know how one, or even a combination of these different actors could cause price inflation that went on for years. Any one of these explanations has some plausibility if you hold your frame of reference to a year or two. But how do you get commodity price increases that cause consumer prices go on from 1990 to 2007? I do not think it will work. I think that the people who use these answers do not actually look at the nuts and bolts. I think they are willing to settle for plausible. I do not like that because we are talking about people’s lives and goals here. Inflation eats away at what a person and their family are depending upon over the course of their lives, even 2%.

Really, think about this. We have all heard that the price of something is the result of supply and demand. When you think about all of the items in the economy, what you really have is that each buyer is allocating his money among the things that they have decided to buy at that time. If something costs more than it did, a person will have to make do with hoping something else will be less expensive, the amount they purchase of that item reduced, or taken off the list completely. If prices continue to go up, more stuff must be scrubbed from the list, unless more money is found. What we generally understand about supply and demand, reasonably, I think, is that the supply consists of the products we want to buy and the demand consists of what we want, our choices. More people want something and its price will tend to go up until there is more of it, and so on. In general, especially in a mostly capitalist economy, that is a good way of thinking about prices. But, in considering price inflation, we have to think more concretely.

At root, supply and demand consists of the products (goods or services) vs. the actual currency, dollars offered for the item. It is a purely mathematical/mechanical thing. At a specific time a certain amount of a product is available and a certain number of dollars is offered and the price is the dollars divided by the number of products. If in the next time period the number of dollars offered is higher per item of product, the price goes up. If the price continues to go up, the number dollars per product is continuing to go up. If this is true generally throughout the economy, then there has to be an increase of in the number of dollars overall. It can’t work any other way. If you look at the U.S. money supply over the years, you will find a constantly increasing supply of money. You will be surprised at the size of the steady increase. (This would be the dollars in the U.S. There is still more money being pumped overseas. Nor do the money supply figures include money that has been created and then invested, say in residential real estate, or in a business.)

That is the other definition of inflation: an increase in the money supply, which can and usually does, lead to an increase in consumer prices (which, for want of a better term, I call “price inflation”). Thus, we have had significant inflation for most of the last 60 years.
So the question is, where do all of those dollars come from? That will have to be the subject of another post. Sorry. The answer is long, complicated, and tedious.

Having just devoted “serious” time and space to talking about inflation, some may say, “But isn’t today’s problem the threat of deflation?” or “But they say that prices dropped this year, and probably will next year, too!”

Prices may have dropped in 2009. Government reports should not be accepted just because they are from the government. The government is not omniscient. What is always important is for you to keep an eye on the things that you and your family need and want. Did those prices go up, down, stay the same? Your personal situation is what counts for you.

More to the point here is that we can do little to change what is happening today, or even in the next several months. My concern is for 2010 and the next few years. Given that inflation is the increase in the money supply, Obama’s plans do make me concerned about what is going to happen. His spending and deficits will tend to put a lot of money into our economy. New money is inflation.

To anticipate my technical discussion of the government’s manipulation of the money supply, the U.S. money supply is increased by means of increasing bank credit, bank loans. Since the recent crisis began, banks have cut down their lending to near zero. That means that the primary money pump has not been working, and consequently, less new money (there is another way new money is introduced, but that is not as large as bank credit manipulation). I will talk about the banks and credit as time goes on.

We are also seeing import prices going up across the board. The value of the dollar has been falling. There are many dollars overseas, and the amount is continuing to increase. It takes only a slight increase in the portion of those dollars to begin coming back to lower the value of the dollar. That is happening. So the prices of imports have been rising. The dollars coming back are also competing for our domestic production, and will be a source for higher prices of our own goods. There are upward pressures on prices today. I think we will see more and more upward pressure as time goes on. Forewarned is forearmed.