Turning the World Upside Down

Some Words On Inflation

“Inflation is always and everywhere a monetary phenomenon,” said Milton Freidman. What he likely meant is that inflation is the increase in the supply of money relative to the supply and demand for goods and services that money is traded for.  Rising prices are not inflation; rather they are the effect of an inflated monetary base.

Inflation – expanding the money supply – is caused by the government.  Inflation allows the government to pay for things they couldn’t normally afford through direct taxation.  But make no bones about it…inflation is a form of taxation.

Through inflation the government covertly confiscates the savings of its citizens.  Where the United States is concerned, because dollars are a global phenomenon, when the U.S. Treasury and Federal Reserve act together to increase the money supply, they tax dollar holders the world over.

There are only two ways for the government to expand the money supply – by borrowing money from lenders or by borrowing money from the Federal Reserve.  The first way is honest, though not always desirable.  The second way is deceptive.  The first way involves an open capital market transaction.  The second way involves printing money up out of thin air.

With that in mind, let’s consider some recent actions by the U.S. Treasury and the Federal Reserve…

Monetizing Debt

In late 2008 and early 2009, Federal Reserve Chairman Ben Bernanke created $1 trillion dollars and ‘injected’ it into the banking system.  This has now come to be known as QE1.  Starting in November 2010, Bernanke began a program to buy $600 billion in government Treasuries.  This is known as QE2.

Where does the Federal Reserve get the money to buy Treasuries?

The answer, unfortunately, is so deplorable it’ll make a credit card fraudster blush.  The Federal Reserve just makes a notation in its ledger and – from nothing – magically has the money to loan to the U.S. Treasury.

This is often referred to as monetizing debt.  In short, the Treasury issues debt and the Federal Reserve buys the debt with money created from nothing.  These actions expand the money supply.  By definition they are inflation.

Over time debt monetization cheapens the existing wealth of dollar holders.  It acts as a tax…as the value of dollar assets decrease and lose spending power.  What’s more, the consequences of these actions can be highly unpredictable…

Turning the World Upside Down

For example, the Federal Reserve’s rationale for QE2 was that it would lower interest rates and encourage borrowing and spending.  They wanted to get the money flowing, increase business activity, and improve the jobs market.  Yet, since QE2 began, yields have not gone down.  In fact, they’ve done the exact opposite…they’ve gone up.

On November 3, 2010, the day Ben Bernanke announced QE2, 10-Year Treasury yields were at 2.56.  As of last Friday they were at 3.42 percent – an increase over 33 percent.  But that’s not all that has happened.  Food and energy costs have gone through the roof.

Back on November 3, 2010, oil was about $85 per barrel.  Last week oil topped $100 per barrel – up over 17 percent in less than four months.  Food has rapidly gone up too.  During the last six months the commodities food price index is up over 27 percent.

Certainly some of the oil and food price increases have to do with geopolitical unrest in the Middle East and North Africa and disappointing crop yields.  But we suspect what is resulting in oil and food price increases is the same thing also pushing up uranium, copper, gold, and silver prices – an infinite supply of digital monetary credits measured against a more finite supply of resource production.  Moreover, because global markets price food and oil in dollars, it’s turning the world upside-down…

“Global food costs jumped 25 percent last year, according to the UN’s Food and Agriculture Organization, fueling unrest in North Africa and the Middle East,” reported the San Francisco Chronicle, last Friday.  “Presidents were toppled this year in Tunisia and Egypt, and Libya is on the brink of civil war.  Concerns about protests have caused world leaders to boost purchases of staples used to make food such as rice and wheat.

“Egypt this week bought 120,000 metric tons of wheat from France and 115,000 tons from the U.S. Iraq tendered for 100,000 tons of wheat this week and Saudi Arabia may buy 275,000 tons of milling wheat, CME Group Inc. said in a report on its website.

In an effort to keep from being tossed out on his keester, “Saudi Arabia’s King Abdullah boosted spending on housing by 40 billion riyals ($10.7 billion) and earmarked more funds for education and social welfare amid popular uprisings sweeping the Arab world.  The monarch also ordered the creation of 1,200 jobs and made permanent a 15 percent cost-of-living allowance for government employees, according to a statement.

“The World Bank said this month 44 million people have been pushed into extreme poverty since June as food shortages lifted the UN food-price gauge.”

As you can see the consequences of inflating the money supply are highly complex and entirely unpredictable.  Bernanke did his magic and food prices increased…soon hungry stomachs in North Africa took to the streets.  Then, wouldn’t you know it, oil prices spiked on fears of supply disruptions in the Middle East.

Here, again, government meddlers have made a mess of things. Here, again, they’ll fix it with more of the same.


MN Gordon
for Economic Prism

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