And why the Fed needs an inflation target.
The official policy of the Federal Reserve (owned by banks, enabled by Congress) is for the cash in your savings account to lose half its value every 36 years. That’s what a 2% inflation target does. Sometimes (like now), inflation runs away from that target, and prices rise even faster.
Their argument for inflation-targeting goes like this-
When consumers expect prices to drop through price deflation, they delay purchases, leading to a decline in demand. This results in reduced production, higher unemployment, and a negative economic spiral. By creating inflation, central banks seek to prevent this behavior.
All good lies (like this) are half true, thus harder to disprove.
There are two kinds of deflation, and both are not created equal. Price deflation is a good thing. Who wouldn’t want the cost of living to come down?
In a capitalist economy, as entrepreneurs compete to sell products, they are incentivized to bring down their cost of production to offer goods and services at the best prices. Otherwise, they can’t gain market share and will inevitably go bankrupt.
They invest time, money and resources into systems, processes, and technology to deliver productivity gains through machines, computer software, and automation, all to bring down prices. Those who bring down prices most – creating more value for consumers – win and become successful.
Of course, once they master logistics and machines, becoming dominant, they often behave differently. Companies like Amazon now advocate for higher minimum wage, to virtue-signal and pretend to care while trying to put small businesses who rely more on humans at a disadvantage. (Just because they got ahead through capitalism, doesn’t mean they wouldn’t love to capture government to stay ahead).
Back to the miracle of capitalism, creating more prosperity and opportunity for all, distributed according to the relative value each of us create for others. It is, truly, a miracle.
Price deflation is a feature, not a bug. It’s good!
But doesn’t this delay purchases, resulting in reduced consumption? Quite the opposite, really. We see price deflation most where government is least, in technology products. We buy new phones, TVs, gadgets, and gizmos all the time despite their costs coming down. It’s a strawman argument.
So, capitalism unfettered results in price deflation, and that’s good. Why then does the Federal Reserve want prices to rise by 2% per year (and more, when you measure fairly).
The real problem is the money system, redesigned in 1971 to remove gold backing. Money is no longer gold, but money is now debt.
It is deflation they are trying to avoid, but not a reduction of consumer prices. It’s debt-deflation, loans going bad, which causes assets to crash and a cascade of bankruptcies. That’s the boogieman.
Sadly, our new (52 years old) money system has inflation (not deflation, like technology and capitalism) built into its operating system. Either that, or it collapses on itself.
It works like this-
Every dollar in existence is created as a loan. Base money is created when the Fed buys debt: treasury bonds, bills, mortgage-backed securities, or more recently, corporate debt. These debts require repayment of principal plus interest. The same is true when individual banks create money in the fractional reserve banking system. They do it as loans, for example, your mortgage (and mine).
That means we need even more dollars tomorrow (more dollars created as more loans, and more dollars the day after that, also created as loans) to service the dollars created yesterday.
If more dollars aren’t created, loans cannot be serviced. They start going bad, which causes others to go bad. If I can’t pay my mortgage, the bank cannot meet all its obligations. Every man’s debt is another man (or woman’s) asset. Your pension, 401k, and insurance products are full of debt instruments.
When they start going bad, it’s cascade of failures. That’s the boogieman they are trying to avoid. It’s a direct result of this crooked, broken, debt-based fiat money system.
When money is debt, inflation is necessary.
If it wasn’t bad enough that our system of money has two gears, inflating away your paycheck, or great-depression-style deflation, the truly ugly part is that the super wealthy are using it to run a leveraged buyout (LBO) on the American Dream (and nearly everything else you hold dearly).
An LBO is a financial transaction where an asset or business is acquired using borrowed money. In an LBO, the assets being acquired are used as collateral for loans.
The incentive for LBOs is hyper-charged by the inflationary monetary system, where borrowed money to control real assets can be inflated away, repaid in cheaper dollars.
Take Invitation Homes as an example, a $21 billion spin-off from Blackstone, the world’s largest private equity company. Invitation operates across the US, with the biggest concentration in Atlanta. Invitation bought ~90 percent of the homes for sale in some ZIP codes in the early 2010s.
While you or I would apply for an individual mortgage and present a prequalified offer for financing to a homeowner that comes with many hoops, Invitation can borrow a billion dollars at an interest rate less than half of our mortgage, then present sellers with an all-cash offering. This means they can pay a higher price, with lower debt-servicing costs (and then rent it back to us to pay off their note).
It’s the same story with private equity and many local businesses. New money is created with preferred rates to funds on Wall Street and in Greenwich, CT. They borrow and buy, rolling up mom-and-pop HVAC companies, physician practices, accounting offices, restaurant franchises, and inflate away the debt.
Wash, rinse, and repeat.
Of course, there’s no reason to be bitter. It’s the system we’ve got (since leaving the gold standard in 1971). Learn it and use it. Make sure your kids don’t wait until their 40s to figure it out. America would be better off on a gold or Bitcoin standard, sure. Vote for people who understand that, but there’s money to be made in the meantime.
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