Monday, October 4, 2010

Economics: Inflation

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Magic tricks! Have you ever seen a magician perform? You pick a card, shuffle the deck, he closes his eyes and spins around three times yet somehow still is able to pick your card out of the deck. We all know there was no magic, but there was sleight of hand going on, we missed something...

Inflation is commonly thought of as the rise in price of consumer goods as judged by the Consumer Price Index (CPI), this is the sleight of hand at work, because we're led to believe there's no way to prevent this natural phenomenon. Wrong. In fact, inflation is actually the increase in the money supply, so the rise in prices are only the effects of inflation. If my friend had the only 10 dollars in existence, they'd own 100% of the money, but if I suddenly created 990 dollars then theirs would suddenly be worth 1% of what it used to be worth. I just drank their milkshake.

Inflation is the insidious thing that allows governments to fund their ridiculous promises and expand their operations & wars (there's many kinds of "war", Iraq is one kind, "War on drugs", "War on poverty", etc). Rather than directly tax people for all of these programs, the government turns to the central bank (for the United States it's called The Federal Reserve) to print up money which it uses to buy bonds from the US Treasury. Inflation has just occurred.

Another word for inflation, one the government hates to use or see, is debase. Debasing the currency is a far more accurate description. Since money is merely a facilitator of trade, you cannot create wealth by simply creating more money, instead what happens is everyone's worth goes down and only the creators of the new money win.

One of the tricky parts of inflation is that it doesn't show up immediately, and it doesn't show up everywhere. If you want to spot it all you have to do is look to where the government spends it. For example, health care. The government pours in billions of dollars into this single sector, and rather than make it more affordable all it does is make our dollar less valuable in that sector.

So, it's not that prices are rising, it's that your money is just worth less. If only that was where it ended. Now imagine there's a trillion dollars floating around society right now, all the prices are adjusted based on that (it's more complicated as far as proving this out, but that's what it boils down to), now imagine I create another trillion for myself. While it's sitting in my possession all the prices stay the same, because that money is not in the market yet, which means I get to buy everything at the old price.

Discount! Great deal for me!

It gets far, far worse. I don't, of course, spend all that money in the same place, rather spend it in 5 places. Well, they'll essentially get a discount too, when they use that money. Now, those business don't immediately give their employees a raise, right? Instead, there's a slow trickle down to the lower income people, but by the time it's traded the hands of all these banks, businesses and government purchases, inflation has already set in and the lower income people have been paying the higher pricing before ever seeing an increase in their wages. They've just been robbed without a gun, and without notification.

The Fed creates a ton of money, they and the government pick who it is spent on, those are the real "winners", and everyone else loses, all of the time. Until the money isn't worth anything at all...

You have to understand that the Federal Reserve wants to keep prices inflated, so in order to do so they must create new money. Inflation favors the debtor. If I owe you $200 Million, and can create it out of thin air then I can pay my debts back cheaply, rather than work and be productive to earn that money. It hurts the debt holder of course, but that's beside the point I'm sure. So, who can we think of that holds a lot of debt? Right, the US Government has over $13 Trillion, so inflation helps them keep up the gamble, until everyone catches on that their debts are being repaid with devalued currency and they stop buying our US bonds. Uh oh.

With the Bush and Obama bailouts we already see the creation of a couple trillion in new money/inflation, but that doesn't even include the $2 Trillion the Federal Reserve created (without approval from anyone), and they're planning on another round of "quantitative easing" aka QE2, aka INFLATION, so what happens if/when that money eventually hits the market place? Hyperinflation. That's next.
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A View of Economics
Week 1: The Coming Disaster
Week 2: What is currency?
Week 3: Inflation
Week 4: Hyperinflation
Week 5: Deflation
Week 6: Money Represents Production
Week 7: Bubbles pt 1 - Housing Bubble
Week 8: Bubbles pt 2 - Pure Credit Expansion
Week 9: Bubbles pt 3 - The Bust is a Good Thing
Week 10: Productive vs Destructive

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