“Inflation can tax the rich and the poor.” Dr. Thomas Sowell, Basic Economics 4th Edition.
Hello Everyone, Happy Tuesday.
Told you, we will be making up for lost time. Glad to have everyone along for the ride. I hope everyone is having a lovely Tuesday so far. That being said, we have an important topic to discuss today. One, I believe, which may alter the future for many years to follow. Though, that is just one man’s opinion. However, as always, I will present the fact, other arguments, and lay out my counterarguments.
Before we start, I leave you with this, “[a] few lines of reasoning can change the way we see the world.” Steven E. Landsburg.
Chairman of the Federal Reserve Jerome Powell will be leading our private central bank into unchartered monetary policy horizons with the Fed’s Federal Open Market Committee (FOMC) Monetary Policy Strategy Report (the “Report”). Shockingly, the Federal Reserve Bank of New York’s FOMC’s Report was unanimously approved by the twelve Governors of the twelve Federal Reserve Banks.
Hot damn. That is a whole lotta Fed.
Uncharted Horizons. Unanimously Approved.
Unacceptably Promoted. Or ignorantly promoted, I am not exactly sure, yet.
Our topic of discussion for the day is the, improper, public discussion of economic policies and the messages promoted to the people of the United States. Then, what the science says should be a proper message to, you know, We the People. Americans.
Especially since these messages are from those who are in power and control of every single economic fate of all Americans. No. That is not an exaggeration. Twelve unelected private citizens control the entire money supply of the United States. Marinate on that.
Importantly and to recap, economic freedom is a prerequisite to individual freedom. Economic freedom from the government, that is. Debt can be a good thing, if the leverage is used properly. As always, with great power comes great responsibility. Not just a cliché; it is the Truth. And the truth will set you free.
Okay. That maybe is too much cheesiness. Back to the facts.
As reported by The Wall Street Journal earlier last week, the Federal Reserve approved a seismic shift regarding how the Fed will set interest rates, especially the Federal Reserve Effective Funds Rate and the Discount Rate. These are the rates, respectively, the Fed lends to its Primary Dealers and the Fed allows banks to lend to each other. Just in case those banks are not able to meet their daily obligations, for some reason. These are the interest rates we all hear about in the news, yet never receive ourselves. Odd.
The Fed’s shift in monetary policy is monumental because it creates a low cost of capital which then creates an incentive for individuals and businesses to take unusual risks with borrowed money. When the cost of capital is low, more capital is sought. As with any other efficient, effective, and cheap input in economic production, when the cost of that input is low, and the output per unit of input increases productivity and profit, or so is believed, more of the input is sought. Who doesn’t love cheap money?
Money, i.e. capital, is an input. Borrowed money spent for productive purposes is a leveraged investment. Borrowed money spent for nonproductive purposes is just debt.
The comparison is easy. If you believed something made you better and it was cheap, you would seek more of it. However, everything is good in moderation, especially cheap borrowed money.
As previously stated here in this column, economics is the science which studies the cause and effect relationships regarding the allocation of scarce resources which have alternative uses.
One of the world’s greatest, and most underappreciated, economists, once used as an analogy: The Garden of Eden was not an economy. If there was enough of everything to go around for everyone, why would we need a price system? There’s a reason that we all cannot own beach front property or ski lodges. Land is a scarce resource.
The free market price system allocates these resources to who can afford it, or at least is taking the risks. Government and Federal Reserve intervention in the market causes distortions in our domestic capital flows of our free market which leads to low growth and stagnation, reference: The Great Recession.
What does a low cost of capital mean? Capital is the means with which wealth is created in the form of “money” or other assets owned by an entity or individual. Does a credit card make you wealthier? Sure, if you use it for revenue generating purposes. Other than that… someone is getting paid the interest.
What is a low cost of capital? This is the price at which money can be bought, i.e. interest rates. Seven percent interest, annualized, on a one-hundred-dollar loan, with no other benefit, would yield $107 at the end of the loan’s maturity, i.e. life span.
Not bad. The S&P 500’s real-rate-of-return (inflation adjusted) as a 20 year annualized average for the year ending June 30, 2019 is 5.90%.
Unfortunately for the previously mentioned $100 debt security, unless bought at a heavy discount to its par value (face value), then the loan would actually yield someone a loss of $3 at the end, accounting for the Consumer Price Index (CPI) for Urban Consumers. This is the measure of cost-push inflation on a basket of goods and services that, you guessed it, urban consumers use in their daily lives. Food, gas, healthcare, etc. This index is pegged to 100. 100 equals an inflation rate of 4.24%. When the index moves past 100, the index ratio changes and the percent of inflation in the economy increases.
Right now, as it stands for the period ending July 2020, the Consumer Price Index, which measures Cost Push Inflation, is at 259. Remember how politicians are not that good at hiding the ball?
Cost push inflation is bad. I do not care what the so-called experts state. “Too much or too little inflation is bad for the economy.” The first part of that statement is correct. The second part, not so much. Inflation, by definition, is the general rise in the price level of the economy. Technological advances, such as our Information Technology boom of the 21st century, should lead to lower costs of production by making processes more efficient, effective, and optimal. When the costs of production become lower, the final price of the output should fall.
There is another type of inflation as well, demand push inflation. That is, typically, a good thing. That means whatever product, commodity, input, resource, or output is in high demand which is outpacing supply. Typically, when this occurs, new entrants will enter the market, thus increasing competition. And again, should lead to the final product or service costing less.
One of the arguments I have been seeing in the media is that “too little” inflation is detrimental to the economy because “consumers wait for prices to fall further before buying.” This then “leads to lower consumer spending” and thus “does not stimulate the economy.”
That is utter nonsense. Cost push inflation is generally caused by an increase in the money supply which is unjustified in terms of growth by a nation’s Gross Domestic Product. Money is a commodity, too, ever since the suspension of the dollar’s convertibility into gold. It has no inherent worth because it is not backed by anything, except the “full faith and credit” of the US Economy and Federal Government. The money in your pocket and in your bank is only worth something because it is backed by the laws of the United States as our legal tender and thankfully, our powerful economy makes the US Dollar an attractive investment for foreign direct investment.
When inflation is low, i.e. the general price level in the economy is rising slowly, that is a good thing. That means prices are not rising out of control, sort of like the stock market in Zimbabwe or the Communist Party of China’s ripped-off version of our NASDAQ.
Assuming, for the argument, the price of goods and services are low and rising slowly, people will then purchase more of those goods and services because their real purchasing power is higher in comparison. That is, the dollar is worth more. Inflation erodes the value of the dollar. Why, then, are low levels of inflation a bad thing?
Moreover, when the price level in a normal economy is low, demand for valuable goods and services rise in relation to the inherent trade offs between supply and demand.
When supply matches demand, there is no price change. When supply outpaces demand, producers and businesses must drop prices for their products to sell them. When demand outpaces supply, the costs of goods and services rise until more entrants, competition, or technological advances allow for more ability to produce. The increased production will bring supply to match demand, thus lowering the price of the product, increase quality and options, and bring the market price towards an equilibrium.
Thus, since money is a commodity, like oil, wheat, or corn, the more “money” there is in the world, the worth and value of money already in the world becomes less. More money enters the world when those printers get to printing over at the Fed. Because the legal tender we use to purchase goods and services becomes worth less when more of it is printed, businesses adjust and raise their prices accordingly. It is called the time value of money, a dollar today is worth more than a dollar tomorrow. Though, it does not have to be this way. Denationalization of the Money Supply— F. A. Hayek.
Because a dollar tomorrow is worth less than a dollar right now, resources become more expensive, i.e. inputs, which then leads to the final product becoming more expensive because it took more dollars to create than the last time.
It really is a thing. The Federal Reserve could make us all millionaires or billionaires. Just have to turn those printers on over drive. Or just hit a button in their computer system and “create” $10 trillion in credit. Oh wait, we did that.
But if we are all millionaires or billionaires, on paper, what so special about the status? Nothing. Just ask the Germans and their problems during the final years of the Weimar Republic. In 1914, the dollar was worth 4.2 German Marks. Then the geniuses over there at the German Central Bank decided to print trillion-dollar notes, and well, we all know what happened next. In 1923, the dollar was worth 4.2 trillion German Marks. And German domestic civil unrest lead to global unrest. Sounds familiar.
So, what does this all mean? With a low cost of capital, it incentives unusual risk taking and an inefficient allocation of a resource that, is scarce, until it’s not. Quantitative easing, too, is another fancy political hide-the-ball jargon. It just means the Federal Reserve Bank is New York “printing money” to buy financial assets from… Wall Street. Principles on How to Manage Big Debt Crises, Part One— Ray Dalio.
With the Federal Reserve, again, committing to what is, in real terms, a negative interest rate and on certain treasuries an actual negative interest rate, it incentivizes banks and individuals to make loans and increase the amount of money in supply.
Here is the example I typically use to express the bad that is Cost Push Inflation. I first actually realized the effects of inflation when I noticed my favorite order from In-n-Out started becoming more expensive in high-school. I did not know it then, as I do now. And yes, I sometimes think with my stomach, apparently.
If my Double-Double with a whole grilled onion, meat, cheese, spread and ketchup only, price rises over time, yet the product stays exactly the same, it became more expensive because the inputs to create the final product did not fundamentally change. The money used to purchase it, however, did. If the burger goes from $5.00 to $5.75 within one year, the cost push inflation of the burger was 15%. Now, take this, and apply it to everything else in your life that you purchase on a daily basis. In 2013, the price of a Double Double was $3.20. In 1970 an in-n-out double double was $.29, and you got a Pepsi with it. Since 1970, assuming the pepsi was $.04 and the burger $.25, it has seen an increase, in fifty years, in price by a magnitude of 12.8.
That is, the burger, in 50 years, became 1,280% more expensive. I would love those kinds of gains in my portfolio right about now. Also, I thought inflation was, on average, 2% a year? (It is, the percent increase in the percentage of inflation is 2% a year. That is a whole lot different than a 2% inflation. Food for thought.)
Within one year, assuming 15% cost-push inflation, your $100 sitting in your wallet became, in real purchasing power, $85. That means on Jan 1, 2020, what your $100 was able to get you, means at 12/31/2020 you can only purchase $85 worth of goods and services. One year. You still have the same $100 bill—with just a 15% loss in real purchasing power. The S&P only returns 5.9%, inflation adjusted, as its average gain the last twenty years. Odd. In the last twenty years, our federal debt has grown exponentially and since 2008, our Total Debt-to-GDP has gone from around 100% to 330%. Since the Great Recession, the Consumer Price Index has gone from around 100 to 259, or an increase of around 150%.
That’s a whole lotta debt. Thanks Fed. Maybe we should make money more expensive in the short run so that in the long run we have a more stable CPI price level. Also, making money more expensive would make people think twice about the investments and risks they want to make. Sometimes making people think a little bit before taking unusual risks; that is a good thing.