INflation
increase in prices
fall in the purchasing value
In our studies so far, we have made some introductory mention of one of the most aggressive enemies of increase — inflation. As the prophet Haggai described it, inflation is like putting all our hard earned money in bags full of holes. (verse 1:6) Let’s go back to the story of the collapse of the German monetary system to refresh our perspective on the power of inflation. By late 1923, it took forty-two billion German marks to buy just one US cent and seven hundred twenty-six billion marks to buy something that had cost just one mark four years before. Of course, this is an extreme case, but it can serve as a stunning canvas upon which to paint the portrait of inflation. The process of inflation is essentially the devaluation of the currency as we have seen in the illustration from Germany and several other historical examples already and with the current practice of printing more currency without the financial backing of gold or silver reserves.
History has proven that as long as countries are on the gold standard, there is no inflation. In the case of our own country, we enjoyed zero inflation for the first century and a half of our existence because we held to a solid banking system backed by precious metals. All that changed when the Federal Reserve Board was created and national income tax was instituted in 1913. In the single century since these watershed events in our nation’s economic history, the dollar has been devalued by ninety-eight percent — meaning that what cost two pennies in 1913 costs a full dollar today. And the inflation continues. Do you remember what you paid when you filled up your gas tank yesterday? Well, on President Obama’s inauguration day, you paid a dollar and seventy-nine cents per gallon. While helping my dad look through some of his important papers, I ran across the life insurance policy that my grandfather had taken out on him when he was born. It had a face value of one hundred twenty-five dollars — no, I didn’t leave out the word “thousand.” That’s the total value of his policy — one hundred twenty-five dollars — but this amount was significant enough back then that it was deemed worthy of writing the policy. With inflation, everything gets more valuable except currency. In the example of this insurance policy, the burial services that would have cost a hundred and twenty-five dollars in 1920 would cost several thousand dollars now. That’s good for the mortuary, but bad for the person who is going to have to pay for the services with dollars from the policy that didn’t inflate over the years.
In reality, the effects at the beginning of inflation are all good. Everyone benefits, and no one pays. This is exactly what happened during the early days of the scenario in Germany. Factories were humming, and unemployment almost vanished. Food and beer were abundant, and incomes for a time rose faster than prices. Printing of new money delays economic collapse because it pumps needed currency into the system to help it generate momentum; however, the sheer principle of supply and demand makes each dollar worth less than the previous one. Because there are more dollars in circulation, the consumers are able and willing to pay more for the goods and services they want to purchase. As prices go up, the actual value of the currency goes down in relationship to what could have been purchased with dollars when there was only a limited supply of them. Inflation causes prices to rise, which causes asset values to fall. Nominal prices may go up, but inflation-adjusted prices drop, meaning that wealth has disappeared — setting the stage for what can be a catastrophic collapse. The individuals who suffer in such a scenario are those who have to spend dollars that they obtained at pre-inflation values — my dad’s insurance policy money for example. Back in 1920, my grandfather was still experiencing the euphoria of the early days of inflation; World War I was ending, the Roaring Twenties were just getting into swing, and the one-hundred-twenty-five-dollar insurance policy he purchased didn’t make a dent in his disposable income yet was still sufficient to cover his expenses had his son died in 1920. However, when my father actually died in 2009, the payout on the policy didn’t even pay for the flowers that we placed on top of his casket. The same thing happens to people who have money in the bank that is accumulating only a small interest rate while inflation is growing at a much higher rate and people who are on fixed incomes that don’t adjust as their expenses increase. For example, the federal government recently denied Social Security recipients a cost of living increase because they calculated that we were only experiencing a one percent inflation rate. They derived at this percentage calculation by ignoring food, gas, and energy costs in the core inflation index. If these expenses — which actually make up the majority of the living expenses of all for us, and especially retirees — were included, the inflationary rate would have come closer to seven percent. The result is that these senior citizens who earned money several decades ago and stashed it away in their bank accounts are suffering a serious double punch as inflation is robbing them of the value of their savings and the government is robbing them of their Social Security benefits.
To be totally honest about inflation, we have to realize that more money — in and of itself — does not cause inflation; it is the velocity in which that money reaches the marketplace. If the government issued an extra billion dollars but the American public took those dollars and squirreled them away in their savings accounts, these new dollars would have no effect on the prices of goods and services and, therefore, no inflationary effect. Thus, we need to consider another “in” factor: INertia (inactive, status quo, stationary, doing nothing). Perhaps it is only a coincidence, but it is interesting that we use the term “currency” to speak of the cash we use in our daily transactions; yet, when we speak of our savings, we use the term “money in the bank” — never “currency in the bank.” “Currency” comes from the word “current,” meaning “in motion.” In essence, currency has value only when it is in motion because it transfers value from one asset to another. On the other hand, money has value in and of itself; therefore, our resources in the bank are money rather than currency. Money only has impact on an economy when both of its fundamental attributes — quantity and velocity, the speed at which it passes from hand to hand in transactions — are in effect. With this basic concept in mind, it is easy to understand why the Federal Reserve Board actively pursues two different strategies in trying to fulfill its job of providing our nation with an “elastic currency” — controlling the production of currency and manipulating the INterest (compensation for delaying the repayment of a debt, money paid regularly at a particular rate for the use of money lent) rate. If all they did was print new money, they may or may not be able to control the national economy because it would be impossible to predict how much of that new currency would actually be released into the economy as opposed to how much would disappear into bank vaults. However, if they also manage the interest rate, they are able to also ensure that the currency they are printing will find its way directly into the marketplace. By keeping interest rates near zero, they are able to discourage people from keeping cash in savings accounts as opposed to being actively exchanged in the marketplace for actual goods and services or in investment stocks that boost manufacturing and business and create jobs. Such momentum is definitely good in overcoming inertia and boosting the economy; however, it also produces the byproduct or side effect of inflation. On the other hand, if currency were to be pulled out of flow in the marketplace and stock market, jobs would be lost due to the decreased demands for the goods and services that require the workers. The result would be downsizing or closures of businesses due to lack of funding through the income produced from the companies’ stocks. Of course, job losses create even more job losses because of curtailed spending by the ones out of work — a snowball effect. So, the powers that control our economy are trapped between the proverbial “rock and hard place” where they are “damned if the do and damned if they don’t.” If they slow the velocity of our currency by either producing less currency or by allowing interest rates to increase, they set the ball rolling to eliminate jobs and stalemate our economy. When interest rates go up, there is less borrowing, and therefore less building and business expansion, meaning fewer jobs and therefore less purchasing power. The economy slows and shrinks. If they continue to keep the economy moving, they simply produce more and more inflation that will eventually wipe out the total foundation of our monetary system.
The present policy of keeping interest rates so low has actually been interpreted as a punishment against those who would want to save. The result has been that presently three fifths of Americans in the work force have neither an IRA nor a 401(k). Only about half of American families have enough savings to cover monthly expenses for more than two months if the breadwinner were to lose his job. Thirty percent of Americans have less than a thousand dollars saved for retirement, just a little over half have less than twenty-five thousand dollars saved, and only about a quarter of those who earn more than a hundred thousand dollars per year have twenty-five thousand or more in their retirement funds. We’ve left the moorings of Benjamin Franklin’s advice that a penny saved is a penny earned — but more importantly we’ve abandoned the scriptural wisdom:
Go to the ant, thou sluggard; consider her ways, and be wise: Which having no guide, overseer, or ruler, Provideth her meat in the summer, and gathereth her food in the harvest. (Proverbs 6:6-8)
As we have already noted, two significant events took place in the same year of 1913 — the creation of the Federal Reserve Board and the institution of the national income tax. In actuality, there is a significant connection between the two changes in our national monetary system. Governments create money (with the side effect of causing inflation) so as to not raise taxes or cut spending. If the government spends more than it takes in, there are four options available — raise taxes, borrow money, create more currency, or curtail its expenses. Cutting expenses is not a generally acceptable approach because it means job losses. Job losses mean two things — one significant to the person in office and one significant to the nation as a whole. On the personal level, lost jobs mean lost votes at the next election — and, therefore, the possible loss of a job by the person who authorized the expense cut. On a national level, each lost job puts the overall economy one step closer to the snowball we just discussed. Borrowing money is far more expensive than cutting expenses or raising taxes, but it is far more acceptable because no one looses a job or has to give up some of his cash. Creating more fiat currency simply postpones the inevitable by creating a growing economy riding on the back of inflation that will eventually implode. Unfortunately, our government has chosen the two most harmful of the four possible options: borrowing money and creating more currency.
To better understand this macroeconomics principle, let’s bring it down to the microeconomics level of our own personal spending. If you max out your credit card with a one-thousand-dollar limit, you have a couple options — stop spending or ask for an increase on your spending limit. If you choose to increase your spending limit, everything will seem fine at the moment because you can still enjoy charging meals at restaurants, buying toys, and having fun. Unfortunately, your eventual pay out is going to be much higher than the original price you paid when you bought the meal or toy. If you increase the limit to three thousand dollars and max it out again, it will take you the next twenty-two years to pay off the balance at minimum payments each month, and it will cost you approximately twice the original amount. If you continue to charge and not pay, you will eventually find yourself in a court battle with all your toys being repossessed along with your essential assets such as your home and car. Additionally, your credit rating will be so severely damaged that you’ll not be able to do any profitable business in the future. Our national economy is currently at the giddy stage of just having the new influx of cash that our imaginary character experienced when he had his credit limit bumped up. When a nation’s money is losing value through inflation, there is a constant psychological pressure to spend rather than to save. This is the economic prod to stimulate spending. This can prompt more spending on marginal and frivolous purchases. Economists call this the “paradox of thrift.” The line blurs between spending and squandering. However, the inevitable day of reckoning — when we have to settle up the account for all this squandering — will eventually come. And when it does, we’ll all suffer.
Unfortunately, the powers that control our economy seem to be mesmerized by the philosophy expressed by former Federal Reserve Board Chairman Ben Bernanke, “Under a paper-money system, a determined government can always generate higher spending and hence positive inflation,” — seemingly ignoring the fact that we will eventually have to pay dearly for the inflation. Yes, there is a short-term advantage of inflation in that we can pay back our loans with less valuable money, but the Fed’s medicine of printing money will become poison through inflation. President Ronald Reagan warned us, “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” Novelist Sylvia Townsend Warner, expressed her evaluation of a government that permitted inflation, “Inflation is the senility of democracies.” Even economist John Maynard Keynes whose economic theories are the foundation of most of America’s current policies called inflation, “Everyone’s illusion of wealth.”
During “The Great Debasement” period of 1542-1551 in England, when the coinage went from seventy-five percent silver to fifty percent, then thirty-three percent, and finally to twenty-five percent, Queen Elizabeth’s economic advisor Thomas Gresham formulated Gresham’s Law: Bad money drives out good. In essence, he observed that the people were hoarding the money with the higher silver content while spending the coins with the reduced levels of the precious metal. The ultimate expression of this reality is that inflation thrives on devalued currency. To quote Thomas Jefferson, “Paper is poverty…It is only the ghost of money and not money itself,” and Queen Elizabeth I, “Brass shines as fair to the ignorant as gold to a goldsmith” — because in the end, inflation will take its toll and we all pay the piper. Today’s dollar has two percent of the purchasing power of the dollar prior to the establishment of the Federal Reserve Board in 1913. Interestingly, our society has moved to an even more phantom monetary system through credit cards and electronic transactions that doesn’t even have the paper substance of Jefferson’s ghost money. Today, only seven percent of transactions are done using old-fashioned tangible, physical currency, and some banks in Sweden keep no cash on hand and accept none for deposit.