There are known knowns; there are things we know that we know

There are known unknowns; there are things that we now know we don’t know

But there are also unknown unknowns; there are things we do not know we don’t know
— The original source of this koan may be ‘Landmark Education of Seattle’, Washington; although generally it is attributed to former US Defense Secretary, Donald Rumsfeld

The significance of the above quotes is that nobody can define precisely what inflation and deflation, and all the variations in between really are, what their causes might be and how we might compensate for their ravages. There are so many economists who promote their theories to fit specific examples in a world of supply and demand where prices are constantly on the move, in a complex web of multiple markets, including interference from financial institutions which add bias to the natural course of market events. Oil prices, for example, which affect us deeply, are influenced greatly by speculators and financial market actors that distort true supply and demand beyond any rational measure.

There are three kinds of lies: lies, damned lies, and statistics
— Mark Twain

We all experience the direct effects of inflation in the movement of consumer prices together with (hopefully) a steady increase in earnings but which have been far and few between these last few years. The fact is that wages have stagnated yet we are expected to pay increased prices in just about all we consume, especially fuel, electricity and taxes; not forgetting a rise in VAT and local taxes all of which remain hidden and lost in daily trumpets of the mainstream press, TV and internet articles. Most of us rely on our money savings to build some kind of increase in net worth and provide for emergencies and the future. Regrettably inflation erodes the purchasing power of our savings at a steady and debilitating rate and is the reverse of what Albert Einstein quoted when he recognised the value of compounding interest or dividend income: “Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pays it.” The human brain has a problem when confronted with mathematics and more so when statistics are concerned; the computed math result rarely matches our intrinsic ability to rationalize our intuitive answer.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value
— Alan Greenspan (before he became a Sith Lord). Do note that a 'Gold Standard' is not necessary as it too can be manipulated. Instead, check out what's called 'Freegold'

 

Here’s a little test to prove the point;

There are 26 people, chosen at random, in a room. You are required to assess the chances of two of them having the same birthday (exclude the year); thus, 26th September, 1st April, 13th June etc. You can choose between four options: Are the chances of two people sharing the same birthday; high, average, low or very low? The answer is found a little lower down the page. If you get this right, without calculating it, you are likely to be within the ten percent of people who have some degree of an intuitively mathematical brain and perhaps you should consider a career in investment banking or economics!

This inflation is inversely related to monetary inflation. 

This inflation is inversely related to monetary inflation. 

Inflation and its opposite, deflation, is the result of the interaction of market forces confused by the application of fiat (paper) currencies. In a normal, free market we have already seen that prices go up naturally if demand increases and supply remains the same. Likewise if supply falls but demand remains the same, which is described as a shortage or scarcity, again prices tend to increase. We would recognize this as ‘inflation’ because it feels like it; prices are increasing but the reality is more complicated when experiencing inflation in a complex, interconnected financial system. It is not easy to define the causes of inflation as so many factors have an influence on prices over and above normal demand and supply and which has been the subject of continuous discussion in economic circles for many years. We know that much has to do with peoples’ perception of what is likely to happen to prices in the future and this is where the answer to our earlier question becomes relevant because perceptions are often misleading.

The answer to the probability of two persons, out of 26, sharing the same birthday is extremely high, in fact, it is almost a certainty. You can prove this by doing an experiment: take one person and compare their birthday with the remaining 25 people. Then, putting aside the first person, you take the next person and compare their date with the remaining 24 and so on. In mathematics this would be expressed as: 1+2+3+4……. + 26 or what is known as a divergent series and the formula; x = (26 x 26) + 26 all divided by 2, results in the answer 351 which is very close to the 365 days in the year. Probability theory suggests that there is almost a 96% chance of two people sharing the same birthday! This is of course counter-intuitive to most people’s thinking and demonstrates how we can be confused and fooled by the manipulations of mathematicians and statisticians. Governments know this and make full use of it by compiling and manipulating statistics to support their policy aims and objectives leaving the populace none the wiser.


Government statistics are compiled and published in the US by the Bureau of Labor Statistics (BLS), and in the UK by the Office of National Statistics (ONS) which employs government actuaries, a rare breed of mathematicians and statisticians, whose main task is to not only work on current national accounts but more importantly to prepare forecasts for politicians to assess the impact of their future policies.

These examples of the inability of our best and brightest to forecast future trends highlight the implausibility of statistics in general and no more so than those involving inflation. The consensus view of economists is that a long sustained period of inflation is caused by the money supply growing faster than the rate of economic growth. The money supply is controlled by central banks and by the setting of interest rates; however, printing too much money can cause inflation. This is admittedly a simplified way of looking at a complex subject however the contra argument points to the lack of significant inflation in the period 2009-13 during a time of excessive money printing. Some argue that the world is in a period of deflation following the crisis of 2008 and that all the excess money supply has not yet reached the main economy but has been ‘stuck’ in the banking system. It is true that nobody is quite sure what is actually happening except that ShopSquawk knows, as many others do, that we’re experiencing inflation in prices from nest supplies, electricity costs, and food prices (especially worms) cleverly disguised by reduced pack sizes and weights. There is no doubt that the standard government measure of inflation, the Consumer Price Index (CPI), in no way reflects the reality experienced by the general public each and every day.

Hey UK students! A good example of the fallacy of these forecasts involves state pension calculations after the Second World War when actuaries calculated the average life expectancy of a male in Britain to be 64 years. The pension age for a male therefore was set at 65 years on the basis that, on average, the state would not need to pay out much in pensions but would be collecting contributions from day one and ‘selling’ the public on the promise that these contributions were going to pay current old age pensioners; in actual fact it was projected that little would need to be paid! As time passed it became clear that men were living longer and now the average life expectancy is 77 years for a male in Britain which has thrown into disorder all the actuaries’ calculations; the government now has a serious problem with pension projections and has already started to increase the pension age.


Deflation however is our current concern in 2013 and one of the things most feared by bankers and the powerful financial elite. Most modern-day economists propose that: “a little inflation is a good thing,” and they fear deflation which is well illustrated by Dr. Ben Bernanke, chairman of the Federal Reserve of America. His studies of the Great Depression have convinced him that deflation was the monster most associated with the drastic economic effects of that day and age.  

It is true that the Great Depression and deflation were found together in some countries but it is important to distinguish between association, correlation and causation by determining a true basis for the causes of deflation.

A recent study by Atkeson and Kehoe spanning a period of 180 years for 17 countries found no relationship between deflation and economic depressions; rather it found a greater number of episodes of economic depression coincident with inflation than with deflation. Over this period, 65 out of 73 deflation episodes had no economic depression and 21 out of 29 economic depressions had no deflation.

The main argument against deflation is that when prices are falling, consumers will postpone their purchases to take advantage of even lower prices in the future reducing current demand. This is projected to cause prices to fall even further in a self-fulfilling prophecy ending in a deflationary economic spiral downward and thus ‘causation is determined’: that deflation causes a depression; this poor excuse for an argument can be found in most introductory economics textbooks. The St. Louis Federal Reserve Bank recently wrote: “While the idea of lower prices may sound attractive, deflation is a real concern for several reasons. Deflation discourages spending and investment because consumers, expecting prices to fall further, delay purchases, preferring instead to save and wait for even lower prices. Decreased spending, in turn, lowers company sales and profits, which eventually increases unemployment.”

This argument can be challenged using several sound economic principles. Economies in the developed world have evolved from manufacturing-based production to a consumption-based one in which 70% of Gross Domestic Product (GDP) derives from spending by the general public on consumable items such as leisure, technology, gadgets, housing, food and power. This has been caused by the shift in production methods using more automation, out-sourcing manufacturing to developing countries and has reduced employment opportunities in much the same way that agricultural labor transferred to factories during the industrial revolution. Our society has become so dependent on ‘consumerism’ that it is almost impossible to project a significant reversal in spending habits regardless of how low prices of consumer goods fall in a deflationary environment. Apple has been able to sell its latest iPhone, while people expect the same phone to be cheaper in the future, in spite of their propensity to wait for cheaper prices.


Economists argue that if we are consuming less, we must be saving more. But this notion relies on the fact that we can actually maintain our standard of living on less expenditure. This has not been the case because consumer debt has risen and taken the place of our reduced purchasing power; our earnings and savings have in fact fallen in the meantime. Moreover, economists postulate that increased savings can lead to deflation but it is clear that deflation does not reduce aggregate demand but simply alters the composition of demand. The demand for consumption goods could decline but be replaced with demand for other kinds of goods even capital goods. The result of this might even lead to growth and more consumption goods in the future, since the economy has more capital with which to work. The period of the greatest growth in the U.S. during the nineteenth century, from 1820 to 1850 and from 1865 to 1900, was associated with significant deflation when prices were halved. To illustrate these trends we can use the thought experiment in our previous ‘apples’ examples.

 

Suppose, in a ‘closed market system’, there are 20 apples and $10 stock of money. The market would eventually set the price of apples at 50 cents each which would match the supply. If the price of apples were set higher, at say $1, there would be surplus apples after the $10 had been spent leaving the market to reduce the price to zero for the remaining apples. If you could not give them away they would perish and the next time apples came on the market the price over a short time would be set lower to match supply. People tend to have long memories where money is concerned, for example, do you know anyone who has ‘forgotten’ a debt? Suppose that the supply of apples increases to, say, 40 apples, the market would eventually adjust the price down to 25cents each, again matching supplies, with all other things being equal including the stock of money. This is how a market adjusts for supply and demand and which some economists equate to deflation, because of falling prices, when in fact the culprit in this case is the ‘supply’ (‘inputs’ in economic terms) which has changed and is reflected in the price.

Apple-1.gif

Next we can make another change assuming that the supply of apples stays constant at 20 apples; the stock of money is increased to $20 this time around. Using the parameters of the last experiment the market will seek to equalize and set the price of apples at $1 each, twice the price in the last example. Here we see inflation in action in its simplest form; change the stock of money and, so long as supply and demand stays level, prices will increase given enough time. It is important to note the ‘time factor’ as there is always a lag in the market between changes in supply and changes in demand and these are not easily discerned in a short time interval. We can now see the interaction of money supply with the demand and supply of goods and services but these are only two factors. There are many influences on the economic models for which we need to account and makes economic forecasting so uncertain to the chagrin of politicians everywhere.

There is yet another aspect to our thought experiment which economists find so fearful; this is where the money supply is distorted by people not spending but saving part of their disposable income. Using the first set of parameters there are 20 apples and a money stock of $10. We assume now that $5 of the money stock is not available for spending but placed under a mattress for a rainy day because the consumer believes that prices might fall in the future. The market now has only $5 of money available for consumption; thus the market will find its equilibrium by setting the price of apples at 25p each and economists will say that ‘deflation’ has occurred and people are saving too much. They will further urge the government to make up for the lack of spending power by injecting $5 into the economy to return prices to ‘normal’. What economists have missed is that the money stock has not changed; rather it has been temporarily removed from the market, to be spent on another day.

If the government responds to the economist’s pressure they will have created a permanent ‘inflation’ downstream by increasing the stock of money unnecessarily.

The economists’ fear is in fact well placed because if the savings situation is allowed to continue for a long time prices will continue to fall and this would result in failing businesses and unemployment will increase. There is always a certain amount of what economists describe as ‘stickiness’ in both ‘input’ and ‘output’ prices.

If we are constantly matching supply and demand we would need to continually adjust wages and salaries and check price labels every day which would be both confusing and impractical. However, this has happened on many occasions; Germany in 1922-3 and more recently in Zimbabwe in 2008 but these events were confined to a virtually ‘closed national economic system’ and did not seriously infect the global financial system; they did not become ‘systemic’. One aim of national economic policy is that of ‘price stability’ and money printing works against this in general.

In the last experiment, when the government adds $5 to the economy, it initially benefits those that receive the money first, government and banks, and penalizes the late receivers of the money, the wage earners and the poor; thus transferring resources from ‘poor asset holders’ to the ‘asset rich class’ thus increasing wealth inequality which we witness today. The early receivers, ‘the rich’, will spend their money in a certain way, or more often than not actually save the extra money rather than spending it, again distorting relative prices in the economy.

A problem arises when the economy improves; people reverse their hoarding traits and start spending their savings and borrowing more money. Extending our experiment yet again, we now have 20 apples and $15 of money stock in the economy meaning that the price of apples will eventually balance the market to arrive at 75p each, showing that inflation has returned with a vengeance. We can further extend the experiment by assuming that $5 extra is ‘borrowed into existence’, which has increased debt, thus the money stock becomes $20 and apples are selling for $1 each. This can be compounded again if, at the same time, the supply of apples falls to less than 20 when prices could ‘shoot through the roof’ and eventually arrive at a state of ‘hyperinflation’ or extreme inflation. This occurred in the early 1970s when the price of oil increased due to restrictions place on oil supply by the ‘OPEC’ oil producing countries. Energy supply is crucially important because people have no option but to consume oil and gas regardless of price and which economists describe as, ‘price elasticity of demand.’ Furthermore, in a global economy, almost all raw materials and goods need to be transported, at one stage or another, during the distribution cycle. Energy prices therefore influence many of the costs associated with delivery of end-products. 


So far we have been dealing with a ‘one product’ economic model using ‘apples’ but our world in reality has many and varied products offering people a choice to substitute alternative products when prices change. 

For example, if beef prices increase consumers can switch to cheaper chicken or, as happened in the 1970s inflation period, when pensioners on fixed incomes were so pressed to buy basic supplies they began consuming pet foods in place of regular produce.

 

Also in a multi-product world, inflation from excessive credit growth will cause changes in relative prices that result in unsustainable investment as happened to housing in the period 2001-2007. Deflation, in the ‘bust’ phase of an economic cycle, is a partial realignment of these relative prices closer to what society really wants to be produced. The printing of money simply interferes with this essential clearing process. The real solution is to end fractional reserve banking and central banking systems and replace it with a sound money system as advocated by the ‘Austrian’ school of economists who are gaining more credibility as time passes.

Inflation is OK if you like pet food. This particular brand is delicious when served in a shiny bowl and it’s own golden brown sauce (just add 1/2 cup warm water and stir)

Inflation is OK if you like pet food. This particular brand is delicious when served in a shiny bowl and it’s own golden brown sauce (just add 1/2 cup warm water and stir)


ShopSquawk considers inflation to be much worse than deflation because it robs wage earners and seriously affects the relative ‘poor’ in our community. Central banks are the primary cause of inflation and are the main reason for the growth of income inequalities, as the rich get richer and the middle class tends to sink towards relative poverty. This trend has been growing since the 1971 ‘sound money system’, based on gold, was replaced with ‘fiat currency’ in the form of the mighty American dollar. Ever since, the charts have shown that the dollar has depreciated in value continuously as central banks print money and create inflation. They have been generous in supporting economic research in academic institutions serving to theoretically justify the central banks’ inflationary policies.

The common fallacy of “a little inflation is good economics” is disseminated by the mainstream media and economists to lull the populations into a false sense of wellbeing when in fact inflation is nothing short of theft because it reduces the value of money in the pocket.

A ten percent per annum inflation over seven years halves the value of your money and for savers and particularly pensioners this is a daunting prospect. We know that the government CPI figures substantially understate inflation but we have no way of measuring the actual rate of inflation, which we are each experiencing, only by noting our perceptions and daily living activity.

 

The Austrian school of economics has always claimed: “fear the boom, not the bust.” It is in boom times when periods of rapid economic growth sow the seeds for a crushing collapse, as experienced in 2008 following the 2001-07 expansion ‘bubble’, which burst with serious consequences. It may be claimed that today we continue to suffer these consequences by having been in a period of ‘disinflation’ not to be confused with deflation. In the same way that our politicians claim to be ‘reducing the deficit’ but are not reducing the overall government debt; disinflation is a reduction in the rate of inflation rather than actual deflation which is the reverse of inflation.

              Before

              Before

                 After

                 After


Inflation is accumulative, in the same way that debt accumulates over time, so that a measured annual rate of inflation compounds on a previous year’s inflation and results in a serious loss of purchasing power sometimes over short periods of time. For example, if last year the rate of inflation was 10% per annum and this year it falls to 9% per annum we can say that we are in a period of disinflation; likewise if inflation suddenly falls to -1% then we can say deflation has occurred in that year but either way, over say five years, inflation has continued its ominous trend. However there is another aspect to inflation which is not always obvious and has to do with the ‘rate at which money moves through the economy’ and described by economists as the ‘velocity of money’.


Now… do not fear! For what is next may or may not give you a headache. If it does, you need not be tested on it. Allow ShopSquawk to introduce to you a simple equation that links four variables associated with inflation caused by the changes in the supply of money which was proposed by the economist, Irving Fisher in 1911:

Ready? It’s painful…

M x V = P x Q

where:

M is the total dollars in the nation’s money supply,

V is the number of times per year each dollar is spent (velocity of money),

P is the average price of all the goods and services sold during the year,

Q is the quantity of assets, goods and services sold during the year.

If you feel like this, remember that M,V,P, & Q are just letters that really only want your love.

If you feel like this, remember that M,V,P, & Q are just letters that really only want your love.

What’s important here is that this formula is purely theoretical and does not take into account one of the most important influences on economies: that of the combined effect of each individual’s behavior. So… that said, memorize it if you want your head to begin to take on an egg-like shape, OR, just move on and realize you can always look it up!

 

Back to the slave drive… in the next paragraph you better mind your P’s and Q’s.


We see that each term is defined by the values of the other three. Unlike the other terms, the velocity of money has no independent measure and can only be estimated by dividing PxQ by M (remember… M is the total dollars in the nation’s money supply). Some supporters of this ‘quantity theory of money’ claim that the velocity of money is stable and predictable. It is suggested that it is determined mostly by financial institutions. If that assumption is valid then changes in M can be used to predict changes in PxQ. If this is not true then a model of V is required in order for the ‘equation of exchange’ to be useful as a ‘macroeconomics’ model or as a predictor of prices and therefore inflation.

Did you remember to put on your egg-head skull cap?

 

The uncertainty surrounding the theory of money and its unpredictability made policy-makers at the Federal Reserve rely less on the money supply in controlling the U.S. economy. Instead, the policy focus has shifted to interest rates such as the setting of interest rate targets by the Federal Reserve, using money printing to maintain their targets, which at present are extremely low in historical terms. These low rates are distorting economic signals, which are so necessary for the smooth functioning of markets, causing increased volatility (meaning up and down and all around prices) globally within all markets. This process is referred to as ‘financial repression’ and many believe that the Federal Reserve has no option but to continue printing money (QE) forever because if they don’t the markets could collapse overnight.

Remember that the ‘Federal Reserve’ is as ‘Federal’ as ‘FedEx’. It’s name suggests to the unquestioning mind that it couldn’t be a privately owned central bank… of which it is. In the same way that FedEx presents an arrow for your subconscious to interpret as the motion of getting your package to its destination, the ‘Fed’eral Reserve bank cross-dresses as a Federal entity, when it really is privately owned.

Remember that the ‘Federal Reserve’ is as ‘Federal’ as ‘FedEx’. It’s name suggests to the unquestioning mind that it couldn’t be a privately owned central bank… of which it is. In the same way that FedEx presents an arrow for your subconscious to interpret as the motion of getting your package to its destination, the ‘Fed’eral Reserve bank cross-dresses as a Federal entity, when it really is privately owned.

 

Ignoring the effects of monetary growth on real purchases and the velocity of money, this suggests that the growth of the money supply may cause different kinds of inflation at different times. For example, rises in the U.S. money supply (money printing) between the 1970s and the present time encouraged, first a rise in the inflation rate for newly produced goods and services in the 1970s, and then asset-price inflation in later decades. It may have encouraged a stock market boom in the 1980s and 1990s and then after 2001, a rise in home prices, being the famous housing bubble which collapsed in 2008. This theory assumes that the amounts of money in circulation are the causes of these different types of inflation rather than being the results of an economy’s normal reactions to supply and demand.

The fact remains that inflation and ‘financial repression’ go together, like peanut butter and bacon, or chihuahuas and tacos. They are inseparable partners, and as inflation develops, financial repression evolves into plain confiscation. Following the 2008 crisis we have seen only increasing financial repression, mostly in the form of price manipulation. Some of this manipulation is overt, as with interest rates, and some is hidden, as indicated by gold-price manipulation, the consumer price index (CPI) or the published unemployment rates. As the US national debt interminably grows this manipulation will be increasingly exposed and the general fear of confiscation will blossom. Any rational investor can see that his bank account is at risk of confiscation, and that the likelihood of being caught in a bank run is rising daily. Little is being discussed in the mainstream media about withdrawal rates of money from bank deposits in the US, EU, and the UK but it is happening. The Cyprus event is having its effect on the behavior of investors, who are classed as ‘the smart money’, and who are ensuring the safety of their wealth by moving it to safer places.


Governments need bank deposits to fund the bonds they force their banks to buy. Regulations, the pressure on the bankers, the open threats are all part of the same means to coerce bankers to fund their debts with your savings. Hyperinflation is the ultimate and most expensive bailout of a broken banking system, which every holder of the currency is forced to pay in a losing proposition, as it inevitably ends in a final destruction of the currency; there are plenty of recent examples, Zimbabwe being the poster child. Hyperinflation is the ultimate failure of an economic system, which can be a good thing, because like a forest fire it is not until the old debris is swept away that a new system can grow and prosper; this is the hope upon which we must all rely. The shrinkage of an economic system exacerbates a fall in tax revenue and increases the intervention of central banks leading to the self-fulfilling outcome of unmanageable government fiscal deficits. Production output will fall and produce a shortage of goods together with an increase in the circulation of money which triggers higher inflation. The general reaction of government is to implement price controls which further distort the normal operation of markets and worsens the situation; politicians and bankers are left powerless.


Now that we have forced you to endure a very long paragraph, we can now see how rising interest rates, which attract deposits and hyperinflation can go together. The loss of confidence in the system will push interest rates higher, which cause even more difficulty in producing goods, unleashing shortages and higher prices.

Meet the old dude named Ludwig. Why his thumb is up is anybody’s guess.

Meet the old dude named Ludwig. Why his thumb is up is anybody’s guess.

Ludwig von Mises remembered in the case of the German hyperinflation: “…with a 900 percent interest rate in September 1923 the Reichbank was practically giving money away…” (Lesson 7 of his book: “Money, Method, and the Market Process”). It is during a period of high inflation in goods, not matched by a balanced increase in wages, that people soon begin to ‘vote with their feet’ and leave the system altogether. The ‘wage-slaves’ finally wake up and decide that, at a certain point, one is better off working outside the system to avoid this hidden inflation tax and of course all government taxes. Just like Romans, who left their cities during the slow decline of their empire, millions of workers in the developed world could decide to become ‘self-employed’ and leave the system. This happens to be a typical characteristic of under-developed economies where it is almost impossible for government to collect sufficient taxes to fund society. This feature of empires in decline is witnessed all too obviously in Greece and Spain today as their economies implode on the anvil of austerity imposed by the EU, IMF and ECB.

Although Europe suffered a continuing recession (starting in 2013) which will likely not be resolved for some years, it is the USA which is driving the global financial system towards its breaking point.  

 

Nobody can forecast what will happen or when, but the present trajectory of the system indicates that at some point all this money printing will have to stop.

 

The consequences are unknown except that it is fairly certain that interest rates will continue to rise with inflation eventually following. ShopSquawk will forsake another thought experiment at this stage, but instead use an analogy which illustrates the strange relationship between the United States and its trading partners of which was published recently: “The king bought a suit every week, and he paid the tailor with a check, which the tailor put in his drawer. After years and years of paying with his checks, the king had an enormous debt to the tailor who had a huge cash balance in his coffers which he thought made him a very rich man. Suddenly, the tailor was in a position to cash his checks, and the king was now visibly insolvent.”

This analogy demonstrates how the United States of America is in the same position as that of the king. The USA pays its debts internally in so much that it finances its budget deficit, created by Congress policy and the President, by issuing its dollar currency which finances its balance of payments deficits abroad by issuing dollar checks to foreign countries and foreign suppliers; in fact these are US Treasury bonds.

The foreign suppliers do not cash their checks. They accumulate them in central banks, or in their treasuries, in the form of a huge dollar balance which today amounts to approximately $5 trillion dollars. The ‘king’, the United States, is running a massive USD 20 trillion financial debt (we have to constantly keep editing this number!) but paying for it with checks that are not being cashed; they are merely ‘promises to pay’ and the deficit, thus the national debt of the United States, continues to increase year in and year out because so far there has been no cause for the global community to do otherwise than believe in the greatest economic power the world has ever seen.

Nobody is asking the USA to pay up, and the foreigners are thus in the position of the ‘tailor’ as they accumulate their checks… but the ‘king’ United States, is in reality insolvent. Everyone knows that there is no way the USA can repay its debts, however, the last thing any creditor wants to do is force liquidation. The general pattern of human behavior is to ‘kick the can down the road’ and close one’s eyes to the inevitable until an event occurs that forces the final whistle; game over. That event is yet to occur but ShopSquawk’s experience of past insolvencies suggests that it will occur in due time. The dollar’s reserve currency status allows foreigners and others to finance the US budget deficit and its trade deficit. Nobody wants to take away the United States’ credit card, upon which there are no restraints, least of all the United States itself. The nations that absorb these ‘reserves’ want a place where they can deposit them and then quickly sell them if they have to, and that kind of liquidity is available only in U.S. markets. The price of this privilege is that in order to maintain the dollar’s reserve currency role and in order for the foreign countries to accept it they have to accept a decline in the value of the dollar which implies continuing inflation.


We have seen that there are essentially three components required to create an inflationary environment. Commodity price inflation is certainly one of them as it impacts the ability of the average consumer to buy more and thus expand the economy. We have touched on the other two: the velocity of money, or how fast money is flowing through the system from the banks to small businesses and ultimately consumers and wage growth which gives the consumer increased purchasing power to fuel growth.

In a recent National Federation of Independent Business (NFIB) survey in USA only a small fraction of respondents stated that this was a “good time to expand their business” while the majority of respondents stated that their major concerns were: “poor sales, taxes and government regulations”. The student might well be a small business, who coincidently creates roughly 70% of all new jobs in the economy, and are probably worried now about poor sales prospects and a weak economic environment. It is highly unlikely that you are going to borrow money to expand your business or extend credit to customers even if you can. Businesses will choose to hoard cash as a guard against a weak economic environment instead of making productive investments that will lead to more jobs and higher wages.

Besides the rise and fall of commodity prices, which contribute to the inflationary backdrop, the demand for money to make productive investments by businesses which leads to higher levels of production, wage growth and, ultimately, consumption is what drives overall inflation.

In current economics inflation is defined as:

 

…a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy.

 

It is difficult to have a “general rise in price levels” amidst a lack of consumer demand driven by suppressed wages, high levels of unemployment and little demand for credit by businesses. The lack of demand exerts downward pressures on the pricing of goods and services keeping businesses on the defensive. This virtuous spiral is why deflationary environments are considered to be so dangerous and very difficult to break. By studying charts of the relationship between these three variables we can observe correlation between the rise and fall of employees’ wages and the velocity of the money supply which has been plunging to historically low levels since 2008 and does not encourage sustained increases in either employment or wages as the demand for money is so low. However, always be aware that in statistics, correlation is not causation, although we may easily perceive this to be the case; another example of misperceptions!


In the 1970’s the economy suffered real inflation and rapidly rising interest rates reaching 25% per annum at one stage. Inflationary pressures have risen recently although economic growth has been torpid. However, even this movement in both economic growth and inflationary pressures peaked in early 2011 and has been in steady decline since. This is why the Federal Reserve remains concerned about their monetary experiment of printing money, euphemistically known as ‘economic stimulus’. Inflating asset prices higher has increased consumer confidence to some extent but has not translated into economic growth; this clearly warns of rising deflationary pressures in the economy and the risk that the Federal Reserve is now caught in what economists call a “liquidity trap.”

As mentioned earlier, the Federal Reserve cannot effectively withdraw from its monetary interventions and raise interest rates to more productive levels without pushing the economy further into recession. The overriding deflationary drag on the economy is forcing the Federal Reserve to continue printing money and forcing down interest rates to support even this historically low-level of economic activity. While mainstream economists and analysts keep predicting stronger levels of economic growth all economic indicators are pointing in the opposite direction.

What remains from what has been swindled from you since 1971.

What remains from what has been swindled from you since 1971.

The dollar in 1971 buys only 18 cents of goods today and that, students, is inflation engineered and implemented by the bankers in their dysfunctional, global economic system. These pieces of the financial jigsaw are possibly the most potentially disheartening because everyone is subject to this despotic hidden tax.

 

The next lesson will expand on the theme we have set here. we will see how the next piece of the jigsaw fits snugly into our inflationary environment of false promises and failed policies. Other ShopSquawk courses will help you manage your financial affairs through what might prove to be a very trying time for all concerned.