Hallow Growth, Part I

Inflation, to the ignorant, means nothing. To the economist and investor, frightening.

What is Inflation?

Simply put, the devaluation of a currency. For example, if inflation is 2%, and The Communist Manifesto is worth $1 (it’s really not worth that much), then within a year it would cost $1.02.

That seems rather insignificant, but it build up over time. $100 in 1980 has the same purchasing power today as $264. That means, if you put $100 in the bank in 1980, today you would have $38 in the bank. It’s just as if someone stole it. And when inflation is high, it leaves deep long-term scares.

Today, what makes the dollar worth anything is oil. Oil is how the Federal Reserve determines how much money is allowed to flow into the market. The US was on the gold standard for a time, but now we’re on oil. In the case of massive amounts of oil is dumped into the market, if money isn’t printed to compensate for that, that oil “sterilize’s.” What that means is that the oil drops in value, because the Fed didn’t compensate.

But, if the Fed prints too many green-backs, the value of the dollar goes down because there are more dollars but not more oil.

Should We Be Worried?

Should we be worried? It appears so. Well-known economist Arther B. Laffer instructs us to “Get ready for inflation.” And mentions how in late 2008 the Fed increased the monetary base by a little less than a trillion dollars. Laffer explains, “By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position.”

But, of course, the Fed won’t admit to what their doing. They claim that inflation is going down, almost as though they had no control over it. Fed Chairman Ben Bernanke doesn’t see much threat. Although, if the Fed announced that massive inflation was to occur, the market would freak out.

By now you might be asking, “But Ben, what about the growth and profits the economy has been experiencing lately?” That is not real recovery. A similar case like this happened in 1976. Because of inflation banks jacked up interest rates to 29%. Then consumers saw saving money as less attractive, and so they spent the money while they had it, and while it was worth what it was. So, businesses experienced profits, and employment went up. But it ended up just being a “passable” year because of the stagflation (stagnation+inflation). So it was just hallow growth. (Information from Econoclasts by Brian Domitrovic, 2009, p. 139.)

Even with Bernanke trying to calm us with warm milk, investors are watching the inflation.

Laffer leaves us with wise words:

Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury’s planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.

In addition, a rapid contraction of the monetary base as I propose would cause a contraction in bank lending, or at best limited expansion. This is exactly what happened in 2000 and 2001 when the Fed contracted the monetary base the last time. The economy quickly dipped into recession. While the short-term pain of a deepened recession is quite sharp, the long-term consequences of double-digit inflation are devastating. For Fed Chairman Ben Bernanke it’s a Hobson’s choice. For me the issue is how to protect assets for my grandchildren.” Economist Arthur Laffer with the Wall Street Journal, June 11, 2009

Tune in next time to find out how to protect your assets.

-Ben

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