Artificial Economy? Yes. Artificial Inflation? No

"Instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion. . . . To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection — a procedure that can only lead to a much more severe crisis as soon as the credit expansion comes to an end. . . . It is probably to this experiment, together with the attempts to prevent liquidation once the crisis had come, that we owe the exceptional severity and duration of the depression. We must not forget that, for the last six or eight years, monetary policy all over the world has followed the advice of the stabilizers. It is high time that their influence, which has already done harm enough, should be overthrown."

-- Friedrich August von Hayek (1932)

--

Your government is creating bubbles all around you. It’s like Ben Bernanke knocked back a couple of handfuls of amphetamines and decided to have a big dance party with a bubble machine. Lawrence Welk would be leading the orchestra if he wasn’t dead. Bubbles. Everywhere. Man, what a bash.

I know we’ve talked a lot over the last year about the $13 trillion obligation the U.S. government has created to fight this economic crisis (and only this economic crisis). Governments around the globe are printing, borrowing, and easing rates with unprecedented fervor, eagerly employing the outmoded and nightmarish Keynesian economic policy now commonly known as quantitative easing.

But none of this is really new. I mean, Japan has been doing it for years. Right? Well, yes… at a time when the rest of the world was in the biggest economic boom -- ever. Smart investors borrowed for nothing in Japan and then invested elsewhere, “risk-free,” at 7.5% (or more). Is it any wonder the Japanese economy never improved?

But now the whole world is doing it. Where are these smart investors going to take their free money now? Nowhere. And so velocity remains nearly at zero… for now.

Because of all this theoretical academic chicanery, however -- even as my nubby little fingers passionately peck out this article -- a bubble, the likes of which we have never seen, is expanding around us. Rates hover at historic lows. Bailouts abound. The federal government is printing more money than ever in history, lending it to itself, and then giving it to banks. As the cash presses against the proverbial dam, and credit eases further, precious metals, agriculture, and oil move ever higher. Treasury yields continue to creep up – despite the Fed’s best efforts to hold down the long-end of the yield curve.

Have you ever seen Monty Python’s The Meaning of Life? Funny movie. Remember the fat guy who exploded in the restaurant? Well that’s what this bubble is going to look like when it blows. But we’re not there yet. Not quite.

And yet, just because this is the ultimate bubble does not mean it’s the only bubble. No, this is but the last in a long line of relatively smaller bubbles your government has manufactured for decades, right under your noses.

Want a few examples?

1. Student loans.

2. Health care.

3. (Everybody's favorite) mortgages.

Do you want to go to school? Are you poor? Well guess who's going to guarantee a loan for you? Yep. Uncle Sam. Cheap, easy money. More demand. Higher prices.

Do you need healthcare or living assistance? Step right up! Your saviors have provided you with a cornucopia of options -- from Medicare, to Medicaid, to everyone's sweetheart: Social Security! And now Our Lord and Savior Barack Obama is promising healthcare “reform.” Do you know what that means? You guessed it. Cheap, easy money. More demand. Higher prices.

Listen, friend. Do you make at least $7 an hour? Do you need a new doublewide? Do I have news for you! Your government, in all its munificence and magnanimity has, for over 70 years, been putting high-risk borrowers like you in their own prefab slices of the American dream! Ask and you shall receive! And now, if you’re a first-time homebuyer, you’re going to get a massive tax credit! Yes! It’s true! Cheap, easy money! More demand. Higher prices. And isn’t that exactly what we want? Really?

This is what happens when money becomes abundant and easy to get! People spend. And when people spend, they create demand for the goods and services on which they spend. And demand creates higher prices. Now think about this… when money becomes abundant for a specific set of goods or services, demand only becomes more focused, and prices within that particular sector or industry rise.

Your government gives away money for many purposes, but perhaps the most publicized and controversial are the areas of student assistance, healthcare, Social Security, and mortgage assistance. Oh, and Cash-for-clunkers. How could I leave that one out?

When your government makes money available, it creates artificial demand for the products and services tied to the industries in focus. The results? Prices in these industries rise. And continue to rise. And continue to rise. Until a bubble forms.

So here's the bad news:

You want to blame Wall Street for the recent housing bubble? Try again. Your government created it (along with so many other bubbles) by encouraging lenders to dole out cheap money to people who couldn't afford the homes they were buying. Now you've seen the results.

Social Security, student lending, and healthcare subsidies are next. Come on. Do you really think the Obama health reform plan is going to make health care cheaper and more abundant? Right. The same day Amtrak becomes solvent.

Barack Obama is an eloquent speaker, and my goodness does he ever exude dignity and poise. And I’m sure his intentions are pure as water from a mountain stream. But I don’t care how well he comes across; he and his new girlfriend Ben Bernanke are going to perpetuate these broken policies, because they have to do something. Right? That’s the political imperative.

So here’s the worst news of all: no longer is the government only creating cheap, easy, abundant cash for specific purposes – like student loans and mortgage assistance. No. Now the government is doing it for the entire economy. That alone is enough to make the Consumer Price Index throb like a toe, freshly stubbed. But then you add to this reckless and profligate mess the fact that the money supply graph has gone vertical in the last year, well…you better believe we’re in trouble.

Do you hear that rumbling noise? The one that sounds like 14 freight trains heading right at you? Yeah. That noise. Well that’s inflation. It’s coming, and it’s got more energy and ire than any hurricane you’ve ever seen.

So board up your windows and doors, because this time it’s for keeps. Even Paul Volcker, in his prime, with a magic wand, a unicorn, a leprechaun, and three eager inflation-fighting little fairies wouldn’t be able to fix this mess.

And Helicopter Ben? Hell. He doesn’t stand a chance.

Disclosures: Paco is long TBT and Gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.

Comments

[D. McHattie]

Good article, Paco. Thanks.

But I'm still not sure how/when this price inflation moves to consumer goods.

Like your example of student loans and real estate, prices rise when you make more money or credit available to purchase that good, service or asset.

So since the banks have been given so much money I see that the prices of things that banks buy will rise. And these banks buy investments so their prices are rising: equities, fixed income (for now), precious metals.

But the question is when do consumers get their hands on this money? Because, it seems to me, that's what's necessary in order for consumer prices to rise.

2009 Nov 23 09:11 AM

[John Galt]

So they create Sallie Mae so that anybody could go to college. To make it more "affordable". How has that worked out? College costs have gone up something like 30x over the last 30 years. If we weren't talking about health care, we'd be talking about the exploding costs of college. But that WOULD piss off the teachers unions.

They created Medicade to make medicine more affordable for poor people. The program was a horrible failure, and rather than fixing THAT, they want to create a new system that reaches to those above medicade.... The country doesn't want it, but we now have 1 party controling our government and they are intend on slamming their ideology down our throats.

They created FHA, community reinvestment and other programs to make "housing more affordable". How has that worked out? The average person can't afford the average home.

The government has been fueling this fire. They print money or tax money from some to give to others and they create more "artificial demand". This demand raises prices and makes everybody worse off. They argue they are trying to, "help people" but they have done nothing but make it worse.

2009 Nov 23 09:27 AM

[Hot Richard]

Interesting to see the immediate and powerful force of the market to correct itself. After the credit storm (we remember 2008 don't we?), lenders WANTED to freeze up credit and only the best of the best were getting loans...but they were getting the money. Not good enough for The Fist.

I'm loaded down with silver and gold and I have a place outside the US where I spend about half my time. I'm ready.

2009 Nov 23 09:34 AM

[John Galt]

D.Mchattie,

Inflation is interesting. The government creates it with their printing press, and then they spend it ( on wars, or entitlements, pay off debts, etc.) They do this because nobody has to vote on it. It is a stealth tax on your purchasing power. They don't need to stand in front of you and tell you they are going to raise your taxes, it's much easier to just print money... Then when prices rise they blame it on greedy businesses ( when in reality it's greedy government).

The newly created money is used by government and favored interest groups ( banks are one of them and in this case). They get new money and are able to spend it on older prices.

Then the people THEY do business with get the new money second, then the people THEY trade with get the new money.

They get a windfall in business, and start to raise prices. Eventually the money trickes through the economy and prices rise. You get (inflation).

After the inflation occurs, it's recorded, and the last thing to raise will be wages. Do you get wages increases before or after inflation? Social security payments go up AFTER inflation.

In effect, they stole a little bit of your purchasing power before the point where your wages/social security payments etc. recalibrated up. The new money was created and trickled through the economy, and the people who touched that new money last, and the people who adjusted to it last, are hit the hardest.

2009 Nov 23 09:35 AM

[eggfaced]

It's a shame because reports of these problems are spun to make it seem like they are failures of capitalism and the government uses them to usurp more power in the areas in which they caused the problems in the first place. When people wake up to this madness there will be a revolution. I just hope its not too late and our whole system isn't completely in ruins by then.

2009 Nov 23 09:54 AM

[conceptwizard]

The solution lies in replacing Milton Friedman's mantra that "the goal of business is to maximize profits, regardless of the social and environmental costs" with a more viable one: "Make profits only within the context of creating a sustainable, just, and peaceful world," and to create an economy based on producing things the world truly needs.

There is nothing radical or new about such a goal. For more than a century after the founding of this country, states granted charters only to companies that proved they were serving the public interest and shut down any that reneged. That changed after an1886 Supreme Court decision that bestowed on corporations the rights granted to individuals--without the responsibilities required of individuals.

2009 Nov 23 10:14 AM

[User 353732]

1. When every debt is guaranteed then no debt is secure because no systen can guarantee itself.

2. The biggest bubble in the world today is the dollar. The essence of any bubble is a small truth enveloped by a Big Lie. The small truth is that, once, the sound dollar was a symbol of honor. The Big Lie is that the fiat dollar is an honest store of value. The bigger the bubble the more massive its inflation and the more devastating the destruction when it implodes.
A star ,before it dies,often expands to many times its usual size, and then......implodes into a small, dead, remnant. So the fiat dollar. First it is expanding to consume the substance of the American economy. Then, after swelling to astronomical multiples of its ratio of debt to wealth creating capacity, it will implode and with it will go America, the hyperpower , America, the idea and America , the middle class nation.

2009 Nov 23 10:42 AM

[American in Paris]

They are failures of capitalism. I live in Europe and we Europeans do live better.

We have better health care systems and fast trains linking major cities.

The American system is almost fifty years beyond Europe.

And I am an American so don't give me nonsense ...

:)


On Nov 23 09:54 AM eggfaced wrote:

> It's a shame because reports of these problems are spun to make it
> seem like they are failures of capitalism and the government uses
> them to usurp more power in the areas in which they caused the problems
> in the first place. When people wake up to this madness there will
> be a revolution. I just hope its not too late and our whole system
> isn't completely in ruins by then.

2009 Nov 23 10:57 AM

[John Galt]

Do Europeans have more living space than Americans?
Even your upper middle class live in apartments, upper middle class Americans live in McMansions.

How about taxes?
How about umemployment?
You have fast trains yes, but smaller countries. We have planes.
How about meritocracy?

The last point Europeans cling to is " we have a better health care system". If that's the case, then why do you guys come here for health care?

2009 Nov 23 11:22 AM

[Mr. Big]

On Nov 23 09:11 AM D. McHattie wrote:

> > But I'm still not sure how/when this price inflation moves to consumer
> goods.
>

Imagine, if you will, that as the US dollar depreciates, the cost of all inputs to goods and services go higher. Oil, copper, steel, etc....they all go up in price the US dollar purchasing power diminishes. We haven't seen this translate to a general increase in inflation yet because businesses are busy laying off workers and through this activity, they are able to keep afloat without raising prices. Besides, it's tough to raise prices when demand is down. If the economy doesn't recover....or is slow to recover, eventually, businesses will come to a point where they can no longer layoff anymore workers without severely crippling the business. Those businesses whose products have high elasticity of demand will go bankrupt. In such cases, as competition dwindles for the products, those last few remaining businesses will have the flexibity to raise prices in order to stay profitable. For those businesses whose products have low elasticity of demand, these firms can simply raise prices in order to stay profitable. In both these scenarios, all prices eventually go up as the US dollar diminishes in value. The Fed would have to respond by careful and incremental increases in interest rates, but at the risk of deepening and prolonging the recession.

In the case where we have a true recovery (remains to be seen), as economic capacity restores itself, more and more workers become gainfully employed. However, as the US dollar no longer buys as much as it used to, workers make up for that by demanding much higher wages just to maintain their standard of living. As wages go up, so too do prices for consumer goods as businesses struggle to maintain margins. In this scenario, inflation can rise rapidly and uncontrollably if the Fed/Government does nothing (or can't do anything) about maintaining the purchasing power of the greenback. In this scenario, inflation can be extreme and the Fed would have no choice but to raise interest rates at a pace that was precedented only once in the late '70s. Such a scenario may result in another severe recession/depression..... on the state of the economy.

2009 Nov 23 11:44 AM

[yellowhoard]

We're going to replay the 70's stagflation, only this time on steroids.

There will be hungry people and burning inner cities with reduced police forces.

You could not pay me enough to be a big city cop or fireman over the next 10 years.

2009 Nov 23 12:23 PM

[tuckfinitee]

Consumer prices can be suppressed indefinitely. Channeling the money flows into the opm mafia(gov/fin),asset prices, off shore through multinationals and old fashioned capital flight will do the trick. The more the public is on gov life support the less the money flow leakage.

You can think of the mexican oligarchy as a model. But a better model is the crime syndicate with its simultaneous centralization/decentr...

2009 Nov 23 01:34 PM

[The Hammer]

Nice article Paco.

Yes the political system has been tainted and corrupted by special interest who own the politicians.
Only an uprising can change this now. The people have lost control of gov't.

2009 Nov 23 02:04 PM

[Rokjok777]

Paco- have a look at Everbank for your private gold-backed currency

2009 Nov 23 02:35 PM

[bob adamson]

John Galt -

One could rhetorically ask: And why to Americans go to India for health care? But this would be unfair in light of the following.

In fact there is a growing international medical treatment tourist trade in which the US participates both as a recipient of incoming patients and as a major source of patients going abroad. Cost, availability of special treatments, avoiding delays and other factors all play their part and it would be a mistake to assume that a country's health care system generally can be judged by the flow of those seeking foreign treatment. In particular, the two way flow between the US and Europe is significant and complex and by no means one way.


On Nov 23 11:22 AM John Galt wrote:

> Do Europeans have more living space than Americans?
> Even your upper middle class live in apartments, upper middle class
> Americans live in McMansions.
>
> How about taxes?
> How about umemployment?
> You have fast trains yes, but smaller countries. We have planes.
>
> How about meritocracy?
>
> The last point Europeans cling to is " we have a better health care
> system". If that's the case, then why do you guys come here for health
> care?

2009 Nov 23 04:22 PM

[John Galt]

Why do Europeans go abroad?
Availibility and Technology

Why do Americans go abroad?
Cost.

Why does it cost more in America?
Regulations, Lawyers, government, Tech, FDA, AMA, Medicade, etc.

2009 Nov 23 05:27 PM

[bob adamson]

John Galt -

You are correct up to a point. Americans also go abroad for availability and technology reasons and because certain procedures available abroad are not allowed or available in the US.


On Nov 23 05:27 PM John Galt wrote:

> Why do Europeans go abroad?
> Availibility and Technology
>
> Why do Americans go abroad?
> Cost.
>
> Why does it cost more in America?
> Regulations, Lawyers, government, Tech, FDA, AMA, Medicade, etc.

2009 Nov 23 06:10 PM

[mna]

The price inflation will move to consumer goods when we force China to revalue the Yuan. Adding insult to injury, even though there's easy money, consumers will NOT get the money because the government will crowd out the private sector's cash.

In other words, consumers will not get the money because it's government allocated. The groups that will get the money are:

- Public sector employees
- Unions
- Special interest groups

If you're in the private sector and creating real wealth, get ready for your wages to stagnate as benefit costs continue to spiral out of control. Also expect your prices to go up when China relents and revalues the Yuan. What a wonderful world we live in.

On Nov 23 09:11 AM D. McHattie wrote:


> But I'm still not sure how/when this price inflation moves to consumer
> goods.
>
> Like your example of student loans and real estate, prices rise when
> you make more money or credit available to purchase that good, service
> or asset.
>
> So since the banks have been given so much money I see that the prices
> of things that banks buy will rise. And these banks buy investments
> so their prices are rising: equities, fixed income (for now), precious
> metals.
>
> But the question is when do consumers get their hands on this money?
> Because, it seems to me, that's what's necessary in order for consumer
> prices to rise.

2009 Nov 23 08:27 PM

[willynill]

Milton Friedman didn't say maximize profits, he said maximize shareholders' wealth--that's different.


On Nov 23 10:14 AM conceptwizard wrote:

> The solution lies in replacing Milton Friedman's mantra that "the
> goal of business is to maximize profits, regardless of the social
> and environmental costs" with a more viable one: "Make profits only
> within the context of creating a sustainable, just, and peaceful
> world," and to create an economy based on producing things the world
> truly needs.
>
> There is nothing radical or new about such a goal. For more than
> a century after the founding of this country, states granted charters
> only to companies that proved they were serving the public interest
> and shut down any that reneged. That changed after an1886 Supreme
> Court decision that bestowed on corporations the rights granted to
> individuals--without the responsibilities required of individuals.

2009 Nov 23 11:34 PM

[LaChic]

well, I have always said that the Fed will get the blamed for everything, and while I agree with the author on many points the problem I have is that the FED is against the wall on this one. If we take the many green shoots coming out from the Obama Adm and all the wonderful news of an economic recovery then the FED is wrong and should be raising interest slowly and now, but my guess is there is no economic recovery, and there are no green shoots, and most of the economic data and job recovery has been inflated to look like a true recovery.

I'm also guessing the Fed can see this therefor staying put by not raising short term interest rates. I think the right thing to do will be to raise interest rates by at least .25 basis points and hold steady for a bit. I think the man will be blamed no matter the outcome of this saga.

The fed is in a tough spot right now, and getting heat from every angle, i hope the man is smart enough to listen to himself and not the Obama adm.

2009 Nov 24 08:53 AM