Saturday, April 05, 2008

A moment on Inflation...

I have commented on the inflation and the state of the economy in the past, however, this particular post will focus on how we can fix the systemic problem plaguing our economy.

I don't characterize the problem as systemic lightly. We need to look at the history of the nation to really determine how we got here. In reality it all seems to have started with the Great Depression, and then was exasperated with the rise of social programs in the 1950's. The demise of the gold standard was only the start of the problem.

Monetary Inflation comes from an increase in the availability of liquid currency. The current situation in Zimbabwe and in Germany between 1914 and 1923 are examples of extreme inflation, also called hyperinflation. These situations resulted from the government printing money to subsidize the cost of their debt, social programs, or militarization. Interestingly, something similar is going on in the United States.

Currently, the national debt stands at just under $9.5 Trillion. Much of this deficit comes from the creating of funds through securities to other countries like China. Until recently, the greenback was the favored international currency because of American economic dominance. However, this is no longer the case, pushing the government to the edge of hyperinflation, something every American should be concerned about.

Debt is really the problem. Historically, the amount of debt has steadily increased. As debt increases, so does the availability of liquidity. Applying basic principles of supply and demand, the increase in availability typically means a decrease in value. The net result of there being more money available for everyone to spend means the decrease in the value of the greenback.

While debt is the problem, it doesn't seem like personal debt is really the issue. Security, as extended by credit companies, theoretically operates to insure the continual operation of the economy by making what is hard to get a hold of easier to attain by the average individual. However, when this tactic is employed by the government, the result is a devaluation of the dollar, and the increase in the value of everything dependent upon that currency.

In the United States, this seems to have created a compound problem. The government has outrageous debt, and to keep up, the average American has to have an equally outrageous amount of debt. All of this money in the air lead to a spike in the number of security instruments available, e.g. mortgage notes, credit card debt, etc. Like the value of the dollar, the value of these securities is contingent on their availability. The increase in the transaction of security instruments, and their increased availability would ultimately lead to their devaluation. However, the value of security instruments didn't seem to decrease in value like everything else in the market. The only reason I can think of is that they aren't real commodities. The only value a security is tied to is the value of the currency that supports it and the currency that supports it and the potential interest that will accrue on the debt.

Lets put the entire economy into perspective for a moment. We have a remarkable increase in the value of property, driving largely by inflation. We have an increase in the transaction of mortgage based securities and other debt securities as a way to create derivative income for large lenders. We have smaller banks getting involved in the business of securities as a way to leverage their business. However, everything is reliant upon a steady value of the dollar. Now, throw current inflation into the mix. The net result is a substantial devaluation of all of these securities. The only way for the debt based economy to keep pace is to issue more debt. Personal debt layered upon the exponentially increasing national debt only adds to the push toward the downward spiral of hyperinflation.

The ultimate question is whether there is a solution. Some have proposed switching back to the gold standard. This is idea is fundamentally flawed because the overnight revaluation of the dollar would make every household rich if they were permitted to retain the money they currently possess. The only way to implement this change would be to redistribute liquid assets to every individual based on their actual gold worth. For example, your $1000 bank account would end up only having a total balance of $25. No reasonable human being would be interested in such a situation.

Instead, a better solution would be to reduce the national debt, increase interest rates, and for the average American to spend a substantial portion of their disposable income. This will result in the constriction of the availability of liquid assets while insuring that the economy keeps pace from a consumer perspective. As the Federal Government and the population restrict the availability of the dollar, we will get back to a point where inflation turns to deflation, bringing the value of the dollar up and the price of everything else down. The steady process would eventually reach a point where the value of the dollar effectively hits the gold standard on its own. At that point, steps should be taken by the federal government to normalize its policy to prevent the situation the United States economy is currently in by developing sound economic policy.

However, the gold standard shouldn't be the goal. Rather, if we can get back to a point where we are close to parity with major international currencies, still have reasonably available consumer credit, and very strict governmental economic policy, we will see a market that returns to being driven by the consumer and not the Government.

That should really be the goal, a healthy and consumer driven market not reliant on the whims of government spending. Instead, the market would permit flexible valuation of commodities based on production, insure that workers receive a livable wage, and result in greater prosperity for all of us.

1 comment:

Kyle Phaneuf said...

So, did you run CAPTLST off the road or what? At least give him the finger? Anyone who goes to the trouble of advertising their capitalist-status on a license plate deserves that much.