The Fed's Motive for Inflating

The Fed's Motive for Inflating
By Bill Bonner, The Daily Reckoning
Oct. 11, 2007

In real terms, the Dow has been cut in half since 2000. You used to be able to sell all your Dow stocks and buy more than 40 ounces of gold. Now, sell them and you get only enough money to buy 18 ounces.

No, dear reader, the Dow is a fake-out…a sideshow…a distraction. The real drama is in the dollar itself. And the real excitement is in the gold market. Yesterday, gold rose more than $10 - to a new high for this cycle.

Oil rose to almost $83 yesterday, too. And the dollar fell to less than $1.42/euro (EUR).

The falling dollar is not just a speculator's plaything. It is the dollar in which almost all Americans' hopes and dreams are calibrated. If a house is worth 300,000 dollars, those 300,000 pieces of paper may represent a lifetime's worth of past effort, and it may also represent hope for future repose. Pensions, insurance plans, stock portfolios, bonds…everything we earn and everything we spend - it's almost all in dollars.

As we pointed out yesterday, the dirty little secret of America's advanced capitalism is that it socializes much of the risk, and most of the losses. The big banks, big financial houses, or even the little householders get in trouble and the government rushes to their aid. "Here, have some more money," says the Fed.

Where does that money come from? It's a long story…but it's not a new story. It's a story that was played out in ancient Rome…in 18th century France…in 20th century Germany…and now is a long-running show north of the Rio Grande.

In effect, and often literally, central bankers create the money - as Keynes put it - "out of thin air." No harm in that, you say; it's got to come from somewhere. Except, this new money competes with all the old money that people worked so long and hard to accumulate. As you will see, below, neither an economy nor a person can tell the difference between a dollar that came from the sweat of one's brow and one that came out of thin air. The result is to increase the overall supply of dollars and reduce the value of each and every one of them. That is the phenomenon we know as "inflation."

The consequences of inflation are well known. So is its source. Everyone knows, in other words, who gets killed and who fires the gun. What we add today is just an incriminating detail - the motive.

Why would the U.S. central bank want to create inflation? Blame Congress, the politicians always want to spend more money than they can raise in taxes. They make the difference up by borrowing, and then the loans need to be refinanced, and more loans added, and the whole thing just goes down a lot more easily if there's a little extra money floating around.

Or, blame consumers. They spend money they don't have on things they don't need. Who do they think they are, members of Congress? They, too, are a lot happier when the money is flowing. And, when the voters are happy, the politicians are happy…and when the politicians are happy, they don't put a lot of difficult questions to their central bankers…so the central bankers are happy too. Let's face it; everyone is happier when there is a little inflation in the system. Economists even came to believe that inflation helped boost employment…and that it encouraged consumers to spend…and that it actually helped created a more dynamic, more robust economy. So, you see, dear reader, even economists are happier with a little whiff of inflation in the air. And if you can make economists happy…aren't you doing God a service?

Okay…now we're getting to the deep, dark heart of the matter. Blame God. God created man. And man likes a little inflation. A little extra money makes people feel like they are getting something for nothing. Who doesn't like that?

But God didn't stop there. He made man. And man likes to get something for nothing. But God made sure there was a worm in this apple. "Something for nothing" always comes at a high price. If the dollar had merely retained its value since 2002 and all else remained even, Americans would have about $10 trillion more of purchasing power today. Instead, they are getting used to foreigners coming in, buying their assets and telling them how cheap everything is. Yes, things are cheap to foreigners; they have real money. But things are not cheap to Americans.

The crisis of 2001-2002 reduced Argentines' wealth by nearly two-thirds. All of a sudden, if they took a trip to Europe, for example, they found they had only a third as much money as they had had before. Foreigners were coming into the country to buy apartments and farms…the Argentines themselves didn't have the money to compete with them. Argentina's rich were fine. They had always kept their money in Miami or Switzerland. They had assets outside of the country. They had sources of revenue and ways to protect them. But the middle classes had their money in pesos. They earned their money in pesos. They counted on the value of their peso-pensions…and their houses…and their savings. But when the crisis came…their money disappeared. Argentina's middle classes were practically wiped out.

Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.
* Read more by Bill Bonner at HERE
* Request a free copy of "The Future of Gold" magazine with Bill's explaination of the "Derivatives Debacle: Little Big Bubbles" HERE
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