Inflation Destroys

Inflation is one of the worst economic consequences of having a fiat money. That is a money not backed by a commodity. Our dollar today is a fiat money because there is no backing of real value, only the faith in the government. When you have a money backed by a commodity, the supply of that money can remain relatively stable. Sure if you have a money backed by say, gold, you can mine more and inflate the money supply, but the mining required labor and capital. With the allocation of resources a requirement for the expansion of the money supply, standard free market forces apply. If more gold is mined, the value of all existing gold in circulation drops. However because gold is less valuable, mining it becomes less valuable and thus the mining industry will slow and equilibrium will be met. The opposite is true, if gold becomes scarce, the value goes up and the return on investment in gold mining increases and more gold will be produced.

The downfall of a fiat money system is that no capital or labor is required to create more. The money can simply be created out of thin air. Because of this, the supply and demand is skewed. The moral hazard inherent in the ability to essentially legally counterfeit money is impossible to overcome. Especially when a government is the entity with the sole capability of creating new money. Because the government wants to spend but doesn’t want to tax, the only option left is to print. Whether this printed money is used to spend directly or if it is used to pay back debt obligations is irrelevant. The money has to come from somewhere… actually nowhere.

So when the government creates more money (Via the Federal Reserve and our banking system, but that is another article entirely.) it increases the money supply. In other words the total amount of money in circulation. Because there is more money chasing the same amount of goods, the real value of each dollar is reduced. Money exists like any other commodity subject to the laws of supply and demand, the more of something there is, the less it’s worth.

This may seem harmless, as long as the rate of inflation remains constant over all dollars at the same time, it is. If gas prices rise by 10% due to inflation, it doesn’t matter as long as wages also increase by 10%. However therein lies the visciousness of the problem.

Say the government or the Fed prints a $100 bill and gives it to a bank to be lent out to another bank, so on and so forth, eventually landing in your pocket after years of meandering through the system. At the time of printing that bill was worth $100 dollars. With it you could buy $100 dollars worth of any commodity or product in the world. Now assuming the cycle of government spending and printing remains a constant, which indeed history would show us it has, by the time that bill ends up in your pocket years later it is still worth numerically $100 but in terms of real value it has dropped. Let’s say it took three years for it to get to you and the annual rate of inflation was 5% year. That means it lost 5% of it’s real value each year ending up at the real value of about $86. Now the point is, in numerical terms it is still a hundred dollar bill but it’s purchasing power dropped by 15%.

A more concrete example would be in the mid 60’s they stopped putting silver in quarters and indeed backing our money with a commodity. At that time you could buy a gallon of gasoline for a quarter. It now takes about two dollars to purchase the same gallon of gasoline. However, if one were to exchange a 1960 quarter for it’s value in silver… one would receive enough money in today’s terms to purchase a gallon of gasoline. The quarter is still a quarter numerically and if taken at numerical value it has lost it’s purchasing power… a quarter’s worth of gasoline today is a fraction of what it used to be. However if you take the real value, the commodity value of the quarter’s silver and exchange it, the price is stable.

The main point is inflation does not spread evenly amongst the economy. The ones who print the money receive the benefit of spending it at it’s current purchasing power. The one’s who are hurt by the inflation are the average people who rely on wages. Their money has been in existence the longest and has been depreciated accordingly. Each year that the government prints more money, our costs increase but our wages do not, or do so at a slower rate.

Ask yourself if times seem harder now then you remember them as a kid, or any length of time ago? Are you making more money now then you were ten years ago? Does it seem like, even if you are, your costs seem to have gotten higher? In light of the recent bailouts and extreme government spending, how do you now feel about the debt our country is in? Im sure you do not want to carry the burden of taxes, but do you want to carry the burden of inflation?

The Dollar: Short-Term Strength

Recently we’ve been seeing a lot of commodities dropping in price, oil being the most prominent. There are a couple of really interesting points-of-view on the topic. The question is: why, in this period of economic crisis is the dollar doing so well? One of my favorite economic gurus, Peter Schiff of EuroPacific Capital, says that it is a result of “Deleveraging“.

Peter’s idea is this… because of the financial meltdown and the necessity of financial institutions around the world to meet debt obligations and generally just get back into the black, they are selling off all their assets. Though to be honest i would assume so is everyone else too. Because the dollar is the world’s reserve currency it is liquid and easily handled and still the preferred method of conducting business so as assets are sold and the sellers seek a currency to replace them with, they naturally gravitate towards the dollar. Because the dollar is subject to the laws of supply and demand, as more dollars are demanded the value of each dollar in existence goes up. The effect of the value of the dollar rising results in the more tangible reduction in the prices of commodities in dollar-terms i.e. gas prices dropping.

This is all very common-sense economic application but everyone seems to be very bullish on the dollar long-term which is unfortunately common but not very sensible. because the response to the financial crisis was for the fed to print as much money as necessary to bailout any institution with it’s hand out, (To the tune of over 7 TRILLION dollars as of recently.) we are seeing the supply of the dollar increasing enormously. Once the fire-sale of assets recedes and investors look elsewhere to look to store their wealth naturally, (Investors like to invest, not hold cash.) the demand for dollars will recede. Quite simply when the supply of a commodity increases relative to the demand, the value will drop. When this happens we get our age old foe: inflation.

However this will not be the same old inflation our parents dealt with. There was an uncommonly large spike in demand followed by and uncommonly large increase in supply which is about to be followed by an uncommonly large DROP in demand resulting in an uncommonly large DROP in value.

The true fear is that as the value of the dollar falls, more businesses will fail requesting the fed to print more money to bail them out, resulting in a snowball effect. This could possibly be followed by the realisation that the dollar is not as stable as it once was and central banks and governments around the world will begin replacing the dollar with other reserves. That would spell the end of the dollar. This is of course a doomsday prediction and it is reasonable to assume that the process would be smoothed over to some extent but make no mistake, the dollar is in trouble and while the crisis may not be biblical in proportion, the average Amercican family would not require much more weight on it’s back to break it.

Who gets to play god?

So you wanna bailout the auto industry. Namely the big three.

Why?

Besides their own obvious personal reasons for not wanting to go into bankruptcy… How are they trying to convince the American public and our elected officials in congress to agree? They say they are too big to fail. Too many people work for them, too many support industries rely on them etc.

But what exactly determines too big to fail? If we leave that determination to the businesses themselves, of course EVERYONE is too big to fail because EVERYONE is going to want a government handout. So we cannot let the business owners themselves be the decider of their own status of “too-big-to-fail-edness”

Can we let our congress make that determination? Perhaps, indeed that is how we are currently handling the situation. But what qualifies congress to make such decisions? They are not all economists and surely if they were they would disagree on certain points. Furthermore, they are going to have to make a determination of the definition of “too big to fail”. Simply by saying yea or nay they will set a prcedent and all future requests for government bailouts and bridge loan will be measured by this precedent. So in essence they will be defining the term.

Say they in fact eventually decide to grant the bailout. Let’s say they grant it because of the mass of unemployment that would follow a collapse of the companies. There could be many reasons why but we we will focus on just this one here. I don’t know exactly how many employees the big three have or how many peripheral industries support them and how many employees they have but lets just call that number: “total number of employees” or “TNE”. So that number is now the precedent and benchmark of how big a company has to be to be called “Too big to fail”. Excellent now we know what we’re doing, and congress has saved the economy.

But wait… what about this other company/industry that has found itself in a quandary and is in dire need of government money. The only problem is, they only have “TNE” minus one employees. Do we just say sorry and let them fail because they do not meet the requirements? What if they had five fewer? Five thousand? fifty thousand? How do you justify giving the money to one and not the other? And, as soon as you do, how do you not justify giving the money to yet smaller companies? If you granted the money to a “TNE minus five thousand” company how can you justify then not giving the money to a company with five thousand fewer employees that that company?

It gets ridiculously confusing and no doubt to make such determinations our government will creates enormous new bureaucracies and raise our taxes to pay for them. And they will all fail. Because a person or group of people cannot rationally predict how an economy will work precisely. You will fall into calculational chaos trying to determine the definition of “too-big-to-fail”.

When you finally reach the point when you give up you will realize that there is no definition. If a company is failing… it is failing. Either by poor management or a shrinking market or whatever the set of circumstances that company is not healthy. The free market is not an economic system… it is human nature and is irrepressible no matter how hard we try. If a company is failing it is because human nature could not support it and no measure of government assistance can mend that sustainably.

Privateering in Somalia

What an interesting news story, contemporary Jack Sparrows and Blackbeards prowling the waters of the Indian Ocean have struck gold to the tune of two million barrels of oil. (approx 100 million dollars worth by today’s prices). This apparently is an escalation in response to an increased number of N.A.T.O. and U.S. warships patrolling the waters in response to a pirate attack on a Ukrainian ship carrying military weaponry including tanks two months ago. At first glance it might appear to be a lazy move by Somalian mercenaries to grab some quick cash… after all isn’t Somalia that broken-down hell of a country wracked by civil war we watched re-imagined in HD in Black Hawk Down? Well yes, but the pirate’s storyline is quite interesting nonetheless and requires a deeper look.

When the country’s government failed in 1991 and the society slid into civil war, a vast fleet of Somalian fishermen we’re uniquely stranded. Without a legitimate government, the fishermen lost the property-rights to the 1800-mile stretch of coastal waters… at least in the eyes of the developed world. Foreign fishing fleets came in and began industrial fishing on a scale the Somalians could not compete with. It is interesting to note that the Somalian pirates target South Korean ships as the Koreans were among the first and most ambitious invaders into the rich Somalian fisheries. Thus the ex-Somali fishermen decided to put their seafaring skills to other uses and began confronting foreign fishing ships and demanding a tax for the right to harvest the fish. This eventually evolved into outright piracy once Somali warlords realized the potential profits in the venture; thus resulting in the pillaging and plundering any scurvy shipper who dared to enter their waters.

This sets up an interesting inquiry into the nature of property rights on the high seas. International law allows for states to lay claim to an economic zone 200 nautical miles of the coast of their respective landmass. When the Somali state failed, their claim was null and void. Or was it? What is the true measure of the legitimacy of a claim? The ability to back it up.

Because they still had guns, they could still make a claim regardless of the removal of international laws from the picture. In both the presence and absence of law, force is law. The question to ask is this:

“What difference is there between a Somalian pirate demanding a fee for fishing or trespassing along his ‘claimed’ waters and any other instance of using force to acquire or retain natural resource rights?”

Now let it be known i do not condone kidnapping or piracy or any other form of using force to advance one’s own agenda. But because of that I see parallels between what the Somalis do and what our own country and indeed every country in the history of the world has ever done when it used force to legitimize claims on natural resources.

All i’m saying is that when you see a story like this that seems so savage, take away the names and places and consider just the situation. Think critically about were you may have seen similar situations before. Maybe you won’t find any… maybe you will find more than you’d like to.

An open letter to the world…

Much of what you know about economics and indeed life in general can be divided into two categories:

1.) The information that you have learned from various conventional, bias sources.

2.) The common sense which I hope and believe you posses.

I just want to open your eyes to other possibilities. Challenge authority, question dogma, ask yourself what you believe. The purpose of this blog is to inform not by static writing but by sparking curiosity to move you to learn more and better yourself.  Not every post is about economics but economics is about everything.

Oh, and why is it called snuffs?

I will, for this blogs one year aniversary, explain the reason… if it lasts that long.