Why Politicians Love Inflation

Within the business world there is lots of talk about how we are seeing price inflation in a lot of different commodities.  Recently General Mills, Kraft Foods, Domino's Pizza, and United Technologies said that they will be increasing the prices for their products (http://online.wsj.com/article/SB10001424052702304741404575564400940917746.html).  So I think the question on a lot of peoples minds is...why print more money if it causes prices to rise?  Who benefits from this?

The government loves inflation because over time peoples income goes up with inflation pushing them into higher tax brackets, this means more tax revenue for the government.  But the main reason that government loves inflation is because politicians like to continue to expand government programs yet they lack the spine to raise taxes in order to pay for it.  Why be truthful to the American people about having to raise taxes when you have a Federal Reserve who can print the extra money needed?  This is exactly what they do.  Since the Federal Reserve was created in 1913, we have had a steady decline in the value of the dollar.   Inflation is a hidden tax, plain and simple.  This is a tax that the politicians know they can get away with.  It is no coincidence that public education teaches very little about Finance and nothing about how the Federal Reserve works.  If we were all to learn about how the value of our money is being destroyed we would put an end to it.  They must keep us distracted with T.V shows, Football, Movies, Pornography, going to bars, buying new cars, ect. If they can keep us distracted with materialistic items, and also keep the political focus on Republicans blaming Democrats and vice versa, then they can continue to get away with this 100 yr heist that has done nothing but cause us to work harder and harder for less pay. 

Why do you think back in the early to mid 1900's families were able to make it on just one income?  Is it because evil Capitalists don't pay their workers enough?  Well if this was the case then the average profit margin for corporations should have gone up dramatically over the last 60 years or so.  For those who don't know, a profit margin in plain English means the amount of profit a company makes per dollar of sales.  So if greedy corporations were just trying to keep more profits for themselves instead of paying their employees more, then obviously profit margins for corporations should be going up dramatically in the last 60 years.  But this just isn't the case.  According to the Commerce Department, the average corporate profit margin ratio in 1940 was about 27%, in the year 2000 the average ratio was 29%.  For the 60 years between 1940 - 2000 the ratio stayed between 25-33%.  In my opinion this data proves that  corporations are no more greedy in the year 2000 than they were in 1940.  Yet it is nearly impossible to survive on only one income these days.  The reason that it takes two incomes is because the value of our dollar has been slowly eroded due to the expansion of the money supply. But to be fair, families these days do buy a lot more items that they don't really need...does everyone in the family really need a cell phone?  Do we need a T.V. in every room of the house?  Do we really need a 30k dollar car when a car for 8k would do just fine?  So in all fairness, most Americans can definitely live cheaper.  But even going without these luxuries it is still pretty much impossible to pay for the necessities on just one income. 

Keynesian Economists argue that a devaluation of the dollar is not the cause of needing two incomes to make ends meet.  They claim if you look at the Consumer Price Index (CPI) that incomes have pretty much gone up right along with inflation.  But then we need to look at who calculates the CPI, and what metrics are they using.  The Bureau of Labor Statistics computes the CPI.  And yes, the Bureau of Labor Statistics is a government organization.  The CPI is used to determine how much of an increase Grandma is going to get on her Social Security check.  If the CPI shows we are having say 3% inflation, then next year Grandma is going to get 3% more from her Social Security.  The U.S. government also issues Treasury bonds that are inflation protected.  These are called TIPS (Treasury Inflation Protected Securities).  Here's how these work.  If the CPI shows we are having 3% higher inflation than we were last year, then your Treasury Inflation Protected Security bond will pay you 3% higher interest that year.  So as you can see, the government has an incentive to make the CPI look like it isn't increasing as much as it really is.  If they can manipulate the CPI then they can save billions in interest payments on TIPS and making sure Grandma doesn't get nearly has high an increase in her Social Security payments.  This is exactly what they do.  Sickening isn't it?

The CPI tracks the prices of a fixed basket of goods bought by a typical consumer.  So you would assume that the items always stay the same, such as the average home price, average rent, average car payment, average cost of meat, milk, wheat, corn ect.  Well the government likes to manipulate these items to make sure the CPI stays as low as possible.  For instance, once the values of homes started to rise in the early to mid 2000's, the CPI stopped using the value of real estate since prices were skyrocketing.  What they did instead was replace it with owner equivalent rent.  They used the average price of renting an apartment/home instead.  During this time people were leaving apartments in droves to buy homes.  So the average cost of renting went down since most people were buying.  So while home prices were going up, the CPI actually showed a decline in the area of real estate.  They use the same techniques when it comes to food.  If meat for instance is showing a huge rise in price, they will give more weighting to chicken if it hasn't risen as much as meat has.  Remember back when gas stations had an attendant who pumped your gas, washed your windshield, and checked your oil for free?  Well services like these that have been cut are not taken into account in the CPI as well.  There are other techniques such as geometric weighting, hedonics, and other gimmicks the government uses as well.

People need to wake up to the fact that inflation is not a good thing.  It causes us to work harder and longer hours just to maintain the same standard of living.  It is just like a tax.  We need to have some honest discussion on whether or not the Federal Reserve is an institution for the people, or is it an institution for the government to silently raise taxes.  I believe that raising taxes is the way to enslave the general population.  We are halfway to Serfdom, but there still is a chance to turn this around.  Lets just hope people wake up.

The Fed's Reason for Printing Money

Once again I find myself having to write again about what the Federal Reserve is doing.  Recently Chairman Ben Bernanke of the Federal Reserve has been getting quite a bit of criticism…and rightly so.  Sarah Palin has been in the news the last few days because of her outspoken criticism of the Federal Reserve pumping another 600 Billion into our economy.  She claims that this will cause inflation.  Palin speaking out is a sign that times are definitely changing.  History has shown that there has been very little talk when it comes to politicians and the Federal Reserve.  I think this is mainly because like most Americans, they didn’t understand how the Federal Reserve worked.  Although, Texas Congressman Ron Paul has been an outspoken critic of the Fed for as long as he has been in office.  But his outspoken criticism never really generated much interest from the mainstream media or the public.

I’m sure a lot of people are asking the question, “why is the Federal Reserve printing more money, what do they hope to achieve?”  That is the purpose of what I am writing about today.  In Ben Bernanke’s (Chairman of the Federal Reserve) own words he claims that the printing of more money is going to cause interest rates to decline, which will cause homeowners to refinance their mortgages.  He also claims these lower interest rates will force people to put their money into risky assets (because you will earn less in interest in CD’s, savings accounts ect) causing the stock market to rise (http://seekingalpha.com/article/234822-bernanke-explains-qe2).  This rise in the stock market Bernanke thinks will cause people to feel better about their financial situation and start spending money again.  Since our economy is 70% consumer spending, he thinks if he can get people spending again it will get us on the way to economic growth. 

I think Bernanke is misguided on so many levels.  Lets take it from the top.  Bernanke thinks that getting interest rates .25% lower is going to cause people to refinance their mortgages.  But the facts show that most people who have equity in their homes have already refinanced.  30 year mortgages are already at 4.5%, is 4.25% really worth paying all the closing fee’s to refinance your home again?  I believe this will have little to no affect on the number of refinances. 

Bernanke claims that pumping money into the economy to lower interest rates will force people to put their money into the stock market looking for a higher return on their money.  CD’s are only returning around 1%, high yield savings accounts are around 1%, and corporate bonds aren’t much better.  Bernanke thinks that if he can make the stock market go up then we will see what he calls the “wealth effect.”  Basically we will all feel better that our 401k’s are going higher, which means we will be more likely to go to the mall and spend.  But in my opinion, the way to get out of our recession isn’t about tricking people to spend money.  I thought everyone has pretty much agreed that over-spending is the reason we got into the mess we’re currently in.  We bought homes we couldn’t afford, encouraged by low interest rates caused by the Federal Reserve, and also by exotic mortgages requiring little to no money down.  In my opinion the root of our problem is because our economy is driven by consumer spending.  The cure is moving away from a consumer driven economy to a more sustainable economy driven by manufacturing. 

Bernanke is trying to encourage spending money we don’t have.  This was what got us into the problem we are now in.  We became consumers, not producers.  The Federal Reserve’s policy of trying to spur economic growth by “tricking” us into spending money will only exacerbate the problem.  This is what Washington does best, it kicks the can down the road.  They can’t tell us the truth, if they did, we would realize that we have to cut spending dramatically.  While this is the tough medicine we need, it virtually guarantees that the incumbents in Washington will be voted out.  It will be obvious that their policies have failed, and they would pay a heavy price at the ballot box.  If there is anything that I have learned about politics, it is that Politicians love power and they are willing to do almost anything to keep it.  Convincing the public that everything is fine gives them the best chance to stay in office.  While the Federal Reserve might succeed in prolonging our day of reckoning, mark my words, the day of reckoning is coming. 

So where do we go from here?  We need to become a nation of producers once again.  That means DRASTICALLY removing regulations so businesses can return to the United States.  Everything from taxes, red tape, to environmental laws must be repealed.  I don’t pretend to have all the answers, but I do have common sense.  About 75% of our budget here in the U.S. is Defense, Social Security, and Medicare.  Another 8% is interest on our debt.  The politicians can talk about cutting pork barrel projects, but this is just political satire.  It will do pretty much nothing to get us out of the mess we’re in.  In my opinion we need to completely abolish Social Security and Medicare.  We must encourage market based solutions to these programs.  Freedom is not giving a portion of every paycheck to the government and then expecting them to take care of you once you retire. I do believe we should continue to pay full benefits to anyone within 10 years of retirement.  But after that it must be completely phased out and fast.  Personal responsibility means we need to save throughout our working lives in order to be able to afford our retirement and medical bills.

Medical bills would come down drastically if our doctors weren’t billing insurance for the treatments we received, but were billing the client directly.  Because we know our health insurance will cover our treatment, we don’t shop around for which doctor has the best prices.  In this type of environment, of course doctors are going to jack up their prices if they know there is no risk of losing the customer.  Medical insurance needs to be more like fire insurance, you only use it in unforeseen emergency situations.  This would keep medical insurance premiums extremely low since it would very rarely be used.  With low insurance premiums everyone would be able to afford it.  With over half of all bankruptcies being caused by unforeseen medical issues I believe this type of insurance would help dramatically.  Standard medical costs will also stay under control since consumers would seek a combination of the best doctor for the best price.  In this environment a doctor would not be able to jack up his prices without risking losing customers.  Can you imagine how much auto insurance would cost if every time you went to get an oil change they billed your auto insurance company?  There is no difference between this and the doctor billing your insurance for a standard check up.  While much more discussion and thought is needed in this subject, I believe it is a place to start. 

Do we really need over 150 military bases stationed across the world?  If that isn’t a military industrial complex I don’t know what is.  Can you imagine if Russia had a military installation in San Diego?  Or how about China having a base in Atlanta?  I would be pretty pissed off.  I’m sure this is how most of the world feels about our military bases throughout the world.  It’s time to pull our troops out of all of those countries and secure ourselves and our borders at home.  Our military budget for the year is over $750 Billion.  This could be cut dramatically by bringing our troops home from around the world.  Some of those troops can be used to secure the Southern Border, the rest could be discharged and used in a more productive capacity in the private sector work force.

We can either start to put these plans into action NOW or wait for the crisis to hit.  If we wait for a crisis to take action, odds are the solution will be more government intrusion and control of our lives.  I don’t see our bond market holding up any longer than 2 years if we don’t take action.  Let’s make the hard decisions now, or risk the International Monetary Fund (IMF) and George Soros making them for us.

Understanding the Federal Reserve

Today the Federal Reserve announced their highly anticipated program that Wall Street calls QE2 (Quantitative Easing 2).  The Federal Reserve said today that they will buy 600 Billion dollars worth of treasury bonds, they also said they would re-invest 250-300 Billion in proceeds of bonds they purchased with their first round of quantitative easing (QE as they call it on Wall Street). 

The first thing I want to explain is what the role of the Federal Reserve is and how it accomplishes this.  Most Americans don’t have a clue what the Federal Reserve is or does.  This is intentional; I received my Finance degree and only learned briefly about the Federal Reserve.  The Federal Reserve is a quasi-government organization that is comprised of un-elected officials that are appointed by the President of the United States.  The reason it is a quasi government organization is because nobody really knows who owns it.  It is supposed to be watched by Congress, but Congress for the most part is not allowed to look at the books of the Fed (short name for the Federal Reserve).  There was a bill that Ron Paul (R-Texas HR 1207) brought to the floor that would have forced the Fed to open its books up to Congress and the public.  This bill (HR 1207) was sponsored by over 300 members of Congress.  Funny thing is, once Ron Paul brought this Bill to the floor for a vote, the bill didn’t pass…hmmm.  With over 300 sponsors this should have passed with ease.  So what happened?  Well there must have been some back room deals going on, because about 117 Congressmen who sponsored the bill ended up changing and voting against it at the last second.  By the way…all 117 sponsors who changed their vote were Democrats (see this link for the list http://florida.tenthamendmentcenter.com/2010/07/hr-1207-hall-of-shame/).  Politics is truly a dirty business. 

The Federal Reserve has 2 main goals: to maintain price stability and full employment.  Now how does the Fed accomplish this?  They use the FOMC (Federal Open Market Committee).  The FOMC is the policy making arm of the Federal Reserve.  They meet 8 times a year to discuss the current market conditions and then decide what to do.  The main way that the Fed tries to manipulate the economy is through the Federal Funds rate.  This is the rate that banks charge each other to borrow money.  The Fed controls the Federal Funds rate by effectively printing money.  It is basic economics.  If there is more money floating around in the economy then banks have more money to lend.  If banks have more money to lend, then supply and demand tells us that interest rates will come down.  This is known in Finance as the Loanable Funds Theory.  So with the Fed lowering interest rates this leads businesses to want to borrow money to grow their businesses.   This also leads regular people like you and me to put our money in the stock market since our money is earning basically nothing in interest at the bank.  This is the way the Fed tries to spur economic growth, by effectively forcing you to take risks with your money.  With all this new money going into the stock market asset prices rise.  Only problem is…this is just paper wealth, the real economy hasn’t really gotten any better.  People just feel a little better seeing their portfolios rise.  Now if businesses take out loans to build factories, this can lead to jobs.  But these are typically temporary jobs since eventually interest rates have to rise or we will see massive amounts of price inflation.  Eventually these factories have to lay off people.  This is the cause of our boom and bust economy.  It is basically the Federal Reserve that causes these bubbles.

Now I want to explain a little about how the treasury market works.  Wall Street likes to use big words to make us feel stupid.  That way we need to pay gigantic fees for their advice.  Well trust me, it’s not that complicated.  The basic concept is the government needs cash to finance its day to day operations.  They do this by issuing Treasury Bonds.  They range from short term to long term, and go out as long as 30 years.  If you would like to purchase these bonds you can do so through the Treasury department directly at www.treasury.gov (though I highly recommend NOT BUYING THOSE).  So the Treasury issues these bonds to the public and also institutional buyers.  Mainly China, Russia, and Japan are the buyers of these bonds.  So essentially they are the Bankers of the United States.  Now as you would expect, our economy looks pretty shaky right now, so these Countries are becoming more and more worried about buying our debt (loaning us money).  Well what happens when creditors become worried about the credit worthiness of the borrower?  They demand a higher interest rate for the increasing amount of risk.  That is exactly what is about to occur and the Fed knows this. 

So now where are we at today?  The Federal Funds rate is at an all-time low of zero (officially the Federal Funds target rate is 0-.25%).  This is an all-time low.  But businesses and consumers still are too shell shocked to borrow money or put their money back in the stock market.  The economy still appears to be on the brink of collapse.  Our creditors (China, Russia, Japan) see this and are starting to scale back the purchases of our bonds (or in other words they are scaling back loaning us money).  Well with less people interested in buying our bonds, interest rates will have to be increased by the Treasury in order to compensate these countries for the extra risk.  But can you imagine how our economy would react if interest rates started to go up?  Think of how bad the housing market is right now, now think how bad it would be if a 30 year mortgage rate doubled from 4% to 8%.  This is why the Fed came out today and said they will be purchasing 600 Billion dollars worth of Treasury bonds over the next 2 quarters.  They are trying every trick in the book to keep our interest rates where they are at. 

Only problem is that this extra money WILL lead to price inflation.  It is just a matter of when.  This will devalue the dollar.  The Federal Reserve has a mandate that they are supposed to maintain price stability.  Well, since the Federal Reserve was created (1913) the dollar has been devalued by over 97%!  How’s that for price stability?  Their other mandate is to maintain full employment.  Employment rates are officially 9.6% in the United States, but if you count all the people who are too discouraged to look for work that rate goes up to about 17%.  Any way you look at it the Federal Reserve has been a colossal failure. 

Over the last 2 years the Fed has pumped 2.5 trillion dollars into the system to try and keep housing prices from coming down and interest rates remaining low.  This will create a massive amount of price inflation.  We are already seeing it in the prices of essential items like food and energy.  It is a shame that for the last 100 years there has not been a safe place to keep your money.  If you want to keep your money in the bank, it will be devalued by the Federal Reserve.  This forces you to put it into the stock market, real estate, or other risky assets.  The older generation is really susceptible to having their money devalued by falsely thinking it is safe inside a bank.  Bill Gross (largest bond fund manager in the world) recently said that with the Federal Reserve’s announcement of QE2 that the dollar will be devalued by 20%.  That means the money you have in the bank will be worth 20% less most likely within about a year. 

Prices soon will start to rise.  Look for it first at the grocery store and at the gas station.  The first thing our elected officials are going to do is start demonizing the Oil companies for raising prices.  They are going to blame speculators, such as myself, for causing the price of food and energy to go thru the roof.  This is because people like me will try to protect ourselves by buying commodity futures (this is basically a leveraged bet on the price of oil, gold, silver, wheat, ect increasing).  The reason prices rise is because traders closely watch the amount of inflation and start buying real items such as oil, wheat, gold, silver ect when they see the government being irresponsible with our monetary system.  So while the Federal Reserve and our elected officials overspending will be causing the increase in prices, they understand that the American people are not educated in Finance.  They can easily deflect public anger away from the real cause and blame Capitalism and Wall Street greed for the reason there is a rise in prices.  Don’t fall for this.  Get prepared yourself by only having enough cash in the bank for an emergency and start putting your money in real items such as exchange traded funds that are backed by silver, gold, oil, agriculture ect.  Yes, there is a risk to investing in these items.  But there is also a higher risk of having cash in the bank as long as you have a reckless Federal Reserve and politicians hell bent on spending our way out of a problem caused by over-spending.