Sunday, August 08, 2010

Inflation the Path to Future Deflation

There are two ways a government can tax. The obvious way is with taxes, and the other way is by printing money. We hear all of this hoopla of “Tax the rich.” I can’t quite figure that one out. First of all if you’re rich, you don’t need to work and there isn’t much the government can tax except for your toys, like mansions, fast cars and yachts. Now if you’re earning quite a bit of money, then the government could get a good share of it. Of course that’s assuming that you’re dumber than a sack of rocks.

Here is a quote from the WSJ by Arthur Laffer
Just look at Sen. John Kerry’s recent yacht brouhaha. He bought and housed his $7 million yacht in Rhode Island instead of Massachusetts, where he is the senior senator and champion of higher taxes on the rich, avoiding some $437,500 in state sales tax and an annual excise tax of about $70,000.
(WSJ Aug2, 2010 page A13)

The government can try to levy a high income tax on the rich, but it will fail miserably. A tax accountant knows all the loop holes that the rich can use to their advantage to avoid taxes.

Inflation is one invisible tax that gets into everyone’s wallet. The eerie thing, is the poor (those living from paycheck to paycheck) never really experience the full blast of inflation. Those saving for retirement get hit the hardest 20 years down the road.

Figure an average taxpayer paying 20% in income taxes. His savings is being taxed by inflation rate of about 6%. Neat! huh? And the ├╝ber rich, with bundles of dollars in the bank, are being taxed while they sleep. In 12 years they will have lost half their purchasing power from inflation alone. Of course if you’re unemployed and broke, you’re not very concerned about taxes or inflation.

In a depression unexpected things happen. Increasing tax rates brings in less revenue. Plus unemployed people generate less tax revenue. At this point, the government has to print more dollars to cover the short fall. It is the same with private business, the fixed costs are still there, the profit isn’t. This is where the herd gets thinned out, only the strong survive. Private enterprise can’t print their way out of this mess like our government can.

The quasi appearance of deflation will show up in items that we can do without; fast food, cable TV, Internet, sports tickets, advertising. The reduction in price of a taco at Del Taco from 59 cents to 39 cents is the final step before bankruptcy---sell them a taco and hope to make a buck on the soft drink. What we are looking at are institutions, that relied on a wild spending economy, to survive. Business models are collapsing. Can a basketball team afford to pay a superstar 16 million if the fans and advertising drop 50 percent? Do we need a Starbucks coffee shop spaced every half mile?

And with public services, we found out here in San Marcos what happens when everyone got together and cut down on water use during the drought, we got charged more for consuming less!

The real thing that bothers me is that the country as a whole is oblivious to the fact that the national debt is drastically out of whack. It’s the concept; “We did it yesterday and it worked, let’s do it again today.” Collectively we have 17 trillion in savings, and the government has borrowed and spent 13 Trillion of it. This is one of those plans that work until it doesn’t.

The deflation that we seem to be experiencing is coming from over capacity. Too many homes, too many restaurants, etc; lack of consumption is about to fix that. The inflation out there is real. My paycheck is buying less and less every day. The neat thing about inflation, the government doesn’t have to collect it as they do with taxes. Inflation generates more taxable income. The government finds it easier to pay off hard earned borrowed dollars with inflated ones in the future.

Real deflation (massive debt destruction) is still possible with this out of control unfunded government deficit spending. All it would take, is for interest rates to hit 8% and Uncle Sam would be insolvent; the national debt bubble would pop. Vaporizing 13 trillion in debt would be equivalent to what happened during the Great Depression. So its full speed ahead, the national debt be damned. We’re not sure where we are going, but we’re making excellent time.


Tyrone said...

This is one of those plans that work until it doesn’t.

I say that a lot about out-sourcing jobs overseas, offering incentives to house "buyers", etc.

Jim in San Marcos said...

Hi Tyrone

The thing that bothers me, is that we the people get to pay for this lack of common sense.

We ought to strip these congressmen of their salaries until they fix it. Of course, that will never happen.

Ohio Loan Officer said...

You are right onabout the fast food restaurants --- look at all of the "Dollar Menus" they all have now. I was reading where franchise owners of a lot of chain restaurants are having a tough time because dollar menus are a money loser. But they have to do it. I have seen inflation on the Dollar Menus lately however--- several have raised the price to $1.29.

Bob Barker said...


Here's the thing. It's pretty simple. For all these years we have had inflation in "good" things and deflation in "bad things.". Mean reversion, as always, is a bitch and now we're getting the opposite. And it's bankrupting the world. The only solution is to write off all the bad debt and start over, which of course is massively deflationary and political untolerable. So we'll just keep rearranging deck chairs on the Titanic. Nothing to see here, move along.


Anonymous said...

I've got all the bases covered.

Deflation = I'm hoarding two $20 bills and four $5's, which I've carefully hidden from the authorities in my rural domicile.

Inflation = 1 roll of authentic USPS "Forever Stamps" (bought at former price of 42 cents per! KaCHING!).

El Scorcho

Anonymous said...

I guess the best place to be is unemployed and broke. Nothing to lose or stress about.

Jim in San Marcos said...

Hi Ohio Loan Officer

The 1.29 burgers are a loss leader. Setup on a soda is about 20 cents and that's where they make their money. You have to admit that 29 cents is one hell of a price hike.

Of course with all the farmers growing corn for our cars instead of beef, I can see why we are paying more. These government programs turn everything upside down.

In our area, I don't see how we can support so many fast food places. Of course when I sold real estate, some of the kitchens were smaller than closets. Boiling water on a stove could be a lost art;>)

Jim in San Marcos said...

Hi Bob Barker

I agree. The only thing that bothers me are the people with savings in the bank. They will take the hit.It's the oldest section of the population--it takes time to save money.

It's going to happen, and as you suggest rearranging the chairs is an exercise in futility.

We will survive, but you're going to have to work hard for those new dollars when we start over. Boy, I'm so excited I can hardly wait;>)

Jim in San Marcos said...

Hi El Scorcho

Everything makes sense when you smoke the good stuff.

I recycle my stamps--a teaspoon of bleach to a cup of water. They are not "forever" if you use too much bleach.

I'm not sure where two twenties and four 5's will get you, but my best guess is three pizzas if you have the munchies.

Take care

Jim in San Marcos said...

Hi Anon 7:33

I guess the best place to be is unemployed and broke. Nothing to lose or stress about

You must be young; at my age, that sounds like a nightmare.

RobertM said...

The Automatic Earth was just discussing inflation yesterday and I agree- deflation it is.

As far as the national debt is concerned, I don't worry about it. We will either fix it or continue down the same road -the more likely scenario- resulting in another great depression, in which case, all but the billionaires are screwed.

AIM said...

We have stagflation, deleveraging and low demand for credit. That is our current scenario. It's a weird mix.

Food, energy, education, other staples are going up in price.

A little bit of this, a little bit of that. As I said, it is a weird mix.

Bernanke doesn't care about CPI or prices going up. All he cares about are asset prices. He's for the banks and big business (the power elite).

The unethical and shortsighted actions of our leaders will run us into a brick wall. We're pretty close to impact now.

Anonymous said...

Think about this for a moment.

We are in a soft depression now, a Japan-like situation. The deleveraging, saving, defaults, foreclosures, bankruptcies, etc. are all slowly unraveling and will continue this for a very long time. Yes, there is a mix of things like the other poster said (stagflation, etc.) but the general flow is deflationary.

What if the Fed really did go heavily into quantitative easing (printing money to buy treasuries so the government oould handle its deficits)?

The inflation fear could really kick in and people will want to get rid of dollars. Consumer and asset prices will shoot up. Bonds will collapse. Deficits will no longer be able to be funded. A Volker type would have to come in to restore faith in the USD and The Fed. Major interest rate increases to get ahead of inflation would need to be imposed. Those rates would send the economy into a tailspin of deleveragin, debt cancellation and depression. (Remember when Volker did it we had the worst recession since the Great Depression. And that was without QE, derivatives, subprime, trade deficits, trillion dollar govmt deficits, housing bubbles and all the other crap going on now. The next downturn would be much worse. The effect of printing trillions would probably be the cause of an even deeper depression than the current one that the authorities are trying to avoid. We'd wind up back where we are now but instead of a soft depression and murderous one.

I don't think they'll inflate. They are powerless and have painted themselves into a corner. The market and the economy and all of their past sins and oversights are in control now.

Plan on a long soft depression.

Jim in San Marcos said...

Hi Anon 6:59

I don't see any Volker type rescue.

We haven't seen any massive debt destruction. I would a consider a government walk-away from Fannie, Freddie and the banking system as an example of massive debt destruction. The Federal Reserve (off the books) and the government will borrow to make good on every bad debt.

The government has printed money to cover all of this and it didn't come from income taxes.

The major problem facing the government is that if the interest rate went to 8 percent on 17 trillion dollars (national debt), that would be 1.35 trillion in interest payments. That's about what we collect in taxes in a year. Of course you could add in social security payments and get to 2.5 trillion in collections. But the budget is over 3.5 trillion.

If the government can't pay the interest on the debt at 8% interest, your cash in hand becomes worthless. At that point they can't borrow any more, the game is over.

The government is borrowing and spending like crazy. The Federal Reserve probably has probably printed between 4 to 10 trillion dollars in under the table money.

The government is inflating like a mad hatter. Ask yourself one question, if we the people can't afford health care in old age, how does it become more affordable if the government handles it? Remember the $2,000 toilet seats and the $12,000 coffee pots for the military?

We have inflation, gas, cigarettes, potato chips and steaks have doubled in price. Nobody is charging more for them, the dollar has lost it's buying power.

At some point the Social Security, Health care and interest on the debt will be too great to paper over. The 8% interest rate seems to be the trigger for financial ruin and massive debt destruction.

At that point we won't have fools running around promising unlimited health care to the silver foxes, it is impossible to foot the bill.

Thank you for your comments and bear in mind there is no right or wrong here, just conflicting opinions. Take care.

Jim in San Marcos said...


I don't see a brick wall, I picture it this way: they walk you up the stairs (inflation), put a bag over your head with your hands tied behind your back, a rope around your neck and then you drop (deflation).

Of course, if you are a Democrat, the car and brick wall analogy works great, the ambulance will come to your rescue, save you and make the Republicans pay for it (I'm just joking, I couldn't resist).

Anonymous said...

Another very logical argument for inflation.

Tomorrow there will be a very logical argument for deflation.

The debate continues. Those intelligent economists versed in the fundamental laws of econmics and economic history (and free from bias, special interests and false data) should be able to determine what the true outcome will be. The only question is who and where are those intelligent economists?

AIM said...

I see it thusly... we have a deflationary phase now in some aspects which is balancing or keeping a damper on high inflation. It won't last for long because soon what Congress has done (recently and over the last 50 years) will finally blow up in their faces and they will ask for quantitative easing from the Fed (they'll print and loan them the money). The government will be a needy and willing borrower and the Fed will be a happy lender. Then the currency will be destroyed.

And for those fortunate to have some net worth, an investment portfolio and some liquid cash reserves (probably 10-20% of the population) the big trick will be turning their cash and currency based investments and holdings into hard assets (income properties, gold, commodities or whatever). Knowing when and how to do that successfully will determine if that 10-20% retain all or the majority of their wealth/savings or if they fall down into and join the other 80% of the population... who will be poor and disenfranchised.

I happen to be in that 10-20%. I've put a small real estate portfolio together and also have a large amount of cash (and I'm continuing to build up that cash via short term real estate projects... remodeling and reselling single family houses).

I'm studying and strategizing all the time and preparing myself for the big switch to QE so that I get out of the USD before my "cash doesn't turn to trash". The trick is pulling the switch at the right time.

Altho (with the rhetoric, bombast and false info from our politicians and media being used for cover-up combined with the stealthy, insidious and hidden movement of inflation), sometimes I wonder if right now is the right time?!

Jim in San Marcos said...

Hi Anon 3:47

Thank you for the link. I don't think we need to find an intelligent economist, they are not going to be of much help. Greed got us into this mess. It was easy to see it coming if you stood on the sideline. The participants couldn't pick the money up fast enough. Now we have a mess. It's going take a long time to repair the damage.

Jim in San Marcos said...


I don't see where we can switch currencies, every government in the world is playing the same game.

As for when it will happen, it's hard to say plus the government can change the rules at any time which is rather unnerving.

I think you're well set to ride it out. Knowing where the life boats are is half the battle.

AIM said...

Clarification: I didn't mean switch out of the USD to another currency. As we both know, there is nothing but fiat money in every other country too. I meant switch out of cash into hard assets.

There will come a time when inflation takes off and those with cash who didn't prepare a plan will have to move fast and buy anything rather than hold cash. And I mean anything.

Tyrone said...

We haven't seen any massive debt destruction. I would a consider a government walk-away from Fannie, Freddie and the banking system as an example of massive debt destruction. The Federal Reserve (off the books) and the government will borrow to make good on every bad debt.

The government has printed money to cover all of this and it didn't come from income taxes.

Where have I heard this?? Oh...

FOA wrote back in April of 2001,
"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! Worthless dollars, of course, but no deflation in dollar terms!"


Jim in San Marcos said...

Hi Tyrone

If I can count you, that makes three of us that see inflation coming. I guess it's a start;>)

Who is FOA and how did you pull a quote from 9 years ago that follows the same thought flow? Was he addressing a future issue he foresaw at the time? This printing of money today, wasn't an obvious issue at that time.

Thank you for the quote.

aim said...

Hey Jim,
You can count me in as well. In one of my earlier posts I stated that we have stagflation (inflation and slow to no growth). Prices of food, energy, education and other staples are going up. We also have deleveraging, defaults, bankrupticies, downsizing and low demand for credit (giving the appearance of deflation). Deflating assets isn't monetary deflation.
Tyrone is right, we can't have deflation if a government can print dollars whenever they think it is needed. Trillions in dollars and credit have been created by the Fed. It just hasn't gotten into the real economy yet. When the newly printed money hits the money supply and the lending starts taking place we will then experience the hard hitting inflation we are all fearing (and should be preparing for). You know how it is... everything is dry and good, someone pulls their finger out of the dyke and... "hey what happened, we and everything is soaking wet and it all happened overnite?!" (inflation).

frakrak said...

Hi Jim, your analogy regarding the gallows "hit the spot for me." I am guessing (since the West has been in near constant inflation for decades) is when this goes hyper-inflationary, and when the lever gets pulled:-)
The only downside I can see here is that your Fed may have to print money for the rest of the world, meaning a few smallish defaults in some far flung corner of this global mess, could pre-empt everyones timing.
Could an analogy be done using Viagra and prozac??
cheers from me

Tyrone said...

FOA is 'Friend of Another'.
A, is, of course, 'Another'.

These gentlemen posted anonymous comments at probably the only Fiat/Gold/money forum on the web in the late 90's and early 00's. Their basic message was that significant monetary change was coming, and that gold was basically free at those prices. They were/are staunch believers that the US$ hegemony was coming to end. Who were they? I don't know, but reading their stuff today, they were g** d*** genius' in their day. You can find that archive at The Gold Trail.

If you want to participate in the analysis of their writings and discussions of the ongoing, world-wide battle for monetary control, I recommended visiting FOFOA, 'Friend of friend of Another'.

You could start reading FOFOA at the beginning, but one of my favorites is Greece is the Word. In the comments of that post, you will find the '01 quote I mentioned previously.

Tyrone said...

I responded to your question, but my comment gets deleted; it happened twice. Blogger seems to be fine. I was able to see the comment posted, briefly, before it went away. Not sure if you disapprove of the response, or if I'm blocked/banned, or blogger is broken.

Jim in San Marcos said...

Hi Frakrak

Glad you enjoyed the analogy. I think we will see this hyperinflation playout in some of the smaller countries first. It should be quick and mean.

Viagra and Prozac I'll work on. A while back I compared the plight of the home owner to a baseball player on Viagra, ex-lax and steroids--he doesn't know whether he's coming or going, but he's going to set some new records.

Jim in San Marcos said...


Glad to see you on board. If you give it some thought, when we save money we are forgoing consumption today and putting it off into the future. When somebody borrows our savings, they are consuming today. If they don't work to pay it back, (ie the government prints it) there is more crisp dollar bills chasing fewer goods.

If this is deflation, we have to be missing something.

Take care.

Jim in San Marcos said...

Hi Tyrone

I cleaned up the comments, your post is there now.

I found out why your post didn't show. Google has added a SPAM filter and it ended up in there. Not sure why. I released it and its there now.

Thank you for the links

Anonymous said...

There isn't ANY protection against high or hyper-inflation. And in our circumstances inflation is inevitable.

Kiss your cash and dollar denominated assets goodbye (kiss you purchasing power goodbye). All of us with Americans who have managed to build something in our lives (savings and USD denom assets) will soon lose a major portion of their net worth.

There is no other country to run to. No place to hide. Our leaders have really made a mess of things this time and we're going to have to pay the price.

Anonymous said...

In '29 when the stk mkt crashed it took 3-4 years before the stk mkt hit bottom. With Japan it almost took 20 years before its stk mkt bottomed. Quite a divergence. We are following the Japan model to a large degree (altho there are many internal differences in America). It is hard to predict where we are going and how fast we are going there. It appears that the FRB and our govmt will do everything it can to forestall and hold off. With that in mind I think it would be a decent guess to say that the stk mkt will slowly trend downwards as will housing prices over a long period of time. And eventually inflation will break through the deflation that we are currently having.

Jim in San Marcos said...

Hi Anon 2:03

You are mistaken, the Japanese market dropped from 39,000 to about 13,000 way back when. Now it is dropping again. Kind of makes you wish you had your money somewhere else.

Anonymous said...

What about the tsunami of 2013. I wrote my feelings at It's hard to say what's happening but I'm betting on hyperinflation.