Saturday, February 26, 2011

Inflation, “Painless Taxation”

Inflation concepts are not taught in school, it is just something we are told to live with. Historically, it has ranged between 3 to 12 percent. Prices increase and employers raise pay rates to offset it. It lends to the perception that you are moving up with each “pay raise.” Notice as you “earn more” you tax rate increases accordingly. Congress doesn’t need to raise the bar, inflation did it for them.

What is inflation? In simple terms, it is the government printing money instead of taxing the people. But there is more to it, than that. In a normal economy we produce 100 widgets and get paid 100 dollars. You get a dollar for each widget. If the government needed 50 widgets, they would print 50 dollars, purchase them, and then consume them. Then there would be 50 widgets left for consumption and 150 dollars chasing the remaining widgets. The net effect is that widgets have jumped in price to three dollars apiece. This is what inflation is all about.

Inflation is too much money chasing too few goods. When Spain brought tremendous amounts of silver back from the new world, inflation took off. This was “real money” but there wasn’t any product to match to it, prices increased dramatically. The same thing is happening here. We get paid money for making product. When dollars are printed, the product is still consumed, but now there are more dollars chasing fewer products. The government can print money, but they cannot print food, energy, and housing. Government consumption, by way of food stamps and unemployment insurance, makes goods scarcer for consumption and prices rise.

The government taxes about 20% of our earnings through income taxes. With inflation there is no government paperwork. Let’s say you were lucky and saved up a million dollars before retirement and it took you 20 years. In this case, inflation is an invisible tax, you haven’t lost any dollars, but your dollars have lost half of their purchasing power. The government’s printing of money has confiscated half of your bank savings. The reason this government game works so well, is that the average person has a complete disconnect, between the concept of the real purchasing power of the dollar, and the apparent value of their savings. Their dollars are all there, nothing is missing---shhh, no need to upset them.

The politicians want to tax the rich; I suggest they are already doing an outstanding job of it. The sky rocketing ascent of the national debt is proof enough. Inflation is rampant if you include food and energy. We will see a dramatic loss of our purchasing power over the coming years. You won’t lose one dollar, but a dozen eggs could cost 12 dollars. Naturally, there will be a Congressional investigation into the chicken farmers gouging the public.

The thing that ought to make everyone angry is that inflation is stealing from those that saved a lifetime. You save hard earned money only to have the government make it worth less over time. Inflation is not perceived by our youth, it takes time to experience the reality of it. But, to those about to retire, they have experienced its effects. The silver foxes can see what it has done to their retirement savings and their plans for the future. Mention any of this to a Congressman and he’ll look back over his/her shoulder to see who you are talking to,--it can’t be him.

What’s next, ten dollars for a cup of coffee? -- And a dollar for cream and sugar? Of course with Obamacare, maybe I can get my doctor to write me a prescription for Bacon and Eggs with Coffee and OJ ( I have a $10 co-pay on prescriptions). That’s an inflation pill I can swallow.

21 comments:

Musgrave said...

Nonsense from start to finish.

First, my two dictionaries of economics do not define inflation as “government printing money” (although that definition was popular twenty years ago). They define it as “rising prices” or words to that effect.

Re the second para, where does the 150 dollars come from???? Presumably the government has printed 200 dollars, but you omit to mention this.

As to the idea that inflation is closely related to the money supply, this is just NOT BORN OUT BY THE EVIDENCE. Governments tried to control inflation by controlling the money supply up to about ten years ago. It didn’t work. With the exception of lunatic regimes like Mugabwe where the money supply doubles every week, the relationship between the money supply is tenuous in the extreme.

“Inflation is too much money chasing too few goods”. That is nonsense. Inflation is caused by excess DEMAND. That demand can easily come from an increased velocity of circulation of money, while the total stock of money remains constant. And velocity can change dramatically.

Jim in San Marcos said...

Mr Musgrave

In my example, 100 widgets were produced, and the producers were paid 100 dollars. Instead of widgets lets say it was 100 bushels of grain. The government went in with 50 printed dollars and bought 50 bushels of grain and gave them to the poor. There are now 50 bushels of grain left and 100 dollars in real claims. There are now 150 dollars chasing 50 bushels of grain.

Lets take the example to an absurd level. Every farmer in the world stops growing crops and will wait for the government check to buy food. You will starve to death.

When the government prints too much money, don't assume that the shelves in the stores stay full and prices rise, the shelves will be empty. When inflation gets bad, the producer cuts out the wholesaler and doubles his profit. At that point, the consumer starts hording and it gets worse. Bartering works. Currency only gets rid of the inconveniences associated with bartering. Toilet paper and soap become currency when the presses are turned on.

Reagan didn't destroy the Soviet Union, they did it to themselves with a printing press.

To extend my example one step further, if the government instead of printing money had taxed the widget producers at 50%. The government would still have 50 widgets (grain) to distribute to the poor, there would be 50 widgets of supply and 50 dollars of claims to product in the system and no inflation.

The only problem right now, is that the government is doing both, printing and taxing.

Tyrone said...

I just paid $3.85/gallon to fill up my car.
I feel gouged.

Cheers!

Anonymous said...

I think you have it a bit wrong JimInSanMarcos. Increasing dollars per product is just a symptom;;; the Fed printing is not the cause (especially since currency is only 5% of the money supply, it is really credit that contributes to the phenomenon of inflation). But these are all symptoms or consequences, not the cause of inflation. The cause of inflation is CONFIDENCE. It is a human emotion that drives inflation/deflation. The sentiment towards the currency. If the majority of a population consider that the dollar is valuable they will hoard it (deflation). If they think it is not valuable or losing value they will spend it quickly to exchange it for something tangible to aid them in the future (inflation). It is CONFIDENCE that determines the velocity of money and the velocity determines whether it will be inflation or deflation. Printing, demand, increasing prices, increasing wages, etc. etc. Those are all symptoms.

Jim in San Marcos said...

Hi Anon 6:00

What I tried to display here was a very simple model of inflation without going through all the theory of cost-push, demand-pull, money, debt, assets, fractional reserve, bank multipliers etc.

When I say inflation is caused by too much money chasing too few goods, you see it all the time. You want a chain saw after a hurricane, it will cost about $1,000. You want to buy super bowl tickets, be prepared to pay an arm and a leg. You have to pay more to get the item.

Easy lending by banks can create inflation. But when you have a government cover a 9 trillion dollar loss in the banking and real estate market, it makes the rest of economics insignificant.

We accuse the Fed of printing money, that isn't even close to what they are doing, the Treasury prints dollars and the Fed doesn't even need them. They print checks.

As for confidence, if you have a $5 dollar gold piece and a 5 dollar bill, which would you spend??? At one time they were both worth one and the same. We went off the gold standard so Congress could print money. Governments can't print gold. Why is a 5 dollar gold piece now worth $350?

The velocity of transferable funds right now is about zero. Everyone is sitting tight and interest rates are negative if you factor in inflation. If you have wealth, there is no reason to save it at these interest rate, mise well spend it and enjoy it.

Thailand lost confidence in its currency last year and the government banned gold purchases. We have only been off the gold standard 75 years and look how bad things have gotten.

Enjoy your paper money while you can, paper currencies come and go, in Viet Nam, I saw many bathrooms wall papered with what was once great wealth.

Confidence on a dollar bill, was once guaranteed by payment in silver, now it is backed by the "full faith and credit of the US government."

I think you are right that the government is banking on the confidence factor with what the Federal Reserve is doing, but I think it will end badly.

Inflation is a sign of counterfeiting and it doesn't matter who does it. They get something without having to work (or tax) for it.

Anonymous said...

Gentlemen, I think the point trying to be made here is that rising prices are not always caused by inflation.

When you use the word inflation it should be per the true definition -- an increase in currency and credit into the money supply which goes into the real economy causing more dollars and credit in ratio to products and services, which can not occur until the velocity of spending is increased.

an armchair economist

Anonymous said...

Right!
And the high prices on chainsaw and football tickets are not due to inflation. that is due to a scarcity and thus an increased demand, it is NOT due to more money/credit being available to consumers (which is inflation).

the deflationist theorists keep saying there is too much debt destruction for inflation to happen. i hope they are right. but then again we could be poised for a rocket ride into inflation and this recent increase in food/energy prices may be the warning of what is to come.

Anonymous said...

The fractional reserve system is a ponzi scheme to induce inflation as long as IOU's are used as colateral to produce more debt. At least that's my two cents. The plain language used in post is good enough for me and most. Even I see a problem when the govenment is writing checks to people who do not produce anything but a crease in the couch in front of TV.

rob

Anonymous said...

Looks like the progression will be deflation-stagflation-high inflation. We are now in the stagflation phase of the progression.

Isn't this just peachy?

frakrak said...

Here's the thing, the inflation rate in this country is worked out over a rather tightly defined basket of goods and services. As far as I know it doesn't take into account spending on the big ticket items, for instance housing.

With the recent flooding here we have had quite a few billion wiped off agricultural income. Less produce to market that has led to increased prices for that produce, because presumably demand has remained stable over time. OK so our reserve bank has predicted a spike in "inflation" because of this, which would make Jim's comments more correct. And the last few comments, not as correct!

Now when you have too much money chasing too few goods doesn't that equate to excess demand, perhaps economists put this to supply side inflation?

Further to this, we are not seeing a classic inflationary spiral, of increased wages forcing up prices. We are seeing more prices rising as real income remains relatively static over time and price rises outstrip this situation. Now this could be due to distortions in the market, due to government intervention, lack of competition, speculation etc....

Perhaps the excess demand also figures into the equation because of easier credit availability seen in the past decade or two?

Jim as a "home economist" when my income has remained relatively static over the years, and as a sole parent with four children, my spending is constantly cutback, as I am faced with budgetary short falls :), so I put it down to inflation.

As for the money supply side of things, intuitively I think your right there also, but will have to get someone like Steve Keen to post that one for me:)

Even though we are seeing inflation, i don't think we are going to see it as a text book case anymore, until we get back to freer markets anyway .....
What I think we are seeing is an illusion of a textbook definition of inflation that doesn't quite fit anyone's definition, perhaps we are all partially right here?

After all it's just economic theory, it's not that it is a science anyway:)

Jim in San Marcos said...

Hi Anon 8:05

You are right that my chainsaw and super bowl were not inflation examples. They were a poor choice. I was trying to explain the concept of "inflation being too much money chasing too few goods." The government prints dollars while the worker has to earn dollars producing something. Both dollars can be used for consumption. The trouble is, the printed dollars reduce the amount of available product left for consumption by the workers. The workers have an entitled amount of consumption, but there isn't enough product left and prices increase. It could be argued that they are saving a portion that off-sets the effects of inflation, but the government steps in and borrows that also.

Jim in San Marcos said...

Hi Rob

Those couch creasers get to eat our lunch and we pay for it (indirectly). I can't blame them for doing anything wrong, they followed the rules. The world is starting to wake up to the fact that things can't continue as they have in the past, it is financially impossible. At some point this mess will self correct and I don't think we are going to like it.

Jim in San Marcos said...

Hi Frakrak

I am seeing the same thing prices are rising but our wages are staying the same. Gas just jumped 30 cents a gallon today, not just a penny or two. It scares me. This hasn't yet filtered down to businesses, where they add it to their costs and pass it on to you and me.

What ever type of inflation this is, it is very unsettling.

Anonymous said...

THE OTHER GUY IS RIGHT. WE ARE IN STAGFLATION. SOMEWHAT SIMILAR TO THE 70'S BUT WHO KNOWS WHAT THE DIFFERENCE WILL BE.

NOT MUCH GROWTH THROUGHOUT OUR ECONOMIC SECTORS, NO NEW JOBS, UNEMPLOYMENT STAYING HIGH, WAGES STAYING FLAT OR CUTTING BACK, ETC.

AND PRICES AND TAXES AND GOVERNMENT SERVICES GOING UP EQUALS STAGFLATION. WELCOME TO THE NEW 7O'S.

AIM said...

We are right in the middle of some very interesting history. Think about it...

A reconfiguration of the Middle East... the USA baby boomers are retiring... USA states going bankrupt... USA government held hostage by Wall St... USA federal deficits spinning out of control... USA Social Security and Medicare about to be blown away by the baby boomers... the weather cycle for the next decade or more will be catastrophic for agriculture... peak oil (and 30 years behind in preparation for alternative energy sources)... population explosions in the Middle East and India (major demand on food and energy)... unpayable sovereign debt across the globe... our lakes, rivers, oceans and forests almost destroyed...

Some could call this the perfect storm that completely reconfigured planet earth.

AIM

frakrak said...

Jim apologies to you and your readers for my last ramble, may I put that one down for being underemployed at the moment?

Stagflation sounds great, does that mean that disco will make a comeback also? :)

Jim in San Marcos said...

Hi AIM

I agree there is a lot out there waiting in the wings. I think you missed war and famine. The four horsemen may ride again. Of course, we don't want to ruin the end of this "movie," so I say no more.

Jim in San Marcos said...

Hi Frakrak

I enjoyed your post, no apology necessary.

On your question "Now when you have too much money chasing too few goods doesn't that equate to excess demand?" Picture it this way, there are 10 slices of pie and 100 people want them--only 10 will come home with a slice.

I agree with you and Anon, Stagflation (high inflation and low growth) is the next step. Of course this time around, energy and food have been removed from the inflation index. So the inflation rate will seem to be a tad bit low to say the least.

AIM said...

The fact is that the US Fed Govmt and the states are in debt too deep to ever repay. And trapped in the vorticity of ever increasing debt. The only way out will be inflation and the destruction of the currency. Something will eventually replace the USD as the world reserve currency (could happen sooner than we think). The question that keeps me up at nite is... "when will this happen?" "do I have 2 years, 3 years, 5 years, 7 years, 10 years before the chaos hits?"

I'm still working on the plan for my wife and I (no kids).

So far it is:
1) all debt paid off.
2) all my health and dental issues fully handled.
3) liquidating and reconfiguring my asset portfolio (gonna stay liquid and actively work at making that liquid cash grow until the time comes when I am forced to put that cash into tangible assets due to extreme currency devaluation).
4) some silver and gold.
5) a small free and clear home, off the grid, on a few acres, in a mild climate with a long growing season, with a well, and some green houses and crop growing areas (this will handle most of my personal food needs and will also give me produce to trade and sell).
6) Eventually my cash will turn into some rental properties that will give me an income stream (whatever the currency may be).

This may not be perfect. I know it has flaws (property taxes, marauders, farm work, etc.) But I can't think of anything better to weather the storm that is coming.

I welcome any advice, constructive criticism, etc.

Anonymous said...

8:01:00,

I'm just pondering here..

I would think that the most powerful asset is knowledge. Specialized skills, technical/mechanical know-how, master/phd degrees, etc. They can't inflate these away or tax you on them, and you can freely move between countries with as much knowedge as you and your wife can carry.

c)off the grid, great. View the estimated operating life of all your gadgets keeping you 'off' the grid (well pump, electric,etc). I think you will find that the best you can do is be temporarily be off the grid, unless you can learn from the Amish.

Anonymous said...

1.26/Litre for gasoline this morning here in Nova Scotia. I have to laugh at the folks who say we are entering deflationary trend.