Saturday, January 19, 2013

Inflation, Here Is How It Works

Picture a pie cut into 4 slices. The whole pie costs one dollar and each slice is 25¢. For simplicity, figure that the baker that made the pie had zero costs and the dollar represented his profit. 25¢ went for taxes, 25¢ went to savings, 25¢ went for groceries and 25¢ went for rent. There are 4 slices of pie that others are now entitled to. There is just one problem; the government needs 50¢ to keep the country moving so it prints an additional 25¢. There are now 5 claims for a slice of pie and only 4 slices available. This is what inflation is all about. The new price for a slice of pie is now about 6 cents more or 31¢ a slice.

This year the baker sells a whole pie for $1.25. Now 31¢ goes to taxes, 31¢ goes to savings, 31¢ goes to groceries and 31¢ goes for rent. Naturally the government will probably print an extra 31¢ to balance the budget. This can keep going on for a long time.

The basic reality here is that government is way over budget and not charging the taxpayer enough in taxes. In this case here, the baker pays one fourth of his income in taxes. To realistically balance the budget, he needs to pay 50 percent. This tax rate would be unacceptable to almost everyone.

Then, politicians create a new wrinkle like health care. The price of each slice cannot increase in price. Picture the same pie now cut into 8 pieces and each one is 25¢. The cost per slice is constant, the number of slices isn’t. Notice that to buy the whole pie, it now costs 2 dollars. If a person wants the same amount of pie, it now cost 50¢.

Then we have financing. Normally in order to raise additional funds to run the government, the Treasury issues bonds which savers purchase. The trouble is, not enough bonds are being sold at 1% interest. So the Federal Reserve steps in and purchases the bonds for currency printed. This theoretically is a zero sum game, the Federal Reserve can come in and redeem the T-bond and take the dollars back out of circulation whenever it deems it necessary. Or why bother? -- With 6 percent inflation and 1 percent interest on the bonds -- they are virtually worthless in 30 years.

Then there was the housing bubble collapse. Congress bailed out Fanny and Freddie and kept all banks solvent. The homes were sold for real cash. The new buyers were supposed to pay back that borrowed money over the 30 year period of the loan. The repaid loan money would be cash that wasn’t available for consumption. That didn’t happen, printed dollars paid off the delinquent loans with no time delay. A tremendous amount of additional currency, available for consumption, was put into the economy.

Then there was the TARP money and the GM retirement fund bailout. 40 million on food stamps and Obama care is coming.

What all this boils down to, is that an awful lot of virtual dollars have been spent on consumption trying to support an economic way of life that we cannot realistically afford to pay for. When the country has borrowed all of our savings and is paying us one percent interest and printing more dollars to pay the new bills, we end up with a smaller slice of pie. The person with no savings and a ton of debt has nothing to worry about, in fact they’ll enjoy the ride --- And that’s about everyone under the age of 45. The people who have saved their whole life for a nice retirement are the ones that take an inflation hit on their savings. The slice of pie that everyone is counting on for retirement may be considerably smaller than expected.

Bernie Madoff couldn’t print dollars, so when bad times came, he couldn’t deliver the interest rates demanded and his empire collapsed. The real peculiar thing was that these people that invested in his enterprise were rich up until the moment they found out that they had been had.

The phrase “Let the rich pay their fair share,” reminds me of another fool in exactly the same situation 224 years ago, that said “Let them eat cake,” neither suggestion offers a real solution. We won’t lose our heads over this, only our dollars in the bank.

As an aside, here is a cartoon from November of 2008 that still has a chuckle in it.

Copyright Jim Brubaker 2013


Luke Smith said...

In some ways, I think we are going through the free-silver movement of the late 1800s all over again. Farmers wanted a bimetallic money standard to increase the price of their crop so they could get out of debt. The industrialists, sitting on vast piles of cash while buying out their competitors, did not want a bimetallic standard.

Anonymous said...


A recently discovered hospital bill from 1962 for a tonsillectomy:

Room $16/day
Physician $9
Meds $3
Dressing 10 cents

Thank goodness there is no inflation.

END THE FED said...

The source of the boom and bust business cycle is the institution of banking, given their powers by the government via the creation of The Federal Reserve Bank. This will be the ruination of our country and economy. The government won't even allow the depression (clean out and rebalancing of the market economy) to occur. They'll print trillions and create insane legislation to prevent the bust from occurring. Delaying this and allowing so much more debt to be created is only setting us up for some sort of pain and annihilation that economic history hasn't seen in a very long time, if ever. This is the biggest debt super cycle that has ever existed. The blowback is going to be incredible. All the responsible people will have headed for the hills (with their bags of money) and will be nowhere in sight when the people finally realize it is time to wheel the guillotines out into the commons of Congress. We are so screwed it is beyond scary!!!

AIM said...

As Martin Armstrong explained, it is really all about CONFIDENCE and it's pendulum swing. After the 2007 crisis the public confidence pendulum swung towards the government: the government will save us and fix the system. When the pendulum swings in this direction it allows government to get bigger, exercise more control, intervene in your personal and business affairs, move towards totalitarianism, etc.

There will have to be a radical drop in the private sector's CONFIDENCE in the government for the pendulum to swing the other way which will then bring about reform, smaller government, reinstatement of freedoms and liberties, reinstatement of rule of law, etc. etc.

If reform is correct and TRUE instead of false data is utilized, we could put an end to the business cycle (boom and bust) and rid ourselves of inflation and other created negative conditions in our society and economy.

It will take some major failures and crises in the public sector/government before that will ever happen. Wonder how long we'll have to wait? 10 years? 20? 50?