Inflation, Federal Deficit Repayment, Money Creation
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Monday December 14, 2009
Today's Zinger:
Inflation: The Government Debt Repayment Plan
Who Said It:
"To say that force is sometimes necessary is not a call to cynicism - it is a recognition of history; the imperfections of man and the limits of reason."
The Morning Briefing:
Money Creation: Money is created by printing (Federal Reserve) or borrowing (Congress).
Inflation: When the government creates money without a commensurate increase in the goods and services flowing through the economy.
There is a real controversy developing in economic circles regarding inflation. As ZingerKing readers know, I have been raising the concern since March 2009 that we are setting ourselves up for a period of high inflation. The level of borrowing by governments around the world to fuel the economic recovery, our governments need for cash to meet current obligations and continued deficit spending and the Federal Reserve printing $1 trillion in cold hard cash, will put pressure on prices.
There is no question that prices for many goods and services have gone down in the past year. But the economic decline that caused lower prices has also reset many salaries of people changing jobs and new graduates. Some economists believe that the decline in prices, deflation that we have experienced in the past year, will provide a cushion for higher prices that will come in the future. I for one do not believe this to be true and we have set ourselves up for a very difficult situation with high inflation and two types of workers, those with reset salaries and those whose salaries were stable through the economic decline.
The Discussion:
Inflation is a measure of price change year-over-year. Therefore, if there is a period of deflation that lasts more than one year, a new base line is in place. For example, a shirt may sell for $50 in 2008. Due to slow demand and new sourcing of goods, from places like China or other Asian countries, the price in 2009 in $40. There has been deflation of 20%. If the price of that shirt remains at $40 for at least one year then any increase is inflation.
What makes this dramatic is the extended period of time deflation occurs. During extended down cycles, wages are negotiated down as well. New hires are offered lowered starting salaries. As any new college graduate will tell you, the starting salaries are 20-30% below prior year starting salaries, if they are lucky enough to get a job. A recent article that I read said that the lower starting salaries for graduates and those experienced workers starting new jobs, will hinder their earnings potential throughout their lifetime. For these people, higher prices in the future will have a dramatic impact on their purchasing power.
At the same time, if you are one of the fortunate ones to have a job with no change in income during this extended down cycle, you will enjoy the lower prices during the down cycle and return to normal buying power as prices increase in the future. It will be a temporary bonanza with moderated long-term inflationary impact.
Who will be the winners and losers?
Younger workers that have maintained their jobs and incomes throughout the down cycle will be winners. During the down cycle they will use their income to capture assets at reduced prices. These assets, like houses and stocks, will accelerate in value in the future as inflation returns and prices approach historical levels.
Young graduates will be heavily impacted. Their lower starting salaries combined with escalating prices for assets that will want, cars and houses, will put these purchases out of reach for a longer period of time.
Workers that were laid off and recently started new jobs will be impacted with lower starting salaries.
Near retirement workers will have different outcomes depending on their individual situation. How long before retirement, the ability to purchase “cheap assets” during the downturn and the income during the remaining years will determine their financial future.
When will we see prices begin to rise?
Lower unemployment will continue to dampen consumer demand and keep prices somewhat in check. However, as the world recovers from the current economic downturn, which it is already doing, prices will begin to rise for commodities and assets. Assuming we do not experience a double dip recession, which is very rare, we can expect prices to begin to rise from world demand in the next 12-18 months. The impact of government borrowing on interest rates will continue to put pressure on prices. Higher interest rates will dampen consumer spending. There is a fixed amount of borrowable funds in the world, and if the governments are soaking up available funds to meet their obligations, interest rates must rise and consumers spending will keep prices low. This of course means that the deflationary period is extended and the full effects of inflation will be worsened. The longer the recession and deflation exists, the more severe the impact of rising prices.
Is there benefit to inflation?
There is a benefit to inflation, but no one wants to talk about it. It may ultimately be the only way out of our Federal deficit situation. Much higher inflation makes the cost of debt less costly. Loans are fixed in value. If you have more dollars to pay for a fixed value debt, the real cost of that debt is less. If borrowing dries up and the economy does not recover quickly enough, the Federal Reserve is left with only one option…. Print money. New dollars minted without an increase in economic activity results in inflation. New money may be used to pay current debts.
The government may not have a choice but to allow inflation to reduce the real cost of our debt. If they can’t get job growth stimulated to increase the economy, and they can’t raise taxes sufficiently to pay the debt, the last lever is allow inflation to cut the cost of our $13 trillion debt.
The Conclusion:
We have now experienced a cyclical downturn that has lasted more than 12 months. The latest estimates show that unemployment and economic activity will remain week for the foreseeable future. This implies that prices will remain weak. Government inflation reports should show that year over year there has been modest to declining prices. This new price peg means that there must be inflation in the future. You should plan for it. Look at who wins and who loses during inflationary period. Owning commodities and assets that have the potential to ride the price wave is just one factor in planning for an inflated future.
Who Said It?
"To say that force is sometimes necessary is not a call to cynicism - it is a recognition of history; the imperfections of man and the limits of reason."
President Barack Obama
Today's ZingerToon:
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Posted by ZK at 12/14/2009 11:01 AM 
Categories: Federal Budget, Economics, Deficits
Tags: Federal Budget Economics Deficits Inflation
Categories: Federal Budget, Economics, Deficits
Tags: Federal Budget Economics Deficits Inflation
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