The Big Lie About Inflation

Federal Reserve Chairman Ben Bernanke in his semi-annual report to Congress indicated that inflation pressures were diminishing and that the near term outlook was good. He also noted that inflation is one of the key factors that the Federal Reserve keeps a close eye on as it affects the economy in many ways.

Listening to Mr. Bernanke, you might be led to believe that the government truly hates inflation and is doing everything in its power to keep inflation under control. Nothing could be farther from the truth. You see, the government wants very much to maintain what it calls a reasonable amount of inflation. It has done so ever since the Federal Reserve was created and given control over the currency in 1913.

There are two reasons why the government wants to maintain a reasonable amount of inflation and I will cover those in a minute, but first, I think we need to accurately define the word inflation.

If you ask the average person on the street what inflation is, he or she will tell you that it is an increase in prices and while inflation cause prices to increase, inflation is not so much about price increases as it is about the increase in the amount of money in circulation and the reduction in purchasing power.

It is just that prices are what we see and live with month in and month out. We have had monetary inflation since the 1913 but the pace of inflation has really gained momentum since Richard Nixon took the U.S. dollar off of the gold standard in 1971. At that point the dollar no longer had any type of backing with the exception of the full faith of the U.S. government.

So, why does the government like and encourage inflation? First, inflation is like a hidden tax. It redistributes wealth. You see, the higher prices go, and the higher wages go, the more money the government extracts in the form of taxes. What you do not realize is that it happens slowly over time and suddenly one day you wake up and wonder why it is that you are making more money than ever and still cannot seem to get ahead. The answer is inflation.

Deflation is talked up by the Feds as a horrible thing that can never be allowed to happen. In fact they like to tie the word deflation with depression even thought the two are not the same. Nobody wants depression so no one should want deflation either. But the fact is deflation actually can make you wealthy while you do nothing but tuck your meager savings into a low interest savings account.

In a deflationary environment, cash becomes king and debt becomes trash. During the depression when prices were dropping and demand was falling for non-essential items, cash was king and those who were savers bought up assets for pennies on the dollar. You might decide that saving money would be a good thing. At least that is what your parents always told you, but the government wants you to spend. The more you spend, the better the economy does and the more money the government collects.

The second reason why governments like inflation is because it allows them to pay off their debts with dollars that are worth less in the future. Imagine if you were the government and you controlled the creation of dollars. Now, suppose your house payment came due and you did not have the cash to make the payment. What do you do? Simple, run downstairs and print some more money. How cool would that be?

The only problem is that it is illegal and you will go to jail for a very long time. Even if it was legal, eventually no one would accept your dollars because they would have no intrinsic value and that is the fate of the dollar in the world today. In the near future, our trading partners are going to stop accepting dollars for payment of our debts because they are worth next to nothing.

Don't believe me? Go to the government's inflation calculator at: http://woodrow.mpls.frb.fed.us/research/data/us/calc/ and see for yourself. Enter 2007 in the first year field and 1913 in the last year field and then click on calculate. You will see that our dollars are currently only worth a nickel. And you thought you were rich.

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