THE BIG LIE III - INFLATION

There are enough lies about inflation that if you tried to deal with them all, you’d wind up writing a textbook. But we have to start somewhere, so ....

Let’s start with the definition. Most people – journalists and economists included – think inflation means “a general increase in prices.” But defining inflation as an increase in prices is like defining war as an increase in casualties. It tells you nothing useful about what caused it. So, for the record, inflation is not an increase in prices.  It's an increase in the supply of money (or credit). When the supply of money (or credit) increases faster than the supply of things you can buy with the money (or credit), prices go up.  No "demand pull"; no "cost push".  Inflation has nothing to do with labor union contracts or monopoly pricing power.  It has to do with one thing and one thing only: credit.

But no one wants to admit the problem is credit because the institutions that create the credit (i.e., banks) make money by creating credit. And the institution that allows them to make money creating credit (i.e. the government) is the world’s biggest user of credit (in other words, the world's biggest debtor).

Not only is the U.S. government the world’s biggest debtor, but it reports to a bunch of ill informed,  irresponsible adolescents (i.e. voters) who refuse to cut back on the stuff they get from the government or to tax themselves enough to pay for it.

As a result, it’s impossible for the government to cover costs on a current basis, let alone pay back what it owes from its past exhuberances.

So, faced with this impossible situation, what does the government do? 

First, it obfuscates.

So for example, on November 10, 2005, the Federal Reserve issued a press release stating that it as of March, 2006, the statistical monetary measure known as M3 would no longer be reported.  According to the Fed, the reason for this was that "M3 does not appear to convey any additional information" and the Fed "judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits."  This was, of course, complete nonsense. M3 was the broadest and most useful measure of money in the economy, including not only checking account balances but time deposits, money market funds and repurchase agreements as well (repurchase agreements being the Fed's favorite mechanism for injecting liquidity into the monetary system). The reason the Fed stopped reporting M3 wasn't that it was not a useful number; it was because it was too useful and showed the money supply growing far faster than the underlying economy.

The second thing the Government does is, of course, lie. 

The first lie is about the amount of borrowing.  The government uses accounting practices that make it look like it’s borrowing less than it's actually borrowing. So, for example for fiscal 2009, the government reported a deficit of about $1.2 trillion. But if the deficit had been calculated in accordance with the "generally accepted accounting principles" that businesses use, the deficit would have been $1.4 trillion – or $200 billion greater.

On a balance sheet basis, at this writing, the "national debt"  as officially reported by the U.S. government, is about $13.85 trillion, or $125,400 per taxpayer.  But this "official number" leaves out unfunded liabilities for Social Security, Medicare and prescription drug benefits of $111.7 trillion, or a staggering $1 million per taxpayer. In other words, most of the debt is hidden. 

(These numbers don't include state and local debt or personal debt of $16 trillion.)

The next thing the government lies about is the extent to which prices are rising.

First, the government pretends that increases in the prices of certain things somehow shouldn’t be counted. For example, asset prices (stocks, bonds, real estate, precious metals) are excluded from the Consumer Price Index (CPI) on the theory that they aren’t “consumed”. Okay, they’re not consumed, but why should a price index be limited to goods that are consumed?  To the extent that inflationary government policies disproportionately benefit the rich (as they have done in America over the past 35 years or so), it’s logical to assume that most of the price impacts will be reflected in asset prices because rich people save more than poor people and asset investments are made from savings.  

Second, the Bureau of Labor Statistics excludes certain prices from the CPI because they’re supposedly too hard to measure. Interestingly, the excluded items go up faster in price than many of the items that are included. Among these excluded items are health care costs and the costs of higher education.

Another exclusion is reflected in the Federal Reserve’s concept of “core inflation” which it reportedly likes to consider in setting monetary policy. As we are repeatedly told in the financial press, core inflation excludes "volatile food and energy prices”. Food and energy prices are volatile alright, but their volatility seems to be primarily in an upward direction.

Creative and entertaining lies are reflected in several "adjustments" that have been built into the Consumer Price Index over the years to reduce the rate of price increases as publicly reported.  Among these are “geometric weighting” which automatically reduces the weight of a product in the index to the extent that its price increases.  The theory here is that consumers will buy less of a product if its price has risen.  Of course they will buy less, but reducing the weight of expensive items results in an index that no longer measures a constant standard of living.  As the CPI is presently calculated, it measures an ever-declining standard of living.   A second categroy of lies are called “hedonic price adjustments” which automatically reduce the dollar price actually paid by consumers within the index to account for supposed increases in product quality or function.  The problem is, no adjustments are ever made to increase the prices of items to account for reductions in product quality, or the availability of customer service.

(A complete catalog of the chicanery engaged in by the Bureau of Labor Statistics is beyond the scope of this post, but if you’d like to educate yourself further, you can go here:  http://www.shadowstats.com/article/consumer_price_index)

To be sure, there are a lot of lies told about inflation. But behind those lies is a bigger lie – a mega-lie, if you will, that we, the American people, like to tell ourselves and each other.

That lie is that the infrastructure and the services we expect from our government – from interstate highways to public education to national defense to Medicare to Social Security – somehow belong to us as a matter of right and should be delivered to us by a beneficent government without the necessity of our paying taxes. This lie is not a new one – Americans have believed they shouldn’t pay taxes since before the Revolutionary War. (Come to think of it, that’s why there was a Revolutionary War.)  But over the years, the list of services we expect has expanded considerably.

Since we won’t tax ourselves to pay for the things we want from the government, and won't even elect people who are willing to tell us the truth about our need to pay for them, the only alternative is lies.  Lying about the amount we owe, lying about the value of our dollars, lying about our ability to repay this debt, and now lying about the printing of money by the Federal Reserve (so-called "quantitative easing") in order to buy government debt that no one else is willing to buy anymore. 

But as they used to say when I was a kid, you can't get something for nothing.  This explosion of debt has caused – and will continue to cause – prices to rise, resulting in an invisible tax paid by us all.

This is also not a new phenomenon.

Before there was a United States, there was a confederation of colonies that met expenses by printing a paper currency called the Continental. These things wound up being worth so little that debtors chased their creditors up and down the streets trying to pay them back with Continentals.  In the 1790s, after the U.S. Constitution was ratified, Continentals could be exchanged  for treasury bonds at 1% of face value.

This could easily happen again in the United States.  Only this time with something called the dollar.
In fact, unless Americans find the will to pay their expenses on a current basis, it will happen again.

But I have no doubt that when it happens, we will probably find a way to lie about it.