Understanding Inflation

The Winners & Losers in Currency Creation

“By this means government may secretly and unobserved confiscate the wealth of the people and not one man in a million will detect the theft.” John Maynard Keynes

The Federal Reserve System (FED), created in 1913, turned money creation on its head.  Pre-1913, gold in bank vaults backed each dollar issued –i.e., sound money. The concern being, of course, that without such a requirement money creation would explode, damaging the currency as well as the economy.    

With the inception of the FED, banks were anointed with the superpower to create money – backed by nothing more than a promise to re-pay the amount listed on the bill.  A hundred years later as reflected in Table 1 below, the dollar lost, on average, 95% of its buying power.

In other words, the ability of the currency to perform one of its primary functions –to buy things– reduced substantially.    This article explains how the money supply, an obviously critical public resource, is abused returning great benefits and profits to the government and certain constituents of the banking system at the expense of the general public.

The Currency Creation Process

There are two primary means by which new money is created.  Namely:

  • The Federal Reserve System – Approximately 8% of the money supply is created by the FED to finance government projects and set interest rates.  Specifically, and at the behest of Congress, the FED literally creates money and then loans it to the government using banks as an intermediary and intended beneficiary (see Graphic 1 for a detailed explanation).   
  • Fractional Reserve Lending – The remaining approximately 92% of new money creation results from fractional reserve lending by banks.  By depositing and then lending in a repeating manner, the banking system turns an initial deposit of $1M into an additional $8.6M of bank deposits (see Graphic 2 for a detailed explanation).

The Inflation Business

There are four primary financial assets in the world: Stock Markets, Broad Money (currency), Global Debt and Derivatives.  Table 2 below provides a high and low estimate for the total value of these assets, with only the Derivatives market varying.  As can be seen, the derivative value is extraordinary, ranging from $544 trillion to $1.2 quadrillion.  If money creators capture just a mere 2.5% of these assets via inflation, the worldwide impact of the inflation business approximates between $23 and $39 trillion, annually.

Typically, people do not describe inflation as a business; but, how is inflation not a major industry?  Inflation results from specific actions taken by the banking system that produces extremely profitable results, for some.  Moreover, and a really damning aspect of the inflation business, is that it is neither voluntary nor mutually beneficial.  Legitimate trade is both.

Why Inflation Matters

When the banking system circulates new currency into the money pool, those funds devalue the previously existing money.  The devaluation occurs because the new money competes for a fixed supply of resources causing prices to rise. The money creation program works stupendously for the government and bankers that produce it, as they receive something for nothing.  Governments gain access to significant, low interest loans making deficit spending possible. Banks benefit as they are free to issue multiple new loans and collect interest without having to pony up any of the funds.    As far as the average consumer and business are concerned, however, freewheeling money creation is incredibly harmful.  It devalues dollars while simultaneously eating away at an individual’s savings.   

A money that is easy to produce is no money at all, and easy money does not make a society richer; on the contrary, it makes it poorer by placing all of its hard-earned wealth for sale in exchange for something easy to produce.” Saifedean Ammous – The Bitcoin Standard P 16

Imagine, for example, a situation where saver Jane puts $5,000 into a safe for future use.   Over time, she would lose purchasing power.  Specifically, let’s say she “saved” the money for a period of 25 years and incurred a modest rate of inflation of 2%.   When she takes the money out, she would only be able to purchase the equivalent of just over $3,000. In other words, her money would lose approximately 40% of its value over the 25 years.  If the inflation rate averaged closer to 4% or 6%, respectively, she would lose approximately 64% or 79% of her purchasing power, respectively, as reflected in Table 3 below.

Indeed, holding financial assets such as a bank or brokerage account is analogous to owning a safe with a backdoor accessible by money creators.  This “backdoor” allows money creators to confiscate a percentage of the account holder’s buying power at their whim. Those who think taxes are expensive may be focused on the wrong target.  The amount of wealth appropriated via inflation is astounding and constitutes one of the key reasons why the middle class in the western world is under pressure. 

Politicians and media personalities regularly express concern regarding wealth inequality.  They suggest the source of the problem is excessive CEO pay or salary discrepancies. This proposed explanation and professed ignorance of a significant source of the problem is disingenuous.  Politicians and media personalities enjoy a front row seat to the banking system’s money creation show, playing for over 100 years now.  A money pipeline goes directly from central banks to bankers and government contractors.  In the process, a small number of people became fabulously wealthy.  A significant contributing factor of the “wealth disparity mystery” is not hard to solve; yet, it is never addressed by those in a position to correct it because it represents a significant source of their power and profit.

The harmful implications of inflation are not limited to eating away people’s savings and driving wealth disparity. On the contrary, the ramifications of rampant money creation permeate the world in countless ways.  For instance, modern war would not be possible without money creation.  Prior to the emergence of central banks, wars were short, limited in scope and waged by professional soldiers on a remote field. Following the introduction of central banks and the removal of hard money requirements (–i.e., the gold standard), endless, prohibitively expensive wars resulting in millions of deaths became not only possible, but the norm.  Even a relatively small war like the 2003 Iraq War cost upwards of $3 trillion or 39% of the world’s gold supply of $7.7 trillion. One might say that the principal weapon of modern war is the ability to create money.  Without this capability, modern warfare would simply not be possible.

Inflation also impacts the ability of the world’s poorest to access life’s basic necessities, such as food and energy.  When newly created currency flows into the world economy those funds compete for control of basic resources and prices rise as a result.  As food expenses explode as a percentage of income, poor families experience extreme hardship. In 2011, for example, Egyptian President Mubarak was removed from office and one of the key triggers was inflation driven food riots.  

Castrating Inflation

When governments anointed central banks with the extraordinary power of replacing hard money (gold standard) with soft money, effectively allowing currency to be created at will — the world changed, notably.  This new-found governmental super power stripped the individual of significant economic power while transferring it to central authorities. In the process, these currency creation decisions twisted, distorted and introduced risks into the world; boiling just beneath the economic surface, threatening to burst forth at any time.  It is my opinion that money creation may well be the dominant trend of the 20th and early 21st centuries.  At what cost, though?  

Freedom seeking persons and societies the world over long for the re-emergence of hard money, whether it be a return to the gold standard, cryptocurrency, a combination of the two in a tokenized gold product; or, in a manner yet unknown.  Were this to occur, the populace’s financial power would return, while implementing serious restraints on governments’ irrational and ineffective spending programs, including war. The wealth inequality resulting from the financial superpowers handed to our banking system overlords would, alas, cease.

Key Takeaways

  • A great theft has occurred.  The perpetrators are the government and the banking system with accomplices in the media and educational system (university economists).
  • The power to manage the nation’s money supply, along with the accompanying and incredible benefits, was given to a small group of bankers – no strings attached –i.e., they did not purchase or otherwise pay for this incredible privilege.
  • In the meantime, the Dollar lost upwards of 95% of its purchasing power since the Federal Reserve’s inception.
  • The inflation business is significant and profitable – perhaps as large as $23 to $39 trillion per year worldwide.
  • Savers are clobbered by inflation, thereby significantly discouraging saving.  In order to keep up with inflation, one must invest or speculate.
  • Inflation harms individuals and society alike as it enables war, massive public debt and drives the world’s poor to desperation because they experience great difficulty acquiring basic necessities.
  • Cryptocurrencies such as Bitcoin or digital tokens backed by gold promise a fairer and more stable money standard than central banking systems.

Next article in the series – Fiat Currencies

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The information provided herein and any accompanying materials is for informational purposes only.  The information is of a general nature and does not address the circumstances of any particular individual or entity. You should not construe any such information or other material as legal, tax, investment, financial or other advice.  I am not a financial advisor and you should consult with an attorney or other professional to determine what may be best for your individual needs. 

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