Wednesday, January 09, 2008

Inflation cause and effect

It's a good thing people do not know what causes rising prices (which they think is inflation) and crashing economies, or they would be really ticked off, or having a revolution in the streets the next day. The cause is too much creation of what they call "money". Artificial demand for real goods and services is caused be artificially creating to much credit, which when accepted, is debt.

Instead of the demand for real economic goods and services coming from the creation, and then spending, of real wealth, it comes from the creation of credit and debt that was not earned because it will not be paid back because there is not enough creation of real wealth to support the future payment of the debt. Debt default causes economic contractions.

Keep an eye out for the amount of debt relative to the amount of wealth. Ratios count, a lot! Also whether the ratio is changing, and if so, which side(s) of the ratio is changing and by how much. There are constants in life, but not many; so are there trends. There are plenty of trends that make huge differences that need watching.

If debt keeps increasing while real wealth creation does not keep pace, or stops, or declines, some kind of economic and financial adjustment has to take place. After all, how long will a debtor be allowed to keep taking on debt when it becomes obvious that the debtor is not doing enough, nor will the debtor be able to in the future, to make the future payments on the debt.

It works the same for individuals, towns, companies, cities and national governments.

The "money" monster is stalking the world.

From the Fed's third quarter "Flow of Funds" report:

Total US credit growth expanded at an annualized $4.99 trillion.

To give that number some perspective, the US has an annualized GDP of about $14 trillion. That means that about 36% of GDP was borrowed. It was not necessarily due to the creation of real wealth, real goods and services.

Imagine what all those dollars are ultimately going to do to the prices of real goods and services; real goods and services becoming scarcer relative to the number of dollars chasing real goods and services.

If someone borrows "money" from a bank, the bank takes that person's I.O.U. and puts it on its books as an asset because, to the bank, it is. If that person takes that "money" and buys debt in the debt market, no real wealth was created. Yet all other things being equal, GDP increases because of those exchanges of "money". A GDP number means a lot less than most people think.

An increasing GDP number can mean that a nation is increasing it total real wealth. It can also mean that it is actully consuming/spending its real wealth, becoming less wealthy. One has to look under the hood, dig into the details, other fundamentals, to know.

By the way, when the bank puts that I.O.U. on its books as an asset, that action increases its reserves. Therefor, since its reserves increased, it is allowed to create more dollars, out of thin air, necessary to make that loan.

If central banks and the banking system as a whole are allowed to create fiat tokens out of thin air, how come "counterfeiters" are not allowed to?

Where was the use of human hands and mind, manipulating nature, being used to create real economic goods and services in these exchanges? Virtually none. Yet GDP increases. GDP can be increasing while the rate of the production of real wealth is actually decreasing. At some point in future time, real wealth is needed to pay off these loans. Let's see now, real debt increasing with real wealth decreasing. ... trouble ahead.

The rate of debt and "money" creation has got way out of line with the rate of real wealth creation. At this point, there is going to be quite the reaction/adjustment/correction. And, it will not be felt just in the US.

Now a days, since 1971 (Brenton Woods Agreement), these huge increases of "money" supply (mostly digital bits on a hard drive) and the huge reaction/adjustment/correction that is inevitable are due to those that control the hard drives that contain the supply of digital bits. Huge increases in supply and the next Great Depression, sure are not due to the invisible hand of a free market. They are due to visable hands that have no business messing about in markets because that makes the markets non-free, which makes the markets not work well, and sometimes to crash.

Suggested reading: Markets Don't Fail - Brian Simpson


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