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Steve Saville: Recognition of the US Inflation Problem

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December 16, 2009 – Comments (7)

Another good article by Steve Saville. Here is an excerpt.

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Recognition of the US Inflation Problem
by Steve Saville

December 14, 2009

When the banking system (the central bank and the commercial banks) creates so much new money out of nothing that the total supply of money rises rapidly, it can be likened to counterfeiting on a grand scale. This counterfeiting distorts price signals, brings about the undeserved transfer of wealth to the first receivers of the new money, and depletes real savings. It therefore damages the economy. There are times when the economy is in good enough shape -- due to an existing large pool of real savings -- that the total amount of wealth is able to grow despite the hindrance of monetary inflation, but there are other times -- now, for example -- when earlier inflation and other central-bank/government-imposed distortions have already weakened the economy to such an extent that adding more inflation into the mix causes an irresistible drag.

The US currently has an inflation problem, meaning that there has been enough growth in the money supply to do substantial damage to the US economy. The crisis of 2007-2009 is evidence of this damage in that it was a natural and inevitable consequence of the preceding inflation-fueled boom. And yet, US officialdom is attempting to overcome the inevitable adverse consequences of monetary inflation by creating even more money out of nothing. The inflation problem is therefore set to become even more troublesome over the years ahead.

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7 Comments – Post Your Own

#1) On December 16, 2009 at 9:23 PM, russiangambit (29.31) wrote:

I posted recently that there is almost an endless supply of excuses to keep the monetary policy "easy". The current one is high unemployement.

I don't know who came up with this crazy idea that monetary supply manipulation ( or pick another word) can fine tune structural imblances in economy to fix the unmployement issue. It is like doing brain surgery with an ax. You can guess the likely outcome for yourselves.

FED cannot fix unemployement and shouldn't even try.  The best hope is that unemployement fixes itself somehow through the confidence games currently played.

Can you imagine Europe keeping their interest rtes at 0% just because of high unemployement? Then they would've been at 0% permanently.

FED should let the market set the interest rates ( or the price of money) and just be a money issuing insitution, nothing more, not a central planner of the such complex economy.

Just off track a little bit, the progress in everything grows at exponential speed, that bring exponential complexity. People are literally drowning in complexity and information. Simple models don't work anymore, the complexity increases the instability in the system. What worked 50 years ago doesn't work anymore. The economy is too complex for  5 fed governors to comprehend no matter how smart they are.  Really, they should physicits on the FED board . Scientists respect the complexity of nature, they understand that for any action there is a reaction. That to change something you have to expand energy which has to come from somewhere. It looks like economists don't understand any of it, you could probably make them believe in perpetual mobile .

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#2) On December 16, 2009 at 9:25 PM, russiangambit (29.31) wrote:

> perpetual mobile

perpetuim mobile, got my latin and english mixed up.

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#3) On December 16, 2009 at 11:19 PM, binv271828 (< 20) wrote:

russiangambit,

I couldn't agree more with this comment and your recent post regarding the Fed's easy money policy.

I really respect your opinions. They are always nuanced and well thought out. You obviously spend a great deal of time trying to understand the big picture, as do I. We don't see eye to eye on everything, but we do on most things. So I just wanted to let you know that I appreciate your comments on my blogs, but also the comments I read everywhere. You certainly help Caps to be a smarter place.

Your brain surgery with an axe is completely appropriate. Money supply is not a delicate tool, nor is it a precision tool. But it gets thought of as this panacea.

Just off track a little bit, the progress in everything grows at exponential speed, that bring exponential complexity. People are literally drowning in complexity and information. Simple models don't work anymore, the complexity increases the instability in the system. What worked 50 years ago doesn't work anymore. The economy is too complex for  5 fed governors to comprehend no matter how smart they are.  Really, they should physicits on the FED board . Scientists respect the complexity of nature, they understand that for any action there is a reaction. That to change something you have to expand energy which has to come from somewhere. It looks like economists don't understand any of it, you could probably make them believe in perpetual mobile

This comment is perfect! In fact most of the best economic commentary that I hear comes not from economists (Krugman for example largely comes up with idiotic conculsions to his analysis) but from scientists and engineers (Saville used to be an engineer, and I didn't find this out until after I had been reading his work for a few years).

The stock market and the economic are systems built by humans. The corollary to to physical systems is not an exact one, but I believe it is a lot closer than most acknowledge. The problem is that the response time is so long, most cannot see the causes and effects. It is like trying to model the response of an extremely overdamped structure, only you don't know what the damping coefficient is ahead of time. If you have a lot of inputs (impact functions and step functions at differnent levels, or even random inputs), you might think there are separate systems in action if you measure the response at different points on the structure, and may not realize that there is in fact one unified system. Sorry, veering off topic.

I hemorrhage a lot when I read economic commentary because nobody tries to understand the complexity of the macroeconomic situation. And since 2000, we have seen first hand how little the ramifcations of monetary policy decisions are made not only by the public, but even by those who are making them. I still hear a lot of "dollar down = stocks up" or "inflation means stocks will rise".

Inflation "helps" (used *very* loosely) stocks rise ... until it doesn't. Stocks can fall in an inflationary environment, because the economic fundamentals are weak, and the inflation starts to exascerbate the weakness, not hide it. This happened in the 1970s. And it is called stagflation.

When stocks fall again due to poor fundamentals, people will say this is proof of deflation. I mean after all, if assets fall, it's deflationary right? Not if you want to understand cause and effect and not if you want to understand what the macroeconomic ramfications are. Mislabelling the next downturn as deflationary is exactly the misperception that the Fed wants so that it can be more aggressive with QE and similar policies (ramp up inflation while everybody is focused on "deflation" -- which is actually a deflation scare). Hell, they even said they were buying more mortage back securities today! (monetizing debt is directly inflationary). It believes that it is helping to solve the problem, but in actuality it is reinforcing it.

The comparison between now and the 1970s has a lot of compelling aspects: high inflationary environment, poor fundamentals, and falling asset prices. The only difference now is that the structural imbalances are a lot worse. Which means that the monetary inflation is going to reinforce the problems much more than they did in the 1970s.

A valid question would be "well once the Fed realizes (supposing they do) that it is a positive term in the feedback loop, not a negative one, won't they just stop inflating?".

The first answer is: no. And the first clue is the yield curve. Nobody but the Fed is buying our long term debt. The only reason why the government is running at the moment is because the Fed is funding the Treasury, it isn't getting money from foreign governments (well it is, but in much smaller proportion). And the National Debt ceiling is being *raised*. The Fed needs to inflate to get the government running.

The second answer is: it doesn't matter. Because once the inflation is detectable in general prices, the massive monetary inflation will have already done vast amounts of damage. And because of the inertia in the economy, we will be feeling the aftermath of that inflation for a very long time.

Things you own go down in value, the things you need to consume cost more. Sounds like stagflation to me.

Sorry for the ramble. I tend to do that (a lot). Thanks for the comment!.

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#4) On December 17, 2009 at 12:32 AM, binv271828 (< 20) wrote:

Also, tying back into the idea of how inflation will actually reinforce economic weakness given the current environment: Peter Schiff had a great bit on his video blog (which kdakota always does a great job of reposting) regarding the PPI interpretation and extrapolation. Check out this post: http://caps.fool.com/Blogs/ViewPost.aspx?bpid=312473 and watch from 3:05 to 5:15. It is easy to see how this argument has ramifications for lower stock prices within an inflationary environment.

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#5) On December 17, 2009 at 4:22 PM, russiangambit (29.31) wrote:

Thanks binv,  I always enjoy your posts. So, keep them coming.

Intresting times we live in. What irritates me is that there is a tendency in the US to always reinvent the wheel. There are countless examples over time of empires loosing their mojo and the solutions they used. Money printing was very popular but never worked.

I am trying to think what worked , and honestly I can't remember a single example. Once empire gets too bloated  and complacent it is doomed to failure until it gets broken into smaller pieces and all the structures of it get renewed from the bottom up. There is never enough political will to do the right fixes from the top down.

That is what  is wrong really - the solution to the structural malaise is form bottom up not from top down, which is being pushed on us right now. Government needs to stop tinkering with market forces, it needs to cut expenses, cut taxes and get out of the way. It is painful for those dependent on the government, which is probably 305 of the poulation, but it is the only way.

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#6) On December 17, 2009 at 5:18 PM, binve (< 20) wrote:

Thanks russian, I appreciate that man :)

Have you ever read The Collapse of the Dollar by Turk and Rubino? They have a fascinating account of the history of fiat currencies. And that excessive money printing has always preceeding a republic's loss of world power. 

That is what  is wrong really - the solution to the structural malaise is form bottom up not from top down, which is being pushed on us right now. Government needs to stop tinkering with market forces, it needs to cut expenses, cut taxes and get out of the way. It is painful for those dependent on the government, which is probably 305 of the poulation, but it is the only way.

I totally agree. The problem of course is that all of this inflation especially the last 30 years has vastly changed the structure of the economy, enabling the finanical sector to have far too much power. And guess which sector has far and away the biggest lobbying presence in both number and capital? Yep, financials. 

Until the structure of the economy is fundamentally altered, financials will continue to have dominant influence / maintain the status quo. But chances are unlikely that the economy will be altered while financials have so much power. Its a catch-22 at the moment.

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#7) On December 17, 2009 at 5:43 PM, binve (< 20) wrote:

russian, kdaktoa just posted a new Peter Schiff blog: http://caps.fool.com/Blogs/ViewPost.aspx?bpid=313978. He discusses almost word for word some of the points of our conversation above.

And you were speaking of the need for top down economic reform, which is the main part of Peter Schiff's platform. I really hope he wins. a) because I think he has the right mind and right thinking on these issues and b) he would replace Chris Dodd, who is largely a financial flunkie.

Should be interesting if a bottoms up revolution will help to begin a top down change (nearly all of Schiff's political funding is grass roots). Very interesting indeed :)

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