Anchoring the Poor in Poverty

There will be no more isolation
In our secret separation
--The Fixx

Thomas Sowell discusses two government policies that serve as taxes on the poor. Money printing (inflation) devalues dollars currently in existence. It is often called 'the invisible tax' because it is difficult for many people to recognize.

Rather than confiscating wealth by direct taxes, the State confiscates wealth by using newly printed dollars to procure resources. Subsequently, there are less resources to purchase--and more dollars to purchase them with. Prices go up and purchasing power goes down. The net effect is the same as direct taxes. Wealth has been transferred from private hands to the State.

Money printing disproportionately hurts the poor because low income people operate mostly with cash. Unlike the wealthy, they have little savings that they can convert into assets, such as gold, that hold their value during inflationary conditions. Inflationary conditions leave the poor running on a hamster wheel as they perpetually struggle to keep up with cost of living increases.

Another government-imposed tax consists of loss of welfare benefits. People trying to climb out of poverty while collecting welfare payments can face situations where a marginal dollar of production costs more than staying on welfare. Tax a behavior, and expect less of it (Econ 101). Welfare benefits serve as the poor's version of 'golden handcuffs' that encourage persistent squalor and discourage productivity.

Inflation and welfare anchor the poor in poverty.

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First User Advantage

"Unexpected, this is. And unfortunate."
--Yoda (Return of the Jedi)

A triumph of the modern State has been convincing people that inflation should be defined in terms of changing consumer prices. Higher consumer prices mean higher inflation.

Prior to the early 1900s (amazing how that period keeps coming up), inflation was classically defined in terms of quantity of money and credit. More money and credit meant higher inflation.

It doesn't require a PhD to sense a relationship between money/credit quantity and prices. Create more money/credit and higher prices should result.

So, doesn't that mean that the modern and classical definitions of inflation are equivalent?

Nope. Today, most money in the system actually takes the form of credit. And the ultimate suppliers of credit in modern systems are central banks. The supply chain generally works like this: central banks lend to big commercial and retail banks; big commercial and retail banks lend to big borrowers such as investment banks big corporations, hedge funds, and regional banks; investment banks and regional banks lend to smaller borrowers such as smaller companies and local banks; local banks lend to individuals and small firms.

It is important to understand that the credit creation process proceeds with successive creditors lending out more than the value of their capital. Banks, for instance, can lend out $9-10 for each dollar in deposits. Investment banks lever up at 20-1 or higher ratios.

The degree of systemic leverage resulting from this approach should be easy to sense. Indeed, when credit is really flowing, $1 from a central bank might pyramid into $50 to $100 of new credit money created in the system.

The classical definition of inflation, you see, focuses purely on the amount of money/credit created by this pyramid scheme.

Here's the thing. We never know where all this money and credit, once created, is going to go--at least right away. Suppose, for example, that big banks borrow $100 billion from the Fed. Instead of lending it, however, they decide to invest it--in stocks, bonds, mortgage backed securities, etc. Little of this money makes its way to the retail end of the supply chain and into the hands of consumers--at least in the short term.

Suppose we have two categories of prices: consumer prices (milk, break, cars, etc) and financial prices (stocks, bonds, etc).

Given the above scenario, which category of prices is more likely to increase: consumer or financial? The financial category, of course, because of increased demand for stocks, bonds, etc. flowing from banks.

Do you see the implications? In our example, $100 billion in new money has been created. But since there has been no measurable effect on the 'consumer price index,' officials proclaim that no inflation is present.

This is precisely what's going on currently. Trillion$ in new credit money have been pumped into the system, but most of it has stayed with the banks, who have used it to buy financial assets. The S&P is up nearly 100% from the March 2009 lows when new money creation went into hyperdrive.

And yet officials report that there is little inflationary pressure because consumer prices haven't moved much.

If you've been wondering how those 'fat cat' bankers get so fat time and time again, you're looking at the primary reason. Our system is rigged to provide financial institutions with 'high powered money'--particularly during times of crisis. This is money created out of thin air that has high purchasing power for those able to use it first. Since big banks are upstream in the supply chain, they get first dibs on it from the Fed. So they use it to buy financial assets and bid prices up.

By the time this money filters downstream to the retail end of the supply chain, much of its purchasing power has been lost because there's much more of it. This pushes prices of consumer and finanical goods higher. Any money held by consumers prior to this inflationary process declines in value as well due to increased money supply.

The implications of this process are many: widening gaps between rich and poor, middle class families increasingly troubled making ends meet, serial financial market bubbles followed by deleveraging busts...

It starts with the Jedi Mind Trick of inflation.

position in SPX

Hedonic Absurdity

Drawn into the stream
Of undefined illusion
Those diamond dreams
They can't disguise the truth
--Level 42

Confusing NYT piece that discusses hedonic adjustments to government-reported inflation data in the plight of poor people trying to make ends meet.

Hedonic adjustments are downward revisions that bureaucrats make to pricing data to compensate for quality improvements over time. For example, although you may have actually paid $1000 for a computer, the government might say that the 'real price was only $800 because you get more for computing performance per dollar today compared to years ago.

Bureaucrats apply hedonic adjustments to product and service categories from ground beef to law services to grass seed.

On the one hand, the NYT article suggests that the poor would be worse off if the performance per dollar of goods and services had not improved over the years. On the other hand, the article also notes that poor people still struggle to pay for basic goods and services.

This lobs a softball-sized question toward the NYT reporter that, unfortunately, is never asked. Why should the poor be struggling to make ends meet if hedonics have pushed real prices of goods and services lower?

The answer, of course, is that real prices aren't lower. Actual prices paid for nearly all goods and services are much higher now than just a few years ago.

Hedonic adjustments are a ruse--a way for officials to manipulate the data to cloak rising prices. Prices are rising because $trillions are being printed out of thin air. The dollars in our pockets buy less now than before.

The group that is hurt the most by this inflation and the hedonics charade is the poor.

The Fed, Food, and Chaos

There's a room where the light won't find you
Holding hands while
The walls come tumbling down
When they do, I'll be right behind you
--Tears for Fears

Thoughtful piece linking Fed policies to uprisings around the world, with Egypt the current focus. We've been noting it for a long time: central bank policies gut wealth over time. Those impacted the most are those with lower incomes since they have little means to protect themselves against inflation.

In an interconnected world, the effects of the Fed's policies are not confined to US borders. Via stimulus, QE2, and other money printing programs, we are exporting inflation to the world. Inflationary effects are exacerbated because the US dollar remains the world's reserve currency. On a beggar-thy-nation planet where all countries want weak currencies in order to gain an edge in trade, as the Fed prints...so does the world.

Commodity prices worldwide have been shooting higher since last summer--none more so than agricultural commodites. One representative ETF above, DBA, is up about 50% since last summer.

Naturally, the effects of higher food prices are felt in developing countries first. Poor people begin to have trouble affording food. And when citizenry can't eat, they riot. Thus the situations in Kuwait, Tunisia, Egypt, et al.

Blend inflation w/ worldwide proclivity toward socialism, and you've mixed yourself a massive chaos cocktail. 

position in commodities

The Oversight of Regulation

The lights go out and I can't be saved
Tides that I tried to swim against
Have brought me down upon my knees
Oh I beg, I beg and plead
--Coldplay

In his weekly radio address, President Obama claims that increased financial regulation will end tax payer funded bailouts and 'put an end to the cycles of boom and bust that we've seen.'

Not likely. Such claims ignore the root causes of boom/bust cycles to begin with, and the role that government has in exacerbating them.

Underlying business cycles are patterns of inflation followed by deflation. Classically defined, inflation is an increase in the quantity of money and credit. In today's monetary systems, the majority of money is in the form of credit, meaning that during inflationary periods, there must be both supply of credit and folks who want to borrow. In free markets there is likely to be a natural ebb and flow to this cycle. This is because there is a group component, or herding impulse, to economic behavior--i.e., collective optimism followed by collective pessimism.

In free markets, there are 'natural regulators' that reign in optimism during expansionary times. One is the price of money, or interest rates. For example, as folks borrow more to fund expansionary and speculative projects, interest rates that creditors charge rise to offset the risk of increased leverage in the system, making further borrowing less likely and slowing down expansion.

Another natural regulator is outright failure. In free markets, poor decisions are penalized by loss of economic resources. Fear of loss tempers feelings of greed, thus reducing potential for exorbitant booms.

But today's markets are not free. Interest rates, for example, are no longer under pure market control. The Federal Reserve and other central banks manipulate interest rates to fix the price of money at non-market levels. Central banks also have power to create money and credit out of thin air, which greatly increases capacity for systemic inflation during boom periods. It didn't take long after the Fed's founding in 1913 before financial system leverage began increasing dramatically.

Increased regulation and oversight can also distort signals of value and risk. For example, FDIC insurance 'guarantees' deposits at participating financial institutions, thus reducing propensity among buyers to kick the tires of financial instituations where they park their money and investments. Conditions of moral hazard develop as folks are prone take more risk, thinking that government has their back if things go bad.

The consequences of this? Potential for much more leverage during expansionary periods than was ever possible in free market situations. Cheap credit, unlimited money creation capacity, and no fear of loss fuels a 'crack up boom' that inevitably spawns a deflationary bust as projects that should never have seen the light of day go to zero value.

Appropriate solutions to this situation are not grounded in more government control, but less. Remove price fixing central banks and their monetary printing presses, and regulations that atrophy buyers' motivation for managing risk, and watch big financial meltdowns disappear.

Like bureaucrats that have preceded him, however, Mr Obama will likely add more fuel that will ignite an even bigger fire down the road.

Soaking the Poor

"I have to believe that when things are bad, I can change them."
--James Braddock (Cinderella Man)

Frank Chodorov explains how incomes taxes work to soak the poor. Using social security as an example, he demonstrates that those who partake in social welfare programs lose thru increased dependence and thru the inevitable inflation that the State must use to pay entitlements.

Do you know what an interesting comparison would be? Examine the progress made in reducing poverty from the country's founding until 1913. Then look at the progress in reducing poverty since then.

Which period was more effective in reducing poverty?

Speed Kills

When the walls come tumblin' down
When the walls come crumblin' crumblin'
When the wall come tumblin' tumblin' down
--John Mellencamp

The below charts are taken from John Mauldin's fine piece on the velocity of money.

Note that velocity falls during economic slowdowns and was negative during the Great Depression (note also that we're on the cusp of negative velocity right now). When velocity falls, so do prices.

Why should falling prices freak people out? Shouldn't we welcome falling prices?

For those with little or no debt, the answer should be a resounding 'yes,' because falling prices increase purchasing power. Prior to 1900, the US saw multiple periods of such 'deflation' while standard of living ripped higher as businesses became more productive.

But in a world lugging massive debt, falling prices are a curse. People borrow money using assets or income as collateral. Falling prices reduce the value of collateral, thereby increasing leverage ratios. At some point, debtors face margin calls from creditors. Or defaults.

In a free market, responsibility for handling this situation lies in the hands of debtors and creditors. Borrowers and lenders have to manage the risk of slowing velocity and falling prices by correctly sizing their loans. They bear the consequences of poor decisions (read: excessive risk taking).

In an interventionary world, responsibility for this situation lies with central banks and government. Each time money velocity falls, bureaucrats intervene to pump money supply higher.

Such a situation invites two chronic conditions. One is that people are motivated to borrow and take more risk than they otherwise would (read: moral hazard). Saving is discouraged. Standard of living appears to be higher than it otherwise would be, convincing people that interventionary policy must be the right thing to do. The chart below expresses this condition.

The other chronic condition is inflation. More money printed means decreased purchasing power per monetary unit . People have larger banks accounts but their money buys less.

It's the Jedii Mind Trick of inflation.

Critical thinkers should be asking whether there might not be a supercycle to this moneyprinting scheme that collapses under its own weight at some point. They should also be considering plausible conditions that could drive the collapse--and where we currently stand vis a vis the list.

Monetary Roundabout

I'll be the roundabout
The words will make you out and out
--Yes

One of the greatest tricks that monetary bureaucrats have pulled over the past 100 years is shifting the definition of inflation from the cause (expansion of quantity of money and credit) to a potential outcome (increase in prices).

Policymakers have also convinced people that the only meaningful inflationary price increases are those that effect some goods and services. Increases in the prices of housing, food, and energy are not part of 'core inflation,' we are told.

We are also told that increases in price of financial securities (stocks, bonds, etc) are not inflationary.

Monetary deception is a primary reason why the chasm between poor and rich is unnaturally widening. More money and credit destroys purchasing power and increases debt burdens on those at the bottom of the economic pyramid. Those at the pinnacle get richer as they get first dibs on the newly minted cash.

It also drives the boom/bust roundabout.

Genuine Disingenuousness

There's things going on behind her back
Oh, they'll give you a heart attack
--Flesh for Lulu

On the heels of yesterday's release of Berkshire Hathaway's annual shareholder letter, I was chatting w/ friends and family about some of Warren Buffett's commentary. Characteristically, my commentary turned negative. It is no secret that I have soured on this man's approach over the past few years, and these pages have recorded such.

I do not like disingenuous behavior. In my view, WB's 'aw shucks' reputation serves as a disingenuous facade. For example, in his recent letter, Mr Buffett rails against the 'ugly result' of government policies that debase the value of money. He notes:

"Systemic forces will sometimes cause them [governments] to gravitate to policies that produce inflation. From time to time such policies spin out of control." (p. 17)

Were this of real concern to WB, he is in a strong position to do something about it--particularly given his cozy relationship w/ the Obama administration. For example, he could use his editorial page power to note how existing monetary policies serves to gut the wealth of savers, particularly older people. He could observe how these policies widen the divide between rich and poor. He could testify before Congress that central bank policies are destroying the value of the dollar and shouldering future generations with unworkable levels of debt.

But he doesn't.

Instead, he has used the media platform to condone such policies, suggesting that people should thank their lucky stars for the interventionary policies of Ben Bernanke & Co.

Even the most superficial review of Berkshire's business model finds a leveraged entity that depends on inflation. This model has been a beneficiary of government's interventionary policies to the tune of eleven or twelve figure size since 2008.

Crony capitalism at its finest.

That, my friends, is what irks me. WB could use his influence to make the system better. Instead, his behavior reinforces what is wrong with the system.

Minimum Wage Laws and ECON 101

I'm ten years burning down that road
Nowhere to run and nowhere to go
--Bruce Springsteen

In an open letter the Obama administration, George Reisman provides a simple ECON 101-based explanation of the negative effects of minimum wage laws. As we have observed many times on these pages, minimum wage laws are forms of compulsory unemployment.

As such, and as Prof Reisman observes, minimum wage laws are anti-labor and anti-poor. They force marginal workers to the sidelines.

If the goal is to raise standard of living of marginal workers, then the correct policy is to abolish the minimum wage and other policies (e.g., forced union pay scales, licensing) that block the path to economic improvement for poor people.

Money printing must also be stopped, as inflation disproportionately destroys the purchasing power of lower wage earners.

Deflationary Leveling

There's something happening here
What it is ain't exactly clear
--Buffalo Springfield

Toddo reflects on the spectre of deflation using excerpts from sone of his past seminal posts. Todd's posts are always insightful, but his thoughts on deflation (and those of Mr Practical) have been among the 'Ville's strongest contributions to the development of my personal thought process over the past few yrs.

One point excerpted from an early 2008 missive is that deflation is a leveling phenomenon. Deflationary declines in prices increase the purchasing power of those at the bottom of the economic pyramid while vaporizing wealth of those near the top (the rich are overweight financial securities that will get hammered in a broad deflation).

Perversely, broad swaths of the populous have been brainwashed into believing the opposite--that deflation is a bogey that must be avoided at all costs--even if it means borrowing and printing ever more money to do so. Yet, it is precisely this inflation that has been increasing the divide between rich and poor. The poor have trouble making ends meet because their dollars buy less. The rich get richer because money pumping jacks the value of their financial assets higher.

Capitalism is not increasing this divide. Forceful intervention that props up bad decisions at the expense of prudent ones is the culprit.
If people thought more clearly about what is going on here, then my sense is that we would welcome deflationary forces that want to bring the economic system into natural balance. We would be starting down the road to real recovery.

Ignore and Get Poor

"You know, I know this steak doesn't exist. I know that when I put it in my mouth, the Matrix is telling my brain that it is juicy and delicious. After nine years, you know what I realize? Ignorance is bliss."
--Cypher (The Matrix)

As noted in this article, the following chart says it all:

Bernanke and other Fed heads have been claiming that their actions have not been stoking inflation.

Today, gold is again marking all time highs, silver is at generational highs, and oil is north of $110/barrel.

Of course, those who slurp down such drivel will be first in line for the next bailout...

position in gold

Shout It Out

In violent times
You shouldn't have to sell your soul
In black and white
They really really ought to know
--Tears for Fears

In a Buzz post this morning, Mr P leveraged a fine essay by another smart cookie, Walter Williams of George Mason University.

I'm going to quote his entire 9:35 am post here. Re-read until you master the thought behind it. If you do, you'll grasp a root cause of our current problems.

Socialism

The following is from an editorial written by Walter Williams of George Mason University:

"Knowing the dangers posed by central banks, we might ask whether our country needs the Federal Reserve Bank. Whenever I am told that we need this or we need that government program, I always ask what we did before. It turns out that we did without a central bank from 1836, when President Andrew Jackson closed the Second Bank of the United States, to 1913, when the Federal Reserve Act was written. During that interval, we prospered and became one of the world's major economic powers.

The justifications for the Federal Reserve Act of 1913 were to prevent bank failure and maintain price stability. Simple before-and-after analysis demonstrates that the Federal Reserve Bank has been a failure. In the century before the Federal Reserve Act, wholesale prices fell by 6 percent (prices normally fall as production increases); in the century after they rose by 1,300 percent. Maximum bank failures in one year before 1913 were 496 and afterward 4,400. During the 1930s, inept money supply management by the Federal Reserve Bank was partially responsible for both the depth and duration of the Great Depression.

It is not wise for us to permit a few people on the Federal Reserve Board to have life and death power over our economy. My recommendation for reducing some of that power is to repeal legal tender laws and eliminate all taxes on gold, silver, and platinum transactions. That way there would be money substitutes and the government money monopoly would be reduced and hence the ability to tax--some people would say steal--from us through inflation.

I could not have said anything better myself, and of course agree. Mr Williams' last statement I have referred to before. By devaluing a currency over long periods of time (which every central bank does), a nation effectively makes the rich more wealthy and the middle class and poor less. This occurs because the rich own assets that rise in price and therefore hold their value relative to money while income is devalued. A middle class wage earner makes less each year without even knowing it.

Of course, government is coming to our rescue with bailout after bailout; it makes their power grow. The Federal Reserve, by driving real interest rates to negative levels for years knowingly provided the fuel to create a massive real estate bubble, is itself the greatest socialist institution ever created. Companies that are too big to fail by definition illustrate socialism.

The U.S. is rapidly becoming socialist where government will become a larger and larger part of the economy and our lives and make more and more poorly thought out decisions. This will over time decrease productivity and profits.

Risk is high, but only the government knows how high.

positions in gold and silver

See It

"No dream is ever just a dream."
--Dr Bill Harford (Eyes Wide Shut)

Last fall, a video that explained QE2 went viral. A brilliant piece.

Now, the creator has developed a video that explains inflation. Another homerun.

Those scratching their heads over the widening chasm between rich and poor should make sure they understand what is being said here.