Inflation is not the increase in money supply it is the resulting price increases and loss of purchasing power of money. Inflation acts as a hidden tax on the people and enriches some while keeping others poor. Those who own assets such as real estate and stocks can benefit enormously while others are caught chasing higher living costs and food prices while wages struggle to keep up. If inflation is bad and causes wealth disparity, why do we allow it? Who sets the wheels in motion for inflation?
Meet the Inflationists
Inflation is often the result of lax monetary policy. When the money supply grows at a faster rate than the economy the unit value of the currency diminishes. This is referred to as the quantity theory of money. Inflation can also be attributed to disruptions created by supply or demand in the economy but on a macro level it is most attributed to poor monetary policy which I will focus on. Where does this policy come from? Inflation rates are result of central bank targeting. They decide what inflation should be and then adopt monetary policy to reach that target. The central bank of the United States is called the Federal Reserve and the Board of Governors is an independent government agency, but the Federal Reserve Banks are set up like private corporations. Whoah back up! The Federal Reserve is mainly independent from the U.S. Government and the member banks are private? Yes, let that sink in. The key word in Central Bank is “Central.”
How new fiat dollars are created
Before new money is created first the Federal Reserve needs to take a guess of what the money supply actually is. They look at cash as well as money market funds, short term notes and other reserves and then they just approximate. You mean they don’t have an exact figure? Nope. Before I explain how money is created today, I would like to point out that it was not always this way. In the past money creation meant physically printing new notes usually backed by physical gold and silver. When you hear people talking about all the money being printed today it is somewhat of a fallacy because most of the money is created as credit and not physical cash. Let’s take a look how this happens.
Only a small portion of new money is created as cash by the U.S. Treasury the rest is created as credit issued by the Federal Reserve. If the Federal Reserve issues 1 billion in reserves to banks those banks can then lend up to 900 million to borrowers. Banks have around 10% reserve requirement so they cannot lend out all of it. The borrowers of the newly issued credit use or transfer the money which then winds up as deposits in other banks. This 900 million of new deposits can now turn into 810 million to be lent out by the new banks and so on and so on. The original 1 billion in Fed credit can turn into 4 billion in newly created credit money. This is the money multiplier and why our current monetary system is a credit system.
Between a rock and hard place
Peter Schiff who is one of the most notable Bitcoin detractors has been dead wrong about it. Where Peter Schiff is correct is in his understanding of the dilemma that central banks face. On one hand if you keep loose monetary policy you risk of massive inflation on the other hand if you restrict the free money spigot too tightly you wind up crashing the economy. It’s a tightrope act being conducted by the Fed and it becomes increasingly harder as time passes.
“The Federal Reserve has trapped themselves; either they raise interest rates and bankrupt the Treasury, or they don’t raise rates, let inflation spiral out of control, and bankrupt the American people,” said Peter Schiff, chief market strategist at Euro Pacific Asset Management.
Inflate or die
If the Fed targets 2% inflation what they are really doing is creating exponential growth in the money supply. At just 2% annual inflation prices will double every 35 years. It is worth noting that many people believe that actual inflation rate is much higher than 2% which means the devaluation of the US Dollar happens much more rapidly. So why even target 2% inflation, why not target 0% inflation? The reason is simply that the system requires it. Without a steady flow of new money entering the system things would work in reverse. Instead of new loans being issued and the economy expands defaults would happen and the economy shrinks. Exponential growth would turn into exponential decay. This is why you see “hockey stick” patterns when you look at charts such as the National Debt. It is simply irreversible.
Savers are losers
The magic of creating money out of thin air makes it impossible to save. Also, the national average rate of a savings account is only .06%. If inflation is 2% that means savings accounts lose money over time. So the bank takes your deposit lends out 90% of it and pays you less than the rate of inflation? Yep, some racket!
Everyone must enter the casino
Since savers are losers and inflation increases the cost of living there is only one thing you can do with your extra money and that is to invest. Capital gains are the only way to stay ahead of the constant erosion of the dollar. Since everyone must become an investor the risk appetite increases. Also, since everyone is forced to enter the markets that means there are less buyers in the waiting ready to soak up liquidity. This conditioned behavior is a result of the credit system and creates investment manias and inevitable crashes such as the Dot com bust of 2000 and the real estate crash of 2008.
The birth of Crypto
“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
This quote is from an article in the Financial Times (2009) which spoke of the massive intervention into the banking system and the resulting devaluation of fiat through bank bailouts. The quote is also contained in the first transaction parameter of the genesis block on Bitcoin. Cryptocurrency was born and this ushered in a new age of monetary thinking. Crypto serves as a new idea for money and is seen as an alternative to using devaluing fiat.
What is money anyway?
Money is just a medium of exchange and serves to be used as a liquid asset that replaces bartering. Instead of finding someone who has a shovel that is willing to trade for a rake money serves as something that holds value and is universally accepted. Gold, silver, seashells, tally sticks have all been used in human history as this medium. Cash used to be backed by physical gold and silver. Now it’s merely just an IOU which is not backed by anything except faith. This is credit money which I mentioned earlier and can expand infinitely. Again, the ever-expanding money supply is the greatest challenge to obtaining and keeping wealth.
Crypto deflates prices paid
Since most cryptocurrencies have a fixed supply, they will likely appreciate over time. The first known commercial transaction using bitcoin was for two Papa John’s pizzas for 10,000 BTC in 2010. At that time BTC was not worth much and was agreed that it was a fair trade. However, when you look at today’s value which is over 600 million dollars you can see how this asset will buy you more as time passes not less. Crypto investors have become quite confident that Bitcoin and other cryptocurrencies will appreciate over time regardless of occasional bear markets. By putting savings into cryptocurrencies, you are almost assured that the money you put in today will buy more as time passes. This creates real savings because crypto has proven itself to be a great store of value that increases over time.
It wouldn’t be fair for me to talk about the positives of crypto without examining the risks. Since cryptocurrencies pose a threat to the current financial system politicians and bankers alike are taking a defensive posture. Former Secretary of State Hillary Clinton recently issued a statement saying “Crypto has potential for undermining the role of the dollar as the reserve currency.” Janet Yellen who is the currently the Treasury Secretary of the United States said, “It is a highly speculative asset, and you know I think people should be aware it can be extremely volatile, and I do worry about potential losses that investors can suffer,” The irony is that she has also discussed the Federal Reserve having its own digital currency. The problem of course is that it would be a highly centralized digital currency which contradicts the main feature of cryptocurrencies such as Bitcoin. In the new infrastructure bill, there was language added for increased reporting requirements. The biggest threat to crypto is not failing on its own but rather be stifled by government regulation or outright banning such as in China.
The birth of cryptocurrencies has ushered in a whole new era of asset class and provided savers with a solution to fiat currency devaluation. Millionaires have been made and savers have seen their savings multiply on a consistent basis. The storm clouds on the horizon come from those who want to retain the current financial hierarchy. The fight has only just begun but for the people’s sake it is the greatest one in their lifetime. A fight that the people are winning, for now.