Rathbun: The silent killerWritten by Gary Rathbun | | GaryRathbun@PrivateWealthConsultants.com
In watching all of the activity is Europe, I surely can’t be the only one that thinks I am looking into the future of our country! Prior to this last week our debt auctions have been deteriorating and the primary dealers have been picking up the excess. Foreign central banks have not only backed off buying our debt but they have started to unload the debt they bought in the past.
This week, however, has been quite a different story. The cover ratio of the last auction was over 4.0. We haven’t seen this much demand for our debt in a long time. Why the change? Simple, our currency and our debt is the least bad of all of the garbage out there. The Euro and the European Union is in grave danger of going away and billions of dollars are leaving those countries and their banks and need to go somewhere, so for now they are coming here.
For the time being this is likely to keep the dollar a little stronger against the Euro. However, it is only a matter of time before inflation rears its ugly head with a vengeance. This administration and this Congress has operated the last three years without a Constitutionally mandated budget and have run up over 5 trillion dollars of debt.
I really don’t expect the piper to come collecting until after the election next November, especially since the Fed has stated that it will not likely raise interest rates until mid-2013. After that, however, is another story. That is unless the powers that be continue to cook the books on “declared” inflation.
Inflation can exist long before the affects of increasing prices are recognized. This is a dirty little secret that is very important to the government to advance its agenda. The government actually needs inflation but it also needs the public perception of inflation to be very modest for as long as it can.
Inflation is the amount of dollars that is in circulation or the money supply. When you add new money or credit to the economy the general level of prices will rise. (Given the amount of goods and services within the system stays the same) The money supply is changing all of the time and prices go up and prices go down. An increase in the money supply is the cause; the change in prices is the effect.
When the money supply increases, more dollars are chasing fewer goods therefore the prices go up. Another way of putting it is when there are more dollars injected into the economy the value of each existing dollar goes down so it takes more of them to purchase goods and services. It is the same with any thing that has value due to scarcity. Picasso paintings are valuable because there are so few of them, if we were to find 10,000 new Picasso paintings stored somewhere, the value of existing paintings would diminish.
I could go into stories of the Weimar Republic in Germany or modern day Zimbabwe, but both of those are very extreme and I think we are a few years away from that type of scenario. (That is not to say that we are not on that path….we are.) Expansion of the money supply creates no additional goods to the economy it just causes the prices to rise and therefore, creating an artificial demand.
This economic principle is formally known as Say’s Law. (Attributed to the French economist Jean-Baptiste Say) Oversimplified, Says Law is stated as supply creates demand but the element of production is critical. A better way of expressing Say’s Law might be that production creates consumption; the supply of each producer creates his demand for the supplies of the produces and so on. Say believed that increasing the money supply creates inflation because more money is pursuing the same amount of goods but this does not increase the real demand.
So far most of the money that has been printed has been use to buy up government debt that no one else wants, so the money has not been introduced into the economy in bulk yet. The Fed is now the government’s largest debt holder and very soon most of the debt will need to be purchased by the Bernacke and his successors.
Next time we will look at why the government likes inflation, needs inflation and what you can do to take advantage of it in your personal investments.
Gary L. Rathbun is the president and CEO of Private Wealth Consultants. He can be heard everyday at 4:06 on After the Bell with Brian Wilson and the Afternoon Drive, and every Thursday evening at 6 p.m. on Eye on Your Money both on 1370 WSPD. He can be reached at 419-842-0334 or at email@example.com.