Wednesday, August 3, 2016

Inflation: a fairytale and a bitter reality bath

Last time we learned that the government's statistics say that consumer price inflation (CPI) is very low, and that the increase in wages, in US as in the Netherlands or in Italy, has kept the pace with inflation.

You can believe the government or not: personally, I prefer to trust my wallet.

They say that inflation is a kind of hidden tax: I disagree with this, to me it is even worse, because when you pay taxes to an efficient government, at least you get something in return, ie services. Inflation is different: it is reallocation of wealth from those who have less to those who have more. Some wealth goes from one group of people to another. And if you lack a minimum of economic culture, it may be very bad for you.

During a boom, nobody notices  that the gap between richest and poorest increases, because everybody feels better, so there is not such a big issue. It is like a rising tide: nobody sees the rocks. But, when crisis strikes, and you start suffering, cutting expenses, holidays, books, restaurants, etc. then suddenly you realise that somebody has done much better than you. You are much closer to the rocks and at that risk of a wreck than many others.

The point to understand is that it is all about who gets fresh money first so that he can use this money to increase his wealth during the booming period, and to buy discounted assets sold by distressed people during a crisis.

So, the real question with inflation is: who gets the new money first?

Inflation is currently caused indirectly by Central Banks and directly by Commercial Banks when they create new money out of thin air. The ones that get the money first (the first group), have more purchasing power than the others (the second group), since they can buy assets that are cheap. After they have bought these assets, the remaining assets cost more, because there are less left around. So, the second group must pay more to buy the remaining assets. The first group has four advantages:
1. they have bought cheap and best assets available at the beginning
2. they can sell high the same assets afterwards, when prices have increased due to inflation.
3. If there is a crisis, thanks to the money they can get cheap, they can buy assets at a super cheap price from the distressed folks who need to sell to pay out their debts, made when prices were high.
4. when the crisis is over, and the tide rises again, their assets increase in value and they make even more money.

Since banks can create money out of this air, the people who manage and steer this money have a huge advantage and political influence over the people who have to work to pay interests on debt, who end up being trapped in a debt cage.
Crisis are heaven for those who have money and financial knowledge. That is why we are living in a permanent crisis, and we continuously need extra money created by Central Banks, since commercial banks have sharply reduced the rate of loans and mortgages, with respect to pre-crisis situation.

We can use an example to illustrate this.

This example is taken from a book written by Dominic Frisby, "Bitcoin: the future of money?".
Imagine a tiny economy. There are 20 people in it. Of these, ten each have $1 in cash, so there is $10 in the entire economy. The other ten people each have a house – these are the only assets in the economy and are each priced at $1. People quite happily buy and sell these houses for $1 each. If more houses appear in this economy, but the amount of money stays finite, the cost of houses will fall. But let us assume for now no new houses enter the economy. One person – Mr King – is suddenly able to magically create another $10 from nowhere. He decides to go out and spend some of this new money. He buys a house for $1, which the vendor is happy to sell because, based on the knowledge the vendor has, that is the fair market price.

Except that it isn ’t because there is no longer $10 in the economy, but $20.

At $1 the vendor has sold his house too cheap – and he has received devalued money in exchange. Mr King then decides to outbid the others and offers $1.50 for another house. This vendor is delighted, sells, probably feeling rather clever, and makes off with $1.50, but even he has sold his house too cheap. Mr King, meanwhile, is developing a nice little property empire. The other vendors hear houses are now trading for $1.50 and now expect that price, which Mr King is happy to pay. In other words, house prices are gradually rising to reflect the new money in circulation. There are some big losers in this process – the people who each had $1. The purchasing power of their money is now no longer enough to buy the house they were previously able to buy. Ultimately, their purchasing power will halve because there is twice as much money in circulation. They haven ’ t acted imprudently in any way – they haven ’ t even acted – yet they are made poorer by this process of other people creating new money. What about the people owning houses? How have they done? Eventually, houses prices in this economy will rise to $2 – there are ten houses and $20 in circulation. The price of their houses should rise to reflect this extra money in circulation, so – as long as they didn ’ t sell – they come out even. They might think they are richer because their house now costs $20, but this is a delusion: it is the same house. They have just survived the inflation, nothing more. If, however, they were one of the early vendors who sold for $1 or $1.50, now they cannot afford to buy back the house they previously sold. They are ‘ priced out ’ and poorer. Meanwhile, Mr King has done extremely well. He benefits, of course, as the recipient of a load of newly created money. But he was also able to buy houses for $1 and $1.50, before they rose in price to reflect the new money in circulation, so, with his houses now valued at $2, he profits from the asset-price inflation too. Wealth, which was originally spread evenly through our tiny economy, has insidiously transferred from cash-holders and those who sold their houses early to Mr King. As a consequence of this process not only has wealth transferred, but those operating in our tiny economy no longer focus on making things. Instead they look for signs of future money creation and speculate on those signs, because there is more money to be made that way.

Who is Mr King in today's world? the finance guys and the policymakers that the finance guys fund on a permanent basis. Because they can get money cheap and sell it high around the globe. And the more money they make, the easier it is for them to control information and rig statistics to make you believe inflation is negative and that you need even more of their money to fight falling prices.

In a world like this, labour is severely hit: it is super taxed, and the money that you make, afflicted by inflation, is worth less and less. So you have to rely heavily on debt, that is money sold high by the very same people that bought your assets at a cheap price!

And the inequality gap widens. See my post about the causes of the raising inequality in the Western Countries.

Do you consider this process democratic, that is a process helping common people in a transparent way? of course it is not: it is a complex process and people prefer to think about something different and more light on a daily basis.  By relying on the State to support their lifestyle, citizens do not realize they are giving away their freedom to the same people who are enslaving them with debt. So it is people's fault, because nowadays everybody can seek for information on internet, if they are willing to do so.

So, solutions must be individual. Because there is no way you can push policymakers to create and apply rules that go against the people who pay the policymakers during their political campaign. It is plain and simple logic. And if you try to explain how things really are, you are considered a boring guy, a fan of conspiracy theories, spreading out useless pessimism. So, keep your ideas for yourself and find the best ways to protect your well-being.

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