The Market Ticker - TIME Magazine Pulls A Lefty

Now this is the definition of obscenity – and ridiculous besides.

Turns outs that it is very unlikely the Fed would cause hyper-inflation. That’s why near zero interest rates and the Fed’s early efforts to drive down long-term interest rates have done little to boost inflation. The real threat of inflation comes from tax policy, namely lower taxes. Lower taxes and the government will have a harder time paying back its debt. Investors run from our bonds and currency. Inflation ensues.

Someone’s got cause and effect backward.

Bond prices are not “inflation.”  Inflation (or the threat thereof) causes bond prices to fall and rates to rise.

Stephen really shouldn’t write about a subject he clearly doesn’t understand.

The extension of credit always comes with interest.  Interest is defined as:

Devaluation of the currency + risk of non-payment + time + profit

That is, interest always contains the elements of:

• The risk you won’t pay the loan back.  That risk may be considered to be “zero” in the case of a sovereign, and in fact there are people who argue it is always zero in the case of a sovereign that issues it’s own currency (that is, one where sovereignty exists as a matter of currency issuance.)  I’ll go ahead and stipulate to that as a tautology, but it only shifts premium somewhere else anyway.

• Devaluation of the currency.  That is, a lender of capital will always seek to at least recover his purchasing power.  Therefore, if you believe the price level tomorrow will leave you need to 110 Quatloos to buy what which costs 100 Quatloos today one year hence, you will always add at least 10% interest to the cost of a one-year term loan.  This is the definition of “inflation”; the debasement of purchasing power for a given unit of currency.

• Time value.  All things you wish to have now but don’t have time value.  That is, there is always a premium denoted simply by having something now rather than later.  This is the reason that it costs more in terms of interest to borrow for a longer term than a shorter one, all other things being equal.

• Profit.  Nobody intentionally lends at a loss.  That is, you must induce someone to lend you their capital by offering them a profit, or at least they must believe they will profit.

Now let’s talk about the devaluation issue, because this is where the bottom line rests.

The current GDP is approximately $14.7 trillion.  There is roughly $53 trillion in credit and another ~$2 trillion in currency in the system today, for a total purchasing power of about $55 trillion.

Note that in 2000 the GDP was about $10 trillion but the total credit and currency outstanding was approximately $25 trillion.

The result?  Inflation.

Now you say “but I didn’t see much inflation.”  Sure you did.  House prices anyone?  Stock prices anyone?  You most-certainly did see inflation!  You might not see it in CPI to any great degree, but a doubling over 10 years is in fact about a 7% inflation rate across the entire economy.

Remember the fundamental economic equation is MV = PQ

That is, Money (Credit) * Velocity = Price * Quantity

This too is a tautology – the amount of money and credit in the system times the number of times each dollar of money or credit is exchanged in the economy must equal the price times the quantity of all items produced in that economy.

The Bond Market is often argued by the Chartalists to be immaterial to the system because the Government (really The Fed) can simply print and spend into existence any quantity of money (credit) desired. 

This is true but intentionally deceptive.  The bond market remains the mediator of excessive government spending, in that it acts as a “sink” to check monetary emission by government.  Should that mediation function be lost, as happens when QE takes place, the government’s emission of additional spending goes directly into the base equation without restraint.

Now you’d think this would reflect directly into wages, and thus while it might cause “inflation” in the technical sense it wouldn’t matter.  You’d be wrong, because all processes, including economic ones, involve inefficiency – even if the monetary system is closed.

Worse, the monetary system is not closed.  When the bond market’s yield is suppressed below the equilibrium point such that investors do not believe the yield properly provides the four points above they take their dollars abroad and buy something “over there.” 

This is effectively “money printing” in those other places, and exports our price inflation.  It also removes the funds that would otherwise press wages upward, making the economic slippage worse.

The consequence is ramping prices into stagnant or declining wages, which produces poverty.

In the foreign net exporting nations it’s even worse – they get massive injections of credit/currency which cause the price level there to rise, but again, economic slippage means their wages don’t keep up either.  So we get foreign asset bubbles and poverty there as well.

Tax policy is an indirect cause.  The so-called “study” from Eric Leeper is beyond ridiculous.  Deficits cause the emission of credit into the economy.  To the extent that you issue more currency or credit (on a percentage basis) than GDP rises, you get monetary inflation.  This is because once again MV = PQ – we’re back to that fundamental equation.

So the bottom line is that if tax policy causes the emission of credit (by the government) at a rate that exceeds true economic growth, then you have monetary inflation.  Tax cuts can cause this assuming spending remains flat, and particularly if spending rises.

But it is budgetary balance that is the actual issue – that is, the presence of deficits which cause the emission of credit - that causes the inflationary impact.

Of course you wouldn’t expect TIME to talk about THAT issue, because then they’d have to explain this graph – which shows MASSIVE monetary inflationary pressure, with George W Bush starting it but President Obama more than doubling the impact over the last two years:

Get your facts straight TIME – mathematical equations always balance.

Always.

Read more at Karl Denninger – The Market Ticker