Tuesday, August 9, 2011

Is inflation the answer?

The Curious Capitalist explores the Fed's options, including having the Fed raise "target inflation" from 2% to 4% or even 6%.

So pushing up "target inflation" rates may seem like a good idea, but there are definitely a few hazards here.

Hazard #1: Seniors

Pushing up inflation means raiding those who have cash. The goal is to raid the coffers of big companies just enough to push them into spending that cash. You're basically trying to "scare" people into spending to produce.

The side effect here is that inflation affects all cash.

Targeting 5% inflation hurts people planning to retire soon (i.e.: baby boomers), but it also really hurts those who are already retired. These people already live off of cash and they've stopped producing. They have way to counter the effects of such growth, they cannot grow their income.

It also sucks for the unemployed who were already falling behind.

Hazard #2: Anger investors

Investors are not stupid, they can calculate the effect of inflation. The 10-year treasuries are currently under 3%. Investors are honestly accepting that this is basically zero growth. You're not moving forward much, but at least you're not losing ground.

Changing the inflation plan to 5% means that 3% investment is effectively losing ground. What's more, everyone who bought these sub-3% bonds in the last 3 years is going to end their 10-year holding at a real loss.

China will not be happy about this move. Forcing inflation is raiding cash. This would be raiding China's coffers in a very real way.

Hazard #3: The gig is up

The long term plan has always been to inflate away some portion of the debt. Everyone is doing it, but there's definitely an aspect of "chicken" going on. No one wants to inflate too much.

Well jumping inflation to 4% or 6% on purpose pretty much ends the game. Then everybody knows the plan. Fiat currency is all about trust. Raiding the savings of hundreds of millions of people is not a great way to engender further trust.

Maybe I should buy gold... or bitcoins... or both :)


Edmundo said...

You can't have one solution to two different problems here.

If money is to facilitate trade, a certain quantity is needed. This quantity increases with growth and with the length of time for which it is hoarded.

If money is also to be a way of accumulating wealth that outlives the consumption of the goods sold in exchange for it, the total amount of it has to be revised downwards as the goods perish or its value has to be depreciated by inflation. Otherwise the total globally accumulated saving is not underpinned by any real wealth - a bubble that must be burst at regular intervals.

Gates VP said...

...Otherwise the total globally accumulated saving is not underpinned by any real wealth - a bubble that must be burst at regular intervals.

@Edmundo, you've pretty much nailed problem #3, which is the big issue.

I'm actually posting this as a counter to the Time article which I think is a little ridiculous. And frankly, it's ridiculous exactly because of the bubble problem.

Every major country has been playing the "inflation" game. Everyone is trying to inflate away at least part of its debt. But if the US jacks up the inflation rate, they're effectively going to pop the bubble.