Inflation or Debt
Inflation is a fundamental property of the Fiat (currency whose monetary value is conferred by the decree of the government) monetary system because of the government’s predisposition to favor debits over receipts. Inflation tends to be low as long as neither the government nor the people overspend. The government controls the people’s spending openly but not solely through interest rates. As the cost of borrowing rises, people would have less incentive to spend excessively. The government’s spending is moderated by its fear of hyperinflation, which could very well lead to its own demise.
The root of all inflation is the excessive creation of money by the federal government or by its cohort banks, who also have been entrusted with a similar but lesser power. The government’s decisive privilege over the banks is that while banks do create money in the form of the loans, the Fed (defined by the collaboration of the federal government and the Federal Reserve) can bring money into existence unconditionally. The loans, however lengthy the terms, will eventually be paid or written off, then the money that had originated ceases to exist. The only way to destroy the base money is for the federal government to achieve a real fiscal surplus and to also have the will to retire the surplus. In the history of the United States, government budget surpluses have been few and far in between, while any retirement remains imaginary. In the following discourse I shall focus on inflation in the US dollar, though the same phenomena apply to all fiat currencies.
Bailout has been a popular term in our society ever since the 2008 mortgage crisis when the Fed spent about a small but significant proportion to the GDP to keep the big banks solvent after being impacted by losses from unscrupulous mortgages. The term has never been more popular now. During the current COVID crisis the government boosted spending far eclipsing that of 2008 in order to rescue a paralyzed and deflationary economy. The purpose of the rescue is two fold. The lesser is to help those in need but the greater is to reverse deflation caused by abatement of economic activities. Under no circumstances would the Fed allow deflation to persist; the economy must always be inflationary. One cannot help but to speculate that with such a massive increase in money supply we are all but certain to experience a dramatic increase in inflation. Some assets such as equities and homes have reached all time highs (a natural consequence of the government spending). Clearly the Fed has no idea and inflation will go through the roof right? Well not so fast… The Fed can bootstrap itself out of the quagmire using a simple tool. No, it’s not the interest rate. It is debt. While the Fed has undeniably flooded the economy, it will gradually soak up the excess by issuing federal debt after the economy begins to recover. Before discussing the process of converting money into debt, let’s prove why debt works. When participants in the economy convert their currency into government debt, those currencies no longer participate in the economy; thus, the total amount of money in circulation is reduced. The effect of this conversion is certainly deflationary in nature. All term loans bear a maturity date and an interest/coupon rate. Upon reaching maturity, however, the principal of the loan plus the interest shall enter the economy and cause inflationary pressure. All for naught and worsened by interest? Suppose the federal debt can be rolled over indefinitely; meaning on the maturity date, a new loan equal to the principal (with compounded interest) is issued. Since lenders are willing to loan out this money indefinitely at a interest rate solely determined by the issuer (lenders have fictitious power in determining the interest rate), it reasons that the same lender would be willing to reinvest part or all of the interest earned*. The Fed continues to issue debt until the remaining money supply is similar to that prior to the decline adjusted for inflation. The added money supply is sequestered as debt, thus its inflationary effects are curtailed. In effect, the Fed is performing redistribution on the money it borrowed from savers as mandated by its policies. The savers are given IOUs to be eventually made whole nominally through inflation.
*With the absolute powers to issue new debt as well as setting its interest rate, the Fed has no incentive to ever reduce but every incentive to increase the amount outstanding, a policy which it has happily adopted throughout history. The numerical representation of the national debt, however large, has no significance to the government; if the number were deemed to be too big, a negative interest rate would suffice (with some caveats beyond this explanation).
Theories are meritless without feasible implementations. Why would anyone consent to wealth redistribution through inflation by purchasing government debts? Well as it’s nothing beyond mandate and necessity. A large quantity of the government debt in the form of Treasuries are being purchased by government Agencies. Social Security, Medicare, and Medicaid are all stored in the form of Federal Treasuries. In addition, the Fed employees’ pension funds are automatically converted to Treasuries. Agencies and private institutions that operate in some government sanctioned sectors such as insurance are required to hold a percentage of their assets in Treasures. Foreign governments for both stability and global trade hold a portion of their assets in other foreign treasures. Individual investors seeking safe haven also hold treasuries; thus, mutual funds and etfs must also buy Treasuries. As the incessant demand in Treasuries continues, principal invested in Treasuries will also reinvest to new Treasuries with their earned interest. Every organization and individual with savings is actually impacted by inflation with or without consent. Every participant in the economy is socializing the furtive effects of inflation. The implementation of the national debt has been extraordinarily successful as the nominal account of the US national debt has increased over one hundred times in the past seventy years while our population has only doubled. The debts are always repaid at a lesser value (interest included) than they were sold as the repayments must indemnify the full interest of inflation that had occurred economically since their existence. Inflation is insidious and omnipresent. Being bestowed the privilege of lending money to the government only to be repaid a portion of the present value in the future is certainly an honor to behold.
Given our current understanding of inflation, there are two macro engines driving the economy. The Fed creates the base money and increases the amount periodically in order to satiate the demand of the economy. The Fed also unleashes an excessive amount of currency periodically and extraordinarily as demanded by the federal government in order to fund its various forms of deficit spending. The excessive currency is necessarily converted to and held as Treasures to avoid unacceptable inflation in the economy. The banks create money through loans such as home mortgages in accordance with the regulations decreed by the Fed. Although this money in the form of loans ought to be temporary in nature but in reality it persists like Treasuries, the total outstanding is always increasing over time. The outcome of these loans is in the exact opposition of the Treasuries. When the interest rate is sufficiently low, people have an incentive to purchase durable large assets like homes. When such purchases occur, money is created from nothing and placed into the hands of the seller. The seller is then able to circulate the newly minted money freely in the economy. Should too many people partake in these loans (in spite of the rise in prices from the higher demand), inflation becomes a serious risk due to excessive supply of money. The Fed then has an incentive to raise the interest rate and sell more Treasuries in order to combat the people’s will to borrow. Consequently an increase in the interest rate cools down the economy and lowers inflation.
Laws we hold to be truth whilst government has the faith of the people:
- It alone fully controls both supply and demand of the money. It has unlimited power on spending and debt insurance.
- It sets all forms of interest rate. All other interest rates are nothing but the Fed rate plus a premium.
The Fed Chairman and the Secretary of Treasury are all too aware of the importance of keeping inflation in check. Maintaining some resemblance of economic growth is important but secondary. As long as inflation is reasonable, people’s faith in the federal currency would persist. When the balance had been upset in recent history, people had experienced an unacceptable loss of wealth. The government was all too capricious and shortsighted while the federal reserve was overly reckless and indulging. As a result the economy was inundated with currency, which caused the people to raise doubts in the government’s stewardship of the economy and its own legitimacy. When managed correctly, the full effects of inflation are surreptitiously (unlike death and taxes) and fully socialized by the society. Notwithstanding the inevitable loss of purchase power experienced by all participants over time, the stability of the government is maintained. A conscientious individual investor need not hold more government debt than what’s necessary and sufficient; any more would only indulge its proclivity to further spend excessively egregiously.
