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Published Articles by David Balovich

Title: Inflation What and Why
Published in: Creditworthy News
Date: 2/19/10

No term in the vocabulary of economics is more misunderstood than “inflation.” The word means “rising prices,” but is used at different times by different groups to describe totally different phenomena.

The most predominant type of inflation is natural and occurs as raw materials are used and must be replenished. . Another type of inflation is expressed through constantly changing conditions of supply and demand, including the fluctuating cost of labor. Yet another type results from the predatory pricing practices of monopolies such as the worldwide oil cartel that continually increases the barrel price of petroleum.

Of an entirely different order is the inflation induced by central banks such as the U. S. Federal Reserve in creating financial spikes or by the federal government in taking inflationary actions such as annually compounded increases in government employee salaries to reduce the real cost of servicing its debt. 

In any case, inflation is a fact of life that is almost impossible to control, let alone understand in all its complexities and details. This article focuses on inflation as it is treated by the U.S. monetary system and in some cases similar Western countries.

You may be asking yourself at this point, “What does this have to do with credit”? It has everything to do not only with credit but also, and most importantly, collections. Because it has to do with money and the ability to earn, spend and collect it. It is the reason why are customers have difficulty paying for our goods and services; why our salaries do not keep up with everyday costs; why our fiends, neighbors and spouses are unemployed; and a factor in the over 15,000 business bankruptcy filings in 2009.

So let’s talk about money. Money is obviously an indispensable component of our economic system. If it is properly constituted and managed, it has the ability not only to obtain goods and services produced and traded within the system, but also to encourage and create new types and quantities of production. The presence or absence of sufficient quantities of money, how it is created and introduced into circulation, how its value is established and maintained, and how it is used or not used to further the ideals of society are critical issues that are once again creeping into our current political debates, not only in the U.S. but also in the free and not so free world.

Unfortunately, these monetary issues only come to the surface within the American political system during election years, thereby failing in some of its most fundamental responsibilities. These issues are not debated because people make the mistake of believing that money is, or should be, a thing of value in-and-of itself, or that this value is created by “market forces,” so is somehow a “given.” Many also believe that monetary policy is a technical subject understandable only to experts, and should be immune from political oversight.

But history shows that money serves its socially-beneficial purposes only when it is regarded as an economic medium-of-exchange and when it is regulated by a government which can responsibly direct its benefits to the common welfare of all citizens. Such is not the case with the U.S. and other Western nations today.

The drafters of the U.S. Constitution held a progressive view of money by the fact that they gave Congress the power “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.” During the nineteenth century, the Supreme Court confirmed, in cases involving the “Greenbacks”, that this authority includes the issuance of paper money.

Through much of U.S. history, the monetary power has been implemented through a variety of methods, though since the creation of the privately-owned Federal Reserve System in 1913, it has been exercised primarily by the private banking system which lends credit into circulation and charges interest for its use. Today it is the political power of the banks and financiers that prevents monetary matters from being examined and debated the way they should be. Banking under a privately-owned central bank is not contained in the Constitution. It is an extralegal construction resulting from abdication by the United States Congress of its own lawful prerogatives.

The way money is viewed in the eyes of the banking system is to confuse it with “wealth.” “Wealth” to them means cash or bank deposits. “Wealth” is regarded as belonging to private individuals, not the government. Granted, the government has the power to commandeer private wealth through taxation, or borrow it through the sale of bonds and other securities. Also, the government holds the title to certain assets, including land, buildings, equipment, etc.

But the government should not originate wealth. Therefore, money, viewed primitively as a commodity with intrinsic value, not as an instrument of exchange created by law, cannot be created or originated by the government. This is the presumption on which today’s bank-oriented monetary system is based, and is why it is so inadequate to meet the needs of its citizens.

We tend to forget the fact that at critical periods of our history, such as during colonial times, the Revolutionary War, and during and after the Civil War with the issuance of the “Greenbacks”, the government did in fact directly issue its own money without resort either to debt instruments marketed to banks and/or the public or to collection of taxes as backing for the currency. That is to say, the government exercised the power at these times to utilize its sovereign prerogative to create “wealth” on behalf of the public from which it received its authority. It then used this “wealth” to meet legitimate public objectives, such as to wage the war that won U.S. independence or the war that preserved the Union . The fact that this wealth was “real” was reflected in the ability of the government to receive such monetary tokens as payment-in-full of taxes.

Also, the government circulated wealth in the form of metallic coinage, gold & silver, though its monetary value has been virtually eliminated by inflation of the Federal Reserve Notes that, since their introduction, have destroyed ninety-five percent of the value of the dollar. Money is then a mere token used to facilitate exchange within this complex of factors.

Unfortunately, the present course of affairs as defined by the current Federal Reserve System which oversees our monetary system falls short of these rightful uses of money. With the participation of the financial industry, the Federal Reserve mainly assures as its first priority that the wealth held by the banks will never be relinquished by them and, if possible, will never be diminished.

Rather this wealth will perpetually increase through the interest charged for its use. Of course money borrowed from the banks may be used by debtors to create new assets or may simply be spent on consumer goods. 

Thus the banks have become the primary focus of power within our nation. This is implied whenever the word “stability” is used with reference to the financial system. Businesses, households, and individuals may be subjected to the “creative destruction” of market forces, but not the banks. Also, given compound interest, a monetary system based on lending must result in the migration of all a nation’s wealth into the hands of the lenders within a few generations. This is what is happening in the U.S. today.

The current crisis dates back to 1979 when the Federal Reserve initiated a severe recession in order to fight the inflation which had built up in the aftermath of the Vietnam War and by the 1971 removal of the gold standard for international currency transactions. The situation was similar to what happened prior to the Great Depression, starting well before the 1929 stock market crash.

Since the recession of 1979-83, the concentration of wealth in the hands of the nation’s upper income groups, i.e., those with money to lend or invest, has been increasing, all the way through the economic resurgence of the mid- to late-1990s and up to today. Claims during this period by the Federal Reserve that inflation has been brought under control are called into question by everyday experience, during which individuals and families have seen large increases in prices for such necessities as housing, utilities, fuel, health care, education, insurance.

In fact, an examination of the Consumer Price Index (CPI) published by the Bureau of Labor Statistics indicates a record of relentless and unabated price inflation since 1965. The rate of increase slowed somewhat during 1979-81, when the Fed-induced recession began, but it resumed its climb and has continued upwards ever since then. In fact, prices have been virtually out-of-control for the last thirty-eight years despite official disclaimers to the contrary. For this the Federal Reserve has offered no explanation, has no answers, and in our view, has never had a plan to implement its function.

As stated in its own 1994 publication, “The Federal Reserve System: Purpose and Functions,” the first duty of the Fed is “conducting the nation’s monetary policy by influencing the money and credit conditions in the economy in pursuit of full employment and stable prices.”

Since the Fed came into existence, neither of these two objectives has ever been achieved. Can it be that given the way our monetary system under the Fed is constituted, the two goals of full employment and stable prices are contradictory? Some have even ventured that the chief method the Federal Reserve uses to reach for price stability has been to create, or at least tolerate, unemployment. In fact the Fed in its actual operations, at least since 1979, has treated full employment and price stability as being mutually exclusive. Otherwise it would not have created a major recession at that time, where unemployment increased by sixty-five percent and many businesses and even some major industries were decimated or destroyed.

The Fed exercises its powers by expanding and contracting the currency through the three tools of buying and selling U.S. Treasury securities through open market operations, operating the discount window at the Federal Reserve Bank of New York , and establishing reserve requirements for financial institutions which are engaged in fractional reserve lending.

The ability of the Fed to control the amount of money in circulation and to influence economic outcomes is limited. Returning to 1979 when the Fed sought to squeeze out the inflation from the economy that had built up during the years following the Vietnam War—partly through the money policies of Arthur Burns, Chairman of the Fed under President Nixon—it did so by raising the federal funds rate for borrowing by member banks. Under Chairman Paul Volcker, who was appointed in 1976 by President Jimmy Carter, interest rates soared at times to above twenty percent over the next several years, rates unprecedented in the nation’s history.

These actions had only a slight impact on reducing inflation, but at a terrible cost to the American economy and to American workers, farmers, and small businesspeople. Also devastated were the poorer areas of America ’s cities that had been steadily climbing out of poverty. Examples were the destruction wrought in places such as Baltimore or Detroit , where huge sections turned into “ghost neighborhoods.”

Since that time, the U.S. economy has not recovered. These were the actions that wrecked our manufacturing industries and produced the so-called “service economy.” The nation languished in this condition as sub-par economic conditions lingered through the Reagan years and into the term of President George H.W. Bush. Continuing poor economic conditions contributed to Bush’s defeat by Bill Clinton in 1992, with relief coming later through the boom of the mid- to late-1990s, during the so-called dot.com bubble.

At this time, huge amounts of investment capital, particularly from foreign countries and businesses, went into building the technology firms that were leading the microcomputer and internet revolutions. But with the recession triggered by the crash of the stock market in 2000, this presumed prosperity was exposed as an illusion. Today we find ourselves again in a serious stage of economic stagnation, marked by rising unemployment and massive increases in consumer, business, and government debt. And inflation marches on.

Faced with such circumstances, the Federal Reserve does not seem to know what to do. By its own admission, it lacks measures and targets by which to regulate the currency.

While the Federal Reserve has a general sense that the money supply must be kept sufficient to meet the needs of the economy, it finds it difficult to compare the growth of the two or define how they relate to each other. So rather than watching monetary targets, the Fed says it is steering by what it calls an interest rate “smoothing” policy. It says it chooses a currency level consistent with economic growth with the intent of supplying enough money to fuel the economy. Thus the Fed claims that it wants to get the price of money right for the economy at any given time, though the target is elusive.

In other words, the Fed doesn’t know what it is doing. What it mainly seems to do is to watch the same economic indicators everyone else does, and if it thinks the economy is “overheating” it raises interest rates. When liquidity contractions appear to be too destructive and the screams from individuals and businesses get too loud, it will then lower them. Unless of course foreign investors start screaming, when the Fed will raise rates again or leave them steady.

After starting to raise interest rates around 1994 to slow down the economy during the dot.com boom which had been engendered by a “strong dollar” policy by the U.S. Treasury to attract foreign investment, the Fed later began to lower them in an attempt to revive the economy when recession began in 2001. But this never really produced any type of recovery.

In particular, housing mortgage rates were lowered to the lowest rates in four decades, thereby increasing available cash to consumers through refinancing of existing mortgages and through new home equity loans. These actions maintained activity in an economy that now relies for three-quarters of the value of its transactions on consumer spending. Of course such an economy is highly susceptible to variations in consumer confidence, which was why, after the stock market plunge following the terrorist attacks of September 11, 2001, President George W. Bush told the public to go shopping.

As the deflating housing bubble has made clear, even this rare bright spot in the declining U.S. economy scarcely improved the employment picture except through low-paying service jobs. Meanwhile, the ability of consumers to support the economy has been weakened by the further decline of manufacturing due to NAFTA, free trade policies, and the globalization of industry. The strong dollar of the 1990s led to massive increases in the trade deficit and even more reliance on foreign purchase in the U.S. bond, stock, and Treasury markets. Now with the value of the dollar falling, purchase by foreigners of securities is also slipping.

Ant the Congress is not taking any action to challenge the interpretation of the proper goals of monetary policy. Indeed, Congress seems totally passive in the face of the Fed’s own confusion.

In actuality, money is, or should be, also as stated at the outset, an instrument created by law to act as a medium of exchange in facilitating the legitimate trading of goods and services within the economy. The Federal Reserve and the financiers do not view money this way. The term of art for a commodity definition of money is “store of value.” It implies that money is essentially the same whether it is being used or not. But this can never be.

It is the duty of those in charge of monetary and economic policies to facilitate the development of society. But today, neither the Federal Reserve, nor other authorities such as Congress, the Treasury Department, or the Executive Office of the President are doing the job they should be doing. Instead, they are operating the monetary system to the advantage and benefit of private banks and the private financial markets.

We might look at the inflation issue from another angle, in that economists have pointed out that periods of inflation seem to coincide with those of war. If we look at the history of price inflation since 1915, we discover a pronounced increase in prices during the periods of World War I and World War II. 

But what about the continued growth of inflation since 1965? What is unique about this period is that the U.S. has been in a state of permanent war mobilization since the Vietnam conflict. We know that no culture in history which has had warfare as its main preoccupation has long survived, unless and until it has seen the error of its ways and changed, or unless it simply was destroyed.

Ancient Greece never really recovered after the Peloponnesian Wars. The debt-riddled, socially-stratified Roman Empire exhausted itself in a blaze of military conflict, then saw defeat and dissolution. The British Empire went bankrupt in a single generation from 1914 to 1945. The U.S. is teetering on the edge of a major financial collapse right now. In fact, those with money are quietly trying to secure their wealth while the unfortunate ones who are heavily mortgaged or locked into inflexible retirement accounts may be left holding the bag.

During 2009 15,000 businesses filed petitions to liquidate or reorganize. 207 of those were publicly traded companies with assets in excess of $600 billion dollars. These bankruptcy filings have affected all of us, directly and indirectly, and should never have occurred and would not have if we had the representation of our elected leaders and the diligence of the agencies they delegated their responsibilities to. We are all in this together, we are all responsible for where we are today and most importantly things will not get any better unless we take the responsibility to make changes. Those include an understanding of why customers are having difficulty with their finances and finding solutions to work with them so that both their business and ours can continue during these uncertain times. Its not the economy it’s the forces that have created this economy and they have no solutions so it is up to us to find the solutions that work for us.

I wish you well

The information provided above is for educational purposes only and not provided as legal advice. Legal advice should be obtained from a licensed attorney in good standing with the Bar Association and preferably Board Certified in either Creditor Rights or Bankruptcy.  

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