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The dirty secret of all governments is that contrary to popular opinion, they do not hate inflation.  All governmental corruption begins when they discover the power of the purse, and that they can use the public purse to perpetuate their power, privilege, and benefits.  Over time all legislators and power brokers arrogate to themselves the means to stay in office and the luxuries it affords at the general taxpayer’s expense.  So of course we hear how the purpose of the Federal Reserve and Congress is to maintain a strict control over inflation, that the Fed is independent of the government, and that it is immune to political influence.  At best this is a Trojan horse.  Inflation is the primary tool used by every government to live beyond its means, and by its “means” we mean its ability to tax.  For taxation is the Achilles heel of all governments, for carried to excess it inspires armed revolution and fall from power.  Governments raise taxes at their peril.  Inflation, however, is a hidden tax, for it is how the government spends and borrows beyond its ability to repay.  By printing money and increasing credit, thereby increasing the money supply, the government creates inflation.  How does this happen?

 

When there is X amount of money in circulation in an economy chasing Y amount of goods and services, and you increase X to 2X chasing the same Y amount of goods and services, you have increased demand for those goods and services, but you have not changed the supply of them.  When demand outstrips supply, the general price level rises.  The rise in prices is a result of manipulating the money supply, NOT by an increase in productivity.  In other words, the increase in the money supply is NOT the same thing as an increase in wealth.  It is an artificial increase that may give everyone a case of the warm fuzzies, until they realize their pockets have been picked while they were celebrating!  This is what happened in the last ten years during the “real estate bubble’.  Millions were celebrating their rapid rise in wealth, and we were saturated with boastful claims of “instant equity”.  What we had was hyperinflation of real estate prices but no increase in underlying wealth.  It was a bubble, and it contained only air, no wealth.  Taxing authorities were flush with new revenue from the inflated values of real estate, and the money poured in.  Politicians were ecstatic, and plans for distributing  the tax revenue to friends and benefactors proliferated.  Everyone was having a great time at the party.  The last ones to leave got stuck with the clean-up.  Governments went from riches to rags over night.  The Fed cranked up the printing presses as their only resort.  People weren’t spending, the taxable base was shriveling like a late-harvest grape in the hot sun, and governments everywhere started warning about necessary cut-backs in services.  And the homeowners, well they have inflated mortgages and inflated property taxes, and deflated value.  They were taxed all right, but by stealth.

If the government had tried, during the peak of the bubble, to raise comparable amounts of revenue through increases in taxation, there would have been riots in the streets.  But the inflation they created by expanding credit markets, was in fact a very clever, hidden tax.  Incredibly, the governments response to the crisis has been,  once again, to expand the money supply.  The inflationary impact of all the newly printed money they have injected into the system is muted, for the moment, by the lag in spending and the poor demand for goods.  But the expanded money supply is out there, lurking comfortably in the books of the banks afraid to acknowledge and write off all the toxic loans of the boom years.    The banks have used the money to shore up their sagging balance sheets, just in case, and the public has decided to save rather than spend.  The economy is lurching like a schizophrenic paranoid between euphoria and deep depression.  The surface temperature of the economy says we are recovering, but further analysis says the virus is still with us.  The government maintains,  like a modern gestalt therapist, that if we all believe we are well, we can transform belief into reality.  Therefore we all need to put on a happy face and spend, spend, spend our way out of the malaise.  The money supply is the lifeblood of our economy.  Believing that we are hoarding the money supply like bad children  the government has applied leeches to relieve the pressure, and to get the excess blood out and into circulation.  So it has borrowed and printed money for bailouts for banks and tax payers, cash for clunkers, and nationalizing whole industries.  Like a drunk conductor at the wheel of a runaway train, there is nothing that Big Government cannot do, cannot fix.  Why didn’t anyone ever think of this before—when there is a downturn due to previous bad policy, the solution is to print your way to prosperity.  Remember twenty years ago when it was “The economy, stupid!”; well, now its “The money supply, stupid!”

The good news is the bad news.  As the economy staggers uncertainly toward a seeming full recovery, the excess money that has been pumped into the system and has been lurking out of sight in the banks will finally have its much delayed impact when it finds its way into the economy.  The Fed operation was a success; unfortunately the patient died.  As the government lurches  madly between transfusions and leeches, between the silent killer of inflation and the bludgeon blows of direct taxation and deflation, eventually in frustration and exhaustion and confusion we will do what all very ill patients do–put our lives and our destinies in the hands of the doctor.  For after all, the doctor knows best, right?  And at the end of the day, there won’t even be any ambulance chasers to file malpractice lawsuits.  It’s illegal to sue your government.  Why?  For starters, they have the guns.

For a brief video on why inflation permits the government to “repay” the national debt at a huge discount, go to  http://www.youtube.com/watch?v=ov21dnYHjXE