Personally, I would love to see the inflation rate stay between 1 and 2% or better yet between 0% and 1%. Why? In the long run low inflation rates benefit everyone, as people can accurately judge their future costs and make sound business (or family management) decisions. In addition to making planning easier it also promotes saving because people know that the money they put away will be worth the same amount (plus interest) as that which they saved in the first place. High savings results in stability in times of need, and it provides capital for industry which generates wealth as new things are produced.
But why save if the value of the money you are putting away is eroding? In a recent article titled The Impact of Inflation on Savings I explained how inflation is like a leak in your savings bucket and so your incentive to fill the bucket is decreased the bigger the leak in the bucket. With a slow leak you figure you can fill it faster than it will leak out but with a fast leak, you may decide to not bother filling it at all or dump out the bucket into something else (like gold or oil or another currency that isn’t inflating).
Why does the government fear low inflation (or deflation)?
So if the government truly had the good of the citizens at heart it would prefer a low or zero inflation rate. But instead the government prefers a higher inflation rate so it can repay its own debts with “cheaper dollars.” Ideally from the government’s point of view it would just print all the money necessary and pay off all its debts in one fell swoop. Poof no debt, no restraints, line their pockets and their friend’s pockets all at once. But since we live in the real world, that is not possible because everything has consequences. The consequences of that sort of profligate money printing is inflation. And too much inflation and the natives get restless and start revolting. So the government has found that they can get away with inflation at around 3% because people don’t notice too much. And as long as it stays below 5% the pot doesn’t boil over but whenever inflation gets above 5% things start getting uncomfortable for politicians. So they have a balancing act, too little inflation and they can’t spend money to buy influence and too much inflation and riots break out.
Stimulating the Economy- The Down Side of Inflation
As we saw, inflation erodes savings and causes consumers to act imprudently and spend more than they would if they had sound (unchanging) money. But this is exactly what the government means by “stimulating the economy” i.e. causing people to spend more than they would prudently do otherwise. This causes a misallocation of funds and when money is freely sloshing around in the economy it allows inefficient industries to proliferate, poor business decisions are made and everything becomes less efficient.
Why is stimulating the economy desirable in the eyes of politicians?
Because most people don’t realize that good times now, come at a price. And politicians only care about the next election. They are perfectly willing to “kick the can down the road” if it will get them reelected. Pass the costs on to future generations as long as we can extend today’s party a bit longer, even though, the obvious long term effects are an inefficient society with more debt than it should have.
When things get too inefficient and funds are too seriously misallocated, we see crashes like we saw in 2008. Then the government has to “do something” so it prints more money to fix the problem it created by printing money in the first place. Plus it gets to use this “crisis” to do what it really loves to do anyway, i.e. line their pockets and their friend’s pockets all at once.
Stimulating the economy is like a drug, each successive round requires a larger and larger dose to get the same “high”. Our most recent round required several trillion and still deflationary forces are pulling the economy down. The key to eliminating the effects of all this misallocation of funds is to allow the inefficient to fail, i.e. allow the inefficient companies to go bankrupt. New operators will buy up the distressed assets and rebuild more efficient organizations without the debt and in the long run the economy will thrive, rather than becoming more and more inefficient.
For more insight into how this whole misallocation came about I highly recommend The Big Short by Michael Lewis plus in Street Smarts by Jim Rogers he goes into great depth on how a variety of factors are creating misallocations in our current economy and how bankruptcy is good for the economy.
- Why Money Printing Makes You Poorer
- The Impact of Inflation on Savings
- What is Quantitative Easing?
- What is the Real Definition of Inflation?
- Disinflation – What is it?
- What is the Phillips Curve?
Recommended by Amazon:
- The Great Deformation: The Corruption of Capitalism in America
- The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It
- After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead
- The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order (Council on Foreign Relations Books
- The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy
Image courtesy of Renjith Krishnan / FreeDigitalPhotos.net