Inflation: The Real Enemy of the Middle Class

I know, I know, your kindergarten teachers have probably already convinced you that capitalism is the root of all economic evil in our society.  Capitalists are the indefensible cause of the rising wealth disparity between “the classes” (notably the “shrinking middle class”).  I mean, we know, we just know – only intuitively, it seems – that those with more-than-us surely couldn’t be smarter than us or work harder than us.  Because, afterall, we’re smart too!  We work hard too! 

How else could the “rich get richer”, leaving the rest of us in the proverbial dustbowl, unless those evil capitalists had rigged the system or were just too damned greedy to give us our fair share?  Right?  I mean, they’re only interested in profits, so, naturally, they’d refuse to hire us at a “fair” wage, which is whatever we might want it to be…..something like a wage that anybody would be willing to accept….one at which everybody can afford a new car, an LCD TV or an iPod, all of the stuff that should have been in the Bill of Rights. 

Well, I don’t know about you, but I do know that I’m smart enough and work hard enough to deserve more-than-I-have.  So, that must mean that my boss has got to be screwing with me.  So, rather than excercise my free will and, say, do what he did (like take on the trouble and risk of starting a business) or simply quit and find a new job, I’ll just stick it right back on him in the form of voting for higher taxes along with a good measure of public castigation.  That’ll fix his wagon.  Why, pretty soon, he’ll be just as poor as I am. 

But hey, let’s face it, the problem that most seem to have with the FREE market is that it produces winners and losers and, most of the time, rather fairly.  It tends to reward talent and effort and punish wastrels and whiners.   Many in our midst just don’t like that kind of fairness. 

Our politicians, of course,  have become quite adept at exploiting the petty jealousy that many harbour over the real-world consequences of applied talent, energy, capital, and risk tolerance.  For many of the wastrels and whiners, however, the “class warfare” engendered in the politics of jealousy is inspired easily enough by simply wanting what they see on the boob tube while they sit there in their underpants eating cheetos. 

Not having what they want is sufficient justification the levy the charge of unfairness.  It’s not all that different, really, than the racist charges being levied at virtually anyone who disagrees with President Obama.  Thirty seconds of thought should dispel such notions, but that particular hurdle may just be too high. 

But wait (!!!!!)  There is, in my opinion, some bit of justification for righteous anger in all of this.  I know you want it….I know you need it.  Aside from a general lack of ambition combined with the sort of vindictive jealousy that I’ve just spent a half page satirizing, there are, in fact, real, substantive issues that are almost certainly holding you back.  

Near the top of this list are the sort of regulatory obstacles that hinder – if not prevent – your own entrepreneurial ambitions, as addressed in a recent post.  As might seem rather obvious, after another thirty seconds of thought, most of these are protectionist rackets designed to limit competititon.  So, yes, those particular capitalists that we allow to influence the power of government to their benefit, they are definitely not your friend.  But, then, those polititians that not only allow, but often profit, from the selling of that power are more evil still.       

But there is another, more generic, more insidious enemy to your aspirations.  This one, as it happens, is also a product of corrupt governance and, too, requires the sale of government power to private interests.  This threat is designed to benefit a special “class” of citizens and to punish the remainder.  It is a game that is “rigged” and one that will make your life something like trying to climb a sand dune, where every step forward will produce a larger slide downward.  

This threat, in a word, is:  INFLATION….you know, the “really good thing” that Misters Bernanke and Geithner are desperately trying to propagate right now and one of the biggest and baddest dangers that our founding fathers warned us about. 

So, we might ask, “who really benefits from inflation”?  Well, as it happens, borrowers do.  The more you borrow (or leverage your purchases) the more you gain through the inflated rise in asset prices, at least until the resulting bubble bursts, but more on that in a bit.  The better your access to and appetite for credit, the more likely you are to succeed in this sort of game. 

As demonstration, consider the following:  With fixed borrowing costs of, say, 5%, cash equity of 10%, and so-called “ideal” inflation rates of only 2.5%, the typical investor realizes a real annual rate of return of roughly 20% on his investment.  And that, my friend, is generally how the rich get richer, not withstanding the quality of the investment and other entrepreneurial talent brought to the equation. 

The point here, is that the “upside” of borrowing should not be so influenced by resultingly inflated asset prices.  Rather, the returns realized from and the justification for incurring the cost of debt should come from the increased productivity or resource management that arises from the investment itself.  Which is to say that credit is not an inherently bad thing….far from it.  When applied to reasonable investment in improved productive capacity and/or necessary, long-lived infrastructure, debt can, in fact, be a very good thing.  

The problem here, as will be demonstrated, is that – even at this level of the debt game – the noted gains produced by inflation tend to be:  (a) excessive, which (b) will always attract malinvestment, which are, in the end (c) unsustainable, as we’ve re-discovered in the past few years. 

The sort of credit-induced inflation produced in our system is, by the by, first and foremost, a product of fiscal malfeasance on the part of government.  It is virtually impossible to sustain a vital and growing economy with an excessively large public sector paid for through direct taxation.  Those taxes, naturally, are siphoned off from the productive capacity of the economy, which then suffers. 

The politically expedient solution, as we know, is to borrow the money not raised through taxes.  As this borrowing reduces the supply of money available to the private sector for investment and, thus, cause interest rates to rise, our central bank will generally intervene in order to artificially reduce the “market rate” of interest.  That may sound (and is generally touted as) a good thing, but what it produces, in the end, is inflation….which is merely the excessive expansion of the money supply, which then – over the course of time -results in rising prices. 

We’ve done this for so long now that we have come to expect those rising prices, rarely questioning whether or not that is, in fact a good thing.  We might note, for instance, that improved efficiency and productivity will generally cause prices to fall over time, just as we’ve seen in the technology market. 

And, that’s a good thing, isn’t it?  Such a decline, by the way, is not “deflation”, it is an improvement in the purchasing power of both your labor and your money.   When we can buy a more powerful computer for less, we should think of that as “progress”.  

How is it, then, that we imagine that rising prices for housing or gasoline or food are a good thing?  What is really happening other than a decline in the purchasing power of your labor and your money?  So, again, who benefits from this sort of system?  Again:  borrowers.

But wait (!!!!!)   If borrowers benefit from inflation, doesn’t that mean that the lender get’s screwed? 

Well, it depends on what kind of lender you are.  If you’re Granny buying a CD at the bank (and, thus, lending those funds to the bank) at a rate below that of inflation, well then yes, Granny’s definitely getting screwed.  But, on the other hand, if you’re the kind of lender that has access to the Fed’s Discount Window, well pal, you just hit the lottery, because your not just a lender, your among the biggest freakin’ borrowers on the planet. 

Consider the process:  Banks (almost always) borrow at rates lower than at which they lend.  The difference between these rates is the source of their profit.  This rate gap can be monetized almost instantly, such as when the loans are packaged up and sold off to Granny for investment purposes.  Such packages, like, say, 30-year mortgage CDOs, where the funds were borrowed at 2% and lent at 5%, realize an immediate 45% gain against the face value of the packaged loans (less the cost of those pesky credit default swaps).  But, of course, many of these banks have been allowed (or found ways) to reduce the amount of “skin in the game” to levels often well below 10%.  At 10%, this 45% gain – which might seem rather large to Granny, get’s magically transformed into a 450% return. 

And that, my friend, is one very common way that the richest get to be the richest. 

Now, if you happen to be born to (or purposefully join) a “class” with limited understanding of and access to credit (not to mention education or ambition), you might just get stuck with going to the payday lenders or, worse still, Sears.  Sorry, but you’re screwed worse than Granny. 

But, even if you’re the sort of prudent, modest, and diligent working stiff we like to think of as “the backbone” of America, this system will actually punish you for saving, for staying out of debt, for not borrowing as much as you possibly can.  Inflation will erode those savings faster than you can imagine.  Whatever future purchase you might save for will generally increase in price at a more rapid rate than you can save.  Tough luck chum. 

But wait (!!!!!)  Haven’t borrowers been justly punished by the Fairest Credit God in the Sky in these recently troubled times?  Ah, well, yes, some of them have. 

The banks, of course, (a goodly number of them anyway) have been bailed out.  They’ve been recapitalized with your hard earned dollars and, lo and behold, are now able to borrow at 0%, which does tend to improve the bottom line. 

Through these bailout-relationships, we might note, Misters Bernanke and Geithner hope to:  (a) prop us the profits and save all those zombie banks which, being less able now to arbitrage their borrowing and lending the old fashioned way, can now at least (b) facilitate the Fed’s thinly veiled monetization of the government’s debt and pocket a handsome transaction fee for their troubles.  Yes, they’re only getting, say, 2.6% on the 10-year, but that’s not a bad return on hundreds of billions of dollars borrowed at 0% with little or no risk capital involved.  And, as it happens, they can choose to pocket 15% or more on the resale of those bonds, assuming they can find a buyer, that is.  Again, assuming 10% in reserves, that’s still a nifty 150% return.  Nice work if you can get it. 

But, yes, a goodly number of run-of-the-mill, pathological uber-borrowers have also been spanked hard enough to return them to whatever “class” they might have originally come from.   It’s all about timing, don’t you know, and whether or not you’re a banker, of course.  

Speaking of timing, for the rest of us, the currently more restricted access to credit has arrived just in time for what may prove to be the best buying opportunity in the past 70 years.  But, as we should know by now, not all borrowers are equal.  While most of us are busy paying back those temporary gains realized in past decades of inflation, others are picking up the deflating pieces with the cheapest money they’ve ever seen.  

So, this class warfare thing….what’s the real root of the problem?  Well, not anything remotely resembling what our (notably leftist) political leaders would have us believe.  It is not capitalism or capitalists per se.  It is not your boss.  It is not WalMart.  It is not insufficiently progressive taxation.  It is not racism.  It is not immigration policy.  It is not the high cost of health care or greedy doctors.    In my (and Thomas Jefferson’s) opinion, the real problem is quite simple:

 I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs. – Thomas Jefferson

Harry Tuttle

One Zombie’s Take on Zombie Banks.  Sometimes, the Zombie POV can be helpful.


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