The Incredible Shrinking US Dollar

US Dollar Inflation

Back in 1989 there was a comedy film that came out featuring Rick Moranis as a somewhat absent minded inventor that inadvertently shrunk his children via an unattended electromagnetic ray gun in his attic.  Today in 2014, we seemingly have a few mad scientists at the US Federal Reserve who are seemingly bent on shrinking the US Dollar, or more precisely, the value or purchasing power of the US Dollar.  And in this case unfortunately, it is not a Hollywood film using special effects but rather more like a reality show with the reality part of it hitting very close to home. 

Of course, this was not always the case as the supposed original sole mandate of the US Federal Reserve Bank at the time of it's creation (and other central banks around the world) was to maintain a stable currency and stable banking system.  Today politicians have deemed that central banks must be responsible for economic growth, employment and a litany of other things that either they cannot perform simply because it is beyond their control, or there is an inherent conflict of interest involved.

With respect to managing the economy and employment, there are those today that believe all you need to do is print money and just like Harry Potter waving his magic wand, all will be well with unemployment and so on.  It does not work that way, and would it not be fun and easy if it did?  All we would need to do is call upon the previous Federal Reserve Warlock Ben Bernanke or the present  head Sorceress Janet Yellen and all would be fine.  But while there are some laws of economics that are indeed definitive (you spend more than your income, you WILL go bankrupt), there are other factors that are simply out of the control of the wizards and every other average citizen for that matter.  Namely, actions taken by private businesses in the economy who are really the only parties in the formula that can build factories, create jobs, innovate new industries, and basically make economic growth happen.  Without them engaging and doing their part, money printing is just ink and paper thrown out of a helicopter offering nothing of long term value (Warlock Bernanke's equivalent of the flying broom).

Whom Does The US Federal Reserve Bank Really Serve?

In terms of the US Federal Reserve specifically, we tend to think most Americans do not even realize that it is literally a private corporation whose stockholders are some of the very same private banks and wall street firms they are supposed to now regulate and supervise (more new powers and authority that the US Federal Reserve Bank was never meant to have).  Do you not think it a bit ironic and also a conflict of interest for the Fed to regulate and supervise some of the very entities that are it's stockholders or clients?  One must remember that even though the US Central Bank known as the Fed (short for US Federal Reserve Bank) was meant to in essence serve the citizenry of entire country, it's primary concerns are going to be those client institutions that maintain a relationship with it, and NOT the general public.  We can see an example of this with the now absurd amount of money printing (or actually the electronic equivalent) meant to save the technically bankrupt member banks - knowing full well that such a policy hurts the average citizen with savings or retirement funds in the long run (via devaluation or debasement of the US Dollar).  While it is true that physical paper money was not printed and thrown out the window to passersby on the street, it was created electronically so that the Fed could buy up all those junks bonds on the books of it's member banking clients.  And now of course, such additional money creation is being used to cover the US Federal Government annual deficits by buying US Government Debt securities.  If the US Federal Reserve did not do this (by acting as a buyer of US Government Bonds when no one else wants them) then the politicians in Washington could not continue to spend beyond whatever taxes they collect and thus also not continue to in-debt the general population.

In theory the US Federal Reserve Bank was meant to be an independent institution, acting for whatever was best for the economy and nation in general, free from political influence.  And there have been points in US history when this was the case.  The actions of former Federal Reserve Chairman Paul Volcker during the Jimmy Carter administration is one such example.  Carter wanted the Fed to relax money policy thus attempting to make is easier for him to get re-elected but Volcker refused.  Instead the US Federal Reserve pushed up interest rates causing a recession, but with the end goal in mind to wipe out the double digit inflation that was plaguing the US at the time.  It did work and inflation was brought down, but of course Carter was not re-elected and will go down in history as one of the few one term presidents.  Of course while former US President Jimmy Carter might blame Volcker for a lost election (we think he would have lost anyway), this was indeed one of the few times in history when the Fed did what was right for the country and not for short term political gain of a candidate or party.

Politicians Just Love Inflation With Fiat Paper Money, And Hate Gold

The truth of the matter is, politicians hate a gold or silver backed monetary system because it prevents them from doing exactly what they are doing now – running up deficits, spending more money than they collect in taxes or other revenues, and running the printing presses to pay for it all (or again, the electronic equivalent).  But all this is not unique to our current day and age, nor our current crop of political leaders.  One must understand one basic premise that has been true about politicians and currency issuance throughout human history.  And that premise is, it is always easier to debase the value of the currency in order to pay off government debts than it is to increase taxes.  Borrowing is of course another way to get the money without increasing taxes, at least immediately, but the fact is this idea is tied directly to money printing because where does the money come from to buy the current US Government debt being issued?  In theory it should be coming from both foreign and domestic entities with excess US Dollars to lend (pension funds, banks, insurance companies, foreign sovereign wealth funds and so on).  BUT, what if no one wanted the US Government Debt any longer because they were nervous about all this money printing?  In other words, would you want to loan your money to someone, anyone, knowing that you might be getting devalued monopoly money in return once those bonds mature?  The answer is that the US Federal Reserve Bank is the buyer of last resort and they can (and do) create money out of thin air (remember Harry Potter and his magic wand) and thus have the money with which to purchase all that government debt that is having trouble finding buyers in the bond markets.  For this reason, we include government debt issuance in the category of money creation because in the end, that is where it will come from.

We have asked the question many times before:  Are they really that stupid or are they that clever to know full what what they are doing?  Ironically enough it was former Federal Reserve Wizard (actually the Maestro was the moniker given) Alan Greenspan who said back in 1973:  In the absence of the gold standard, there is NO WAY to protect savings from confiscation through inflation.  Then he went on to say: The financial policy of the welfare state requires that there be NO WAY for the owners of wealth to protect themselves.  Then of course he became head of the Fed and started drinking that spiked water they seem to have in the water coolers inside the Federal Reserve building in Washington (he went from babbling about irrational exuberance to praising the banks for all of the new and innovative no money down liar loans that caused the eventual mess it became  – sounds like a bad recreational drug reaction to us, but we could be wrong.  But seriously, someone should check on those water coolers). 

Savers And Investors Benefit From Deflation - Debtors Benefit From Inflation

Most people do dislike to delve into economics because they think it boring or too complicated.  However, the fact is that it can be quite simple and you do not need to take a math class at the Hogwarts School of Wizardry to understand some things that effect you directly and personally.  Basically explained, deflation simply means your money is worth more or can buy more than was the case previously.  Inflation, in contrast, is the devaluation or debasement of the value of money, meaning you lost purchasing power and can buy less.  Most average consumers associate inflation with higher prices at the stores, supermarkets and any place else they buy something or pay a bill.  And of course politicians just love to blame the business owners or firms for increasing consumer prices, and thus blame all of the inflation on rising prices (to a magician, this would be known as misdirection so the audience does not see how the magic trick is done).  But rising consumer prices are merely the RESULT or symptom of a devalued currency.  In other words, the devaluation comes first, and then it starts to show up in the rest of the broader economy.  So to blame private business from increasing prices is sort of like blaming someone from taking a cold remedy after they caught a cold.

With all that said, why is it that a nation with chronic and perpetual annual deficits and ever increasing debt want to see inflation or devaluation of the nation's money?  The answer to that question is quite easy – it is the only action or activity that can be done without the general population having the slightest clue (that is until they start to see the effects later on).  It is good deal for the government really in that they get to wipe out their debts and it did not cost them anything politically speaking.  However, those people that are hurt in the end are going to be savers, investors and those people living on a fixed income (such as retirees).  When we have deflation or a monetary unit that is increasing in value, the reverse is true.  Savers and companies with large amount of cash on hand get to buy more with their money.  Anyone with little or no debt plus some decree of cash will be rewarded.  Anyone, or any government, with large amounts of debt of course will be in a tough situation because it will be harder to pay off those debts as they will be paying back with more costly or more expensive money.  Governments in such a situation have to work harder, cut costs or expenses, and basically do what you would have to do when trying to pay off your own debt.  No one likes to do that, as it always much easier to just print it.  Too bad that option is not available to the rest of us.

And not to go off on a tangent, but it is bad enough that the US Federal Reserve is basically doing everything it can to guarantee a loss of purchasing power for average citizen, the worst of it is the US Federal Government obfuscating the fact that there is inflation in terms of what they are reporting to the general public.  As just one of many examples, Mr. Peter Schiff, who is the CEO of Euro Pacific Capital (and also author of a few books regarding the economy) had his staff do their own independent research as to what the changes of the CPI (consumer price index) has been over the last 10 years or so.   According to official government statistics, the CPI, or otherwise said the increase of prices consumers pay over time (remember that price increases are the symptom, not the cause) has gone up by about 35 basis points on the index over the last 10 to 12 years.  However, the reality is (and all of you reading this know it to be true), consumer prices in the US have actually gone up by 80 or 100 basis points in some cases.  Stated another way, the actual rate of inflation has been anywhere from double to triple what the US Government says it has been.  So why do they disguise the truth?  The simple answer is Social Security and other government payments that are required to be increased by the inflation rate.  The lower the officially reported inflation rate, the less they need to increase Social Security and other payments, using the so-called official government statistics as the cover story.   All of this reminds us of an old joke about people working in the former Soviet Union.  The joke is: The people pretend to work, and the Russian (Soviet) Government pretends to pay them.  Flash forward today to the US Government.  They pretend to report the true actual state of the union (in terms of the economy, inflation, unemployment and so on) and perhaps some of the people pretend to believe them.  We do not.      

Saving Yourself From The Malfeasance

There are a number of economic writers forewarning of a coming economic recession, collapse, depression (whatever term you prefer to use) that will be far worse than what happened in 2008 or maybe anytime prior.  And the reasons all of them give are basically the same.  The continued deterioration in the balance sheet of the US Federal Government and US Federal Reserve Bank (and that of other countries as well) along with money creation to supposedly solve the problem.  Plus of course we have demographic issues of the Baby Boom Generation starting to retire, which will put even more pressure on these government operated retirement programs, such as Social Security and Medicare (in the US).  But the problem is predicting the exact occurrence, event or moment there will be a market reaction that will tip the scales.  Just like the Jenga game, you know at some point the stack of small square shaped logs will fall.  What you do not know is which piece of the tower that a player takes out will make the whole thing come down.  It could be the implementation of another global trade settlement system in gold or some other currency.  It could be the complete withdrawal of bonds buyers for US Treasuries and news being leaked that the Fed is monetizing 100 percent of the US Government debt.  It could be any number of factors that spark the herd to run for the exits.  In terms of the 2008 – 2009 crisis, one must remember that an auditor from one of the US Government bank supervisory agencies (the OTS or Office of Thrift Supervision if we are not mistaken) testified to the US Congress in 2006 about the shoddy mortgage loan practices he had seen at the banks under his area, and warned of the systemic risk.  Of course he was ignored and Congress feigned complete surprise about the crisis when it actually happened, but the point is this guy was calling the alarm a full 2 years before everything went south.  And he was not alone.  There were others talking about the possible coming crisis if nothing was done back in 2005.  So, you never really know what will be the lynch pin.  As it turns out, many people consider the Lehman Brothers failure to be the one identifiable event that started a ripple effect, but the truth is there were many grenades just waiting to go off (AIG, Merill Lynch, Bear Stearns, Fannie-Mae, Freddie-Mac).            

The key question to be asked is: What Can You Do About It?  How can you save yourself and your family from ruin that came about because you did nothing wrong, but the so-called guardians of the nation's money supply certainly did?  Some will suggest that the US Federal Reserve Bank be eliminated entirely and while it does sound like an enticing idea, we think it will not happen for a variety of reasons (political being just one).  Rather, it is our option you must think like a chess player, calculating any possible scenarios 3 or 4 moves out.

Assuming you are resigned to the idea that they will continue an attempt at even more inflation, and even more US Dollar devaluation, you need to start thinking about getting some of your wealth out of the US Dollar and maybe even out of the US.  Gold, silver, real estate, farm land, commodities, and even works of art have typically held as a sensible hedge against inflation.  But, the question then becomes where do you keep it?  Where do you put money into real estate if not the US?  Even if some US banks did start offering accounts in other currencies, is it wise to keep such accounts inside the US?  During the depression of the 1930's former President Roosevelt, with the stroke of a pen, outlawed private gold ownership in the US.  In fact, they went so far as to start breaking into people's bank safe deposit boxes looking for gold.  Something that was legally permissible prior, without restriction (it was not until the 1970's under the administration of US President Gerald Ford that ownership of gold by private citizens was permitted again).  We are not suggesting necessarily that private ownership of gold will be attacked if there is in fact another financial crisis, but we cannot rule it out either.  Neither can we rule out a restriction on access to your own money in a bank savings account with a US based bank, or wire transfers abroad, or even ownership of cash.  There are some economic commentators that suggest they might create two US Dollar currency units, with the real deal being the money outside of the US and new Hokey-Pokey Dollar created for use inside the US.  The truth is, we have no idea what they may end up doing, but the possibility of it is enough to motivate investors to think and plan ahead.