FMX | Connect – www.fmxconnect.com - (Reported 9/27/2010)
Master of the Universe: A Rejoinder to Quantitative Easing
“Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability…The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.” – Excerpt from 9/21/10 FOMC Statement
The high economic priests are at it again. With consumers struggling to find jobs, burdened with high levels of debt, squeezed by rising food and energy costs, and hampered by declining home values, the Fed somehow thinks it is appropriate to prevent price deflation from occurring. The Fed believes deflation is the enemy of our economic well-being. But in reality, it is merely the enemy of the Fed’s economic justification.
The Fed claims that its actions promote price stability. However, prices have been anything but stable since the creation of the Federal Reserve in 1913. In fact, prices have skyrocketed over the past 100 years, as the Fed deteriorated the purchasing power of our currency. As evidence, we’ve provided some examples of price levels at the time of the creation of the Federal Reserve in 1913.
In 1913, Sears offered a kit to build this fourteen-room home for just $2,702. The labor to build the home was estimated to be an additional $1,300. If you wanted hot water heat, gas lighting, and plumbing, that would cost you another $730.00. Today, depending on where you live, this home may cost you 50+ times as much and little of that price increase can be explained by advancements in the structure of the home. We may do a better job at insulation and fire-proofing, and certainly we have better choices for windows, but wood is still wood, glass is still glass, and cement is still cement, last we checked.
Not convinced? Now consider that over the past 100 years, we’ve invented computers and the internet. We’ve enhanced global trade by removing tariffs and trade barriers. We’ve developed high-tech means of finding natural resources. We’ve developed powerful tractor-trailers and high-speed shipping. We built an international highway system. We converted our trains from coal/steam to diesel power. We developed efficient processes like just-in-time inventory management and overnight global shipping. We’ve perfected the chain saw and created power tools. We built an electrical grid and cellular towers. We created products like “Liquid Nails” and “Blown-in” insulation. With all these enhancements to the cost structure and sales channel, you’d think this house should cost a fraction of what it cost to build in 1913. The 5,000% price increase over the past 100 years can only be explained by the devaluation of the dollar.
Still not convinced? How do you then explain why women’s leather-handbags were once $1.25-$4.98 in the same 1913 Sears catalog when Sears now offers similar handbags for $50-$100 (a 1,900-3,900% price increase)? Has leather become hard to get? Are the cattle now fighting back?
Maybe the cattle have indeed taken up arms, as a pound of sirloin cost 24c in 1913. That same steak now costs $3.99/lb at Shop Rite (1,563% increase).
Or how about the price of U.S. first class postage having risen from 2c in 1913 to 44c today (2,100% increase). Clearly, it must be cheaper and easier to get a letter across the country now than it was in 1913, when you might have needed an armed escort and a few weeks supply of food and water.
Or how about something that hasn’t been innovated at all since 1913: the pocket knife. Sears sold pocket knives for 50c in 1913, now you can find similar knives on Overstock.com for $10.99, plus shipping (2,098% increase).
And let’s not forget that taxes have gone up, both absolutely and as a percentage of income, since the income tax began in 1913 (not a coincidence) and was set at 1% of income with exception to incomes over $500,000, which were taxed at the top marginal rate of 7%.
In a pure free market economy, aggregate price levels should rarely rise and should never rise over the long term as innovation, productivity, and competition drive down prices over time. In a pure free-market economy, long-term corporate profit growth would only be achievable when companies can consistently demonstrate that they can improve upon their products relative to their competition and that they can out-produce their competition at lower costs.
In today’s economy, the ever-deteriorating value of the dollar creates the illusion of profit growth. Companies can achieve growth via price increases that are caused neither by demand growth nor by product improvements. These price increases happen solely because the purchasing power of the dollar deteriorates each year and we have a Fed that believes that inflation should be an inherent and integral part of our economic system. If the price increases noted above are deemed price stability by the Fed, we’d gladly take our chances with price instability.
The Fed needs inflation to justify its existence as master of the universe. Without inflation, the real value of savings would rise and consumers would be far better off financially. Recognize that households are Net Asset Holders, not Net Debtors. Therefore, increases in the purchasing power of the dollar – not decreases – are essential to increasing the standard of living. Without inflation, consumers would rely less on government entitlements like Social Security, as their life savings would retain much more of its purchasing power. Consumers would also require less debt financing and the world’s biggest banks would lose their grip on the economy. How dare we use savings and not credit cards to finance our desires?
Additionally, how then would our government be able to fund its whims when the money supply is no longer limitless? It is much easier for politicians to say “Yes” to appease their voters and friends when money has no store of value. The Fed justifies its existence by allowing politicians to borrow whatever they need and when our sovereign debt becomes burdensome for our economy - as it has today - well then the Fed just creates more money out of thin air and kicks the proverbial can down the road.
However, this monetary and fiscal imprudence has a cost and the cost isn’t just the cost of inflation. Fiat money distorts the true economy and therefore money is not always allocated to its area of highest return. Over time, distortions to the real economy can have tremendous adverse effects.
Take for instance that we have amassed substantial trade deficits since the mid-1970’s and those deficits have been financed by ever-increasing debt. Note that prior to President Nixon’s removal of the gold standard in 1971, the United States was a modest net exporter of goods. As Nixon removed the implicit linkage between the dollar and gold, the Fed was given the ability to create money out of thin air. As that money didn’t have a place to go, it went toward higher levels of consumption, and conversely, higher levels of debt.
It is not healthy for an economy to import more than it exports over a long period of time. Such an occurrence violates the economic theory of comparative advantage. The whole concept of comparative advantage - and that of the benefits of international trade - is that it is an exchange of goods and services. Each country therefore specializes in what it can create best and exchanges those goods with one another so that each country maximizes its output and marginal utility.
Yet, in the post gold-backed dollar economy, the creation of fiat money has distorted the comparative advantage relationship. The United States is now taking in cheap goods from the world and exchanging these goods only fractionally. The differential is made up by declines in our standard of living and net worth. This is not a positive externality, but rather, a devastating consequence of fiat money.
You can blame the decline in your wealth, the reduced purchasing power of your money, and the downshift in your standard of living squarely on the Federal Reserve and those politicians that justify its existence. The Federal Reserve System – and the use of fiat money - needs to end.
Still not convinced?
HOUSEHOLD NET WORTH – AN INFLATIONARY PHENOMENON
In the below chart, we take Household Net Worth and deflate it by the GDP price deflator to arrive at a “Real” HHNW amount. As you can see, the bulk of the gains in HHNW since 1970 – roughly $41.4 trillion – have come from inflation and not true economic wealth. On a real basis, households are no better off than they were in 1999 (based on the Fed’s measure of inflation, which may be too low).
The case we just laid out has a purpose. Please tack this note on your wall as a reminder of the realities of monetary stimulus if and when the Fed re-starts its Quantitative Easing program in the coming months. This will serve as a helpful reminder of why any market euphoria that results from additional QE should be dismissed as misguided exuberance. The Fed cannot create wealth, only you can.
All the best,
Rich Farr
Boenning & Scattergood, Inc., Member FINRA, SIPC
rfarr@boenninginc.com
Office: (610) 684-5423
Trading: 610-862-5330
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