Beware the Inflation Monster

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Money Rand inflation

Inflation is not evenly distributed in an economy. When the money supply is inflated (this is what South Africa is doing now with quantitative easing [QE] and lower interest rates) price inflation starts with the property that is bought first with the newly printed currency. Government bonds are bought first, thus their yields go down which means interest rates go down, but the market price of the bond goes up due to the inverse relationship between yield and market price of any asset.

Governments, despite taking on more debt and therefore increasing the probability of going bankrupt, experience a decrease in borrowing costs and therefore a reduced need to raise taxes.

The people who own bonds are more or less the same people who buy assets like real estate and shares; they get the money after the government gets it (in the sense that newly printed money is used to buy bonds and after that, shares and other assets).  That is where you see price inflation next. But most people think it is a good thing, and call for even more of the inflation.

Eventually, inflation makes its way to the consumer economy, typically through government spending and the expansion of credit by central banks. That is when everyone starts noticing the inflation and this is when central banks typically respond by reducing the money supply. Notice: the consumer economy is last in the chain of receiving the newly-created currency.

The implication of how this works is dire. Consumers are only able to consume by typically exchanging their labour for the currency. This labour also allows them to take on debt and consume more than they make in the present moment, by consuming less than they make in the future. This process robs consumers of the opportunity to save and accumulate assets.

How does this work? Since all the asset prices are inflated before consumers receive the currency, they can only spend on consumption goods. The assets that build wealth are put out of their reach by increasing faster than the rate at which wages are increasing. This means that wealth accumulates at the top to an unnatural degree and resentment starts bubbling up in society.

It is a phenomenon with which every lover of liberty has to contend.  Central banks have gone beyond the point at which we can still tolerate them. They have debased our money, our labour itself, in order to finance reckless government policies. The financial sector, custodians of our savings, allow them to do this because the people who run the industry are higher up in the chain of receiving newly-created currency.

This is not a screed against the rich. Far from it. It is a plea for a return to sound money. Most wealthy people are as ignorant about the unholy alliance between governments and their financiers as the rest of us. Sound money cannot be created at a whim, just like your hard work cannot easily be replaced by shortcuts.

Sound money has value independent of government fiat. It is freely traded in the market even when its use as money is outlawed by legislation. It is independent money and so it should be if you are expected to trust that it will hold the value of your labour through time so that you can pass it on to your heirs. It is not for anyone to claim to know which assets best fits the characteristics of sound money in the market today. The only thing we can do is to point out which assets do not fit the proper definition of money in a functional sense.

For money to fit the proper conception of ‘money’, it must, among other things, be a medium of exchange (is everyone else willing to exchange their goods and services for it?), a unit of account (can you use it to measure and record the value of other goods?) and a store of value (how well does it maintain its purchasing power?). This last aspect is important because if money does not do this well, everyone who saves it will become poorer over time.

It is clear that while the rand is a unit of account and a medium of exchange, it is not a store of value. As this is being written, the rand has lost 15% of its value against the dollar in just the last month. Of course, consumer prices go up all the time even if the rate of increase sometimes slows down. In fact, it is a stated policy of virtually every central bank that consumer prices cannot be allowed to fall.

Yes, believe it or not, most of the world lives under a system which cannot allow ordinary people’s costs to decline. Why would that be so, why would a fall in costs and therefore an increase in disposable income, be bad for consumers? 

Is it possible that the entire scheme needs inflation in order to be able to siphon the value of savings denominated in the currency without having to raise taxes? Of course, the inflation tax targets the poorest as well as those most likely to be unaware of the cost of inflation, keeping in mind that consumer prices grow exponentially since inflation, like the return on your investments, compounds. This dispenses with the need to make the politically unpopular decision to raise taxes for everyone- simply do it in a way that people are unaware of.

The South African Reserve Bank (SARB) announcement that they will start buying government bonds up to a maturity of a year. This is a troubling sign of things to come. Not too long ago Ace Magashule announced that the ruling party had resolved to adopt quantitative easing as a monetary policy tool of the Reserve Bank. The Governor of the SARB rejected the idea at the time, saying it was unnecessary since we had not run out of room to cut interest rates and were not in a recession.

We are in a recession now, but we still have plenty of room to cut interest rates.

The Reserve Bank says that the drying up of liquidity in the bond market justifies the decision they took. What does a lack of liquidity mean? It means the bond issuer (the government in this case) cannot attract funding at a level they can afford. The buy-sell spread had widened to 30 points up from the typical 1-2 points.

This is the secondary market. It does not mean that a Treasury bond auction has failed. But if it persists, that is exactly what will happen. Ultimately, the government needs the production of others to fund itself.

This means that our central bank is now monetising government debt in order to prevent government defaulting on that debt. This is the classic pre-hyperinflation scenario. What will happen to those who have to retire in the coming years?