The Federal Reserve is the central banker in the United States. The Federal Reserve is responsible for banking regulation, money supply, reserve requirements placed on banks, printing money and interest rate policy. What the Fed really does is expand the monetary base in the economy. What this truly means is a fascinating concept in the economics of money supply that is terribly misunderstood and misused. Let’s Begin!
First to understand the Fed one must understand the multiplier principle and the concept of new money. The multiplier principle simply stated is what a dollar spent in the market creates. In other words when you spend a dollar, how many times does it turn over in the economy, or what factor does the dollar create. If a dollar spent means another dollar spent, then the factor is two times; this concept is also known as the velocity of money. Second is the idea of new money. Equity is not new money. Equity is normally just a transference mechanism. In other words, a dollar invested by a person already had is a dollar sitting idle in a regular common equity share. Investment dollars are normally not spent but sit idle until a dividend is perhaps paid. This dividend was someone else’s money, often is reinvested, and therefore never really expands. However, when options are attached to an equity share, if the call is covered, then these dollars will mean new money entering the system. Options on equity shares are a fancy and tricky way of issuing debt in the equity market disguised as equity. On the other hand, when the Fed prints money never circulated, and then loans it out, if it is repaid it is expanding the monetary base because it is new money injected into the system. The Fed was designed to issue debt, and subsidize the governments demand for money, hence we the people.
Many people think debt is bad. Debt for the common household is not a good idea unless there is more than enough cash flow to service the debt. Government debt can always be serviced by printing new money and issuing public debt if the public, or a government is willing to purchase the debt instrument. Government debt is new money entering the system expanding the monetary base. This new money is turned over in the economy and has a multiplier effect. As a result, government debt is the only real way an economy can expend outside of productivity increases and consumer activity. Back in the 1980’s and early 1990’s the common thought by supply side economists was that too much government debt would eventually bring down the economy as Ross Perot, the presidential candidate in 1992 tried to convince the voter; well after 30 years this never happened. Why? The reason the economy never came to some cataclysmic failure was because government debt was still purchased and serviced.
In the 2008, the markets were in poor financial shape since the banking system was not supported by debt service, mostly from the housing markets poor quality of debt under the Federal Reserve chairman Alan Greenspan’s idea of deregulation along with the Congress. What happened then? The Federal Reserve embarked on a very aggressive monetary easing policy initiated by Ben Bernanke post 2008. The expansion of the money supply led to the longest economic expansion in the United States history that is still going on from 2010 to now. All the while government budget deficits increased, national debt increased, and wages did not keep pace with real inflation.
Currently the national debt is $23 Trillion, and people and governments are still willing to purchase it. The idea that debt will bring the US economy down is a fallacy of great proportions, and at best a lie to keep the common voter confused by the aristocracy. Had Ben Bernanke and the Federal Reserve not acted, the US economy would have gone into a downward spiral.
Consequently, debt that is good debt, serviced by the borrower, is new money entering the markets that expands the monetary base; this is known as the modern monetarism theory, not to be confused with supply side economics debunked trickledown theory, which is just a game to feed the power of the aristocracy. To understand this more clearly one must also understand the governments published inflation rate; for it too is a fallacy founded to help the power of the aristocracy.
The US government reports inflation as a percentage of price level changes. This inflation rate calculation is extremely complex and considers some very misunderstood concepts about product and service utility that raises price, then lowers the published inflation rate; in addition to other methods that skew this number. A person might ask how that could be. Remember your wage cost of living raise is calculated based on the governments reported inflation rate. This is the main reason wages do not keep pace with inflation.
First let’s discuss utility, and features of products and services relative to the inflation rate calculation. Utility is the benefit a buyer receives from a new feature of a product. For example, if a TV or cell phone contains a new feature that you do, or do not use, the price goes up regardless. Due to the utility factor, the inflation rate of the item can decrease due to the benefit the government calculates from the utility they feel the consumer derives. This means many times the inflation rate decreases for that product because of the calculated benefit. This is both complex and misunderstood, many people do not benefit from the utility theory if the feature does not create real productivity increases.
Next is the concept of stripping out volatile energy and food prices. Consumer’s use energy and food daily. This means the inflation and deflation these categories of goods produce directly impacts a family’s personal inflation rate and non-discretionary spending. Consumers use energy and food more than any other type of product.
Next is the inclusion of items that most consumers purchase once in their lifetime, or very seldom. A house is purchased rarely, sometimes once in a lifetime. Cars, appliances, roofs, air-conditioning and many other items are purchased every 5-20 years. As a result, these less frequently purchased items only affect non-discretionary prices when the purchase is made. This is a technique that further blurs the real inflation rate increasing the power of the aristocracy.
Consequently, inflation rates result in calculations that are higher or lower than most family’s experience. This causes inaccurate wage increases because companies normally give cost of living increased based on the consumer price index which is the inflation rate calculated.
Normally these indexes result in lower rates of inflation than the family, or consumer experience which contributes to wages not keeping pace with real inflation. These calculations the government publishes are not developed by political parties and bear no relationship to the parties in office. Calculations from the government are based on governmental regulations set forth that affect these entities methodologies of calculation. These calculations and regulations are derived from economic advisors’ discussions with legislators, cabinet leaders and agency leaders and Bureau of Economics and Labor. Remember inflation rates can be different depending on geographic location. Consumers should make decisions based on their own personal inflation rates to reduce financial risks to their family. So now I ask the question who is fooling who here?
By Jeffrey Waks, Accountant and Financial Analyst
January 14, 2020