BY KRISTI REED
It’s coming. We have been warned for years and now it appears the Fed is going to pull one of its most dangerous tools out of the bag – inflation. If you thought your financial situation was bad before, it may be about to get a lot worse.
Even though leading economists claim the recession ended in mid-2009, reality has painted a very different picture. Nationwide unemployment still stands at nearly 10 percent, job creation is lackluster and the housing market remains a disaster.
Despite numerous attempts to stimulate the economy, the current administration has failed miserably. Instead of improved economic conditions, all we have to show for months of unprecedented government spending is an insurmountable pile of debt and looming economic disaster.
Since the administration has tried and failed to get the economy back on track, it now appears as if the Federal Reserve is ready to take more definitive action to spur the economy.
Terms like quantitative easing, debt monetization and monetary policy tend to make eyes glaze over and heads nod, but the words should really trigger alarm bells.
The Fed has been toying with the economy since the recession began, but its tinkering has not had the desired impact.
Despite lowering the interest rates to near zero to make money readily available, borrowing and spending has not increased as expected. Ideally, businesses would borrow this cheap money and expand their businesses. More jobs with higher wages would be created and people would spend those earnings thereby stimulating the economy. This increased demand for goods and services would also increase prices.
This has not happened. Instead the country is facing the prospect of deflation. Businesses and individuals are hoarding cash instead of pumping it into the economy. The Fed does not like this.
One solution to this problem is inflation. If inflation is allowed to go high enough and interest rates remain low enough, it becomes less attractive to save money because the effective interest rate (interest rate minus inflation) is abysmally low or even negative. In theory, people and corporations who are making low or negative returns on their cash holdings should be more willing to utilize that capital differently i.e. invest in the economy.
Though increased spending and economic growth may be the stated goal of allowing inflation to increase, there is another, perhaps more pressing, reason – debt reduction.
Economic prophets of doom have long warned the government would eventually use inflation as a debt reduction tool due to worries that no amount of spending cuts or tax increases can actually bring the national debt under control.
Harvard economics professor and former International Monetary Fund economist Kenneth Rogoff said he would like to see inflation at six percent to “ameliorate the debt bomb and help us work through the deleveraging process." The Fed’s current targeted inflation rate is 1.7 to two percent a year.
What happens at six percent inflation? According to economists, a $1 trillion debt would effectively decrease 27 percent to a worth of $734 billion after just five years. You can see why this might sound attractive to a government facing trillions of dollars in debt.
It sounded good to the Weimar Republic too until things went horribly wrong.
Savings were wiped out, income investment was reduced to nothing and prices spiraled completely out of control. Journalist and historian William Shirer described the devastating effects of hyperinflation upon the German people:
"What good were the standards and practices of such a society, which encouraged savings and investment and solemnly promised a safe return from them and then defaulted? Was this not a fraud upon the people?"
Is our own government poised to commit such a fraud? Evidence points to yes. If you want to reduce debt, you can cut spending, raise taxes or rely on inflation to do the dirty work for you. There is no real appetite in government to cut spending. Raising taxes is a politically dangerous move, so what does that leave? The smart money, for whatever that may soon be worth, is on inflation.
Kristi Reed is a reporter for MainStreet Newspapers Inc. She can be reached at email@example.com.