Inflation, Inflation, Everywhere Inflation

It is interesting to see our government telling us on a regular basis that there is no inflation or very little. Of course we all think inflation and begin looking at prices and how much they have increased lately.

Inflation isn't really a measure of how much prices have increased but how much the money supply has increased. Price increases are the result of an increasing money supply. When the Federal Reserve determines that we need more money floating in the banking system, they create more dollars. Used to be, they did this by firing up the printing presses. Now it is simply a matter of digitally crediting banking institutions with more funds.

Basic economic theory says that if you create more money, that money will be used to buy more goods and services. Prices go up for two reasons; either increased demand or limited supply.

The Feds, in their infernal wisdom, believe that by manipulating the money supply, they can control swings in the business cycle. What really happens is that they cause companies to spend money to meet the increasing demand for their products. Demands that wouldn't be there if there wasn't so much extra money floating around. This malinvestment by companies creates imbalances in the economy, which at some point must be dealt with, usually in the form of an economic bust.

An example is the currently red hot housing market in several cities around the country. The run-up in prices has been fueled by unusually low interest rates. Interest rates that cannot stay low forever. This is bubble waiting for a sharp pin in the form of higher interest rates. When, not if, interest rates start moving up, the real estate markets will fall, in some cases, rapidly. You do not want to be overextended in those hot markets when that train roars into town. I predict that people will literally walk away from their homes and leave huge mortgages behind.

Since the Federal Reserve's formation in 1913, the dollar has lost 98% of its value. This is a result of a continuous increase in the money supply. There was once a time when we held gold as a backing for our dollars. The exchange rate was fixed at $35 per ounce; however, in 1971 President Nixon closed the gold window and floated the dollar, no longer tying its value to gold. It is estimated that if we were to fix dollars to gold once again, gold would be valued at over $4000 per ounce. That's how many extra dollars we have floating in the system right now.

Some day this problem is going to come home to roost and when it does, we as a country will suffer. We will no longer be an economic super power. The government will no longer be able to pay for all of the stuff they pay for. We will have to take care of ourselves. That is why it is so important to make sure that your financial house is in order and well diversified. (See my previous posts about this important subject.)