Saturday, April 14, 2012

Inflation and paper money

Since 1971 when President Richard Nixon got the US dollar off its tie to Gold which was at $35/oz at the time (this event has been called the Nixon Shock), the entire population of the world is now used to living, working, paying with fiat paper money. Fiat means "let it be" and implies the government is telling the public to use it, and they have an effective way to convince the public: this is the only way you can pay your taxes, and paying them you better do.
Since then, prices of pretty much everything has drastically increase, only a few advances such in computers are as fast or even faster than inflation to make a difference. In June 1977 for example, an Apple II computer with 4Kbytes of ram was selling for $1,298. Today, the MacBook Pro with 4Gbytes of memory (1 million times more memory) sells for about this same price.

The BLS (Bureau of Lie on Statistics, - sorry I mean Bureau of Labor Statistics) is telling us inflation (as defined today) is no more than 2%. In reality, prices are rising at least at 6% or more as stated by private companies such as which measures them as the government used to in the 1970s. One of the tricks the BLS uses is to exclude food and energy which, I don't know about you, are the very 2 principal items I cannot personally exclude from my personal life. The stated reason is that they are too seasonal and volatile. Well, they would just have to compare it from a year earlier when it was during the same season. Another trick is to account the improvements in the technology sector such as the personal computer. They would account for a reduction in the price of personal computers because of the new technology, even if the price is the same from the prior year.

Why are they doing this? There is one principal reason. The first is to lower inflation expectation in the minds of the public. Strangely it is effective as the lower the inflation expectation, the more likely this will reduce inflation itself. Prices rise faster when people expect prices to rise as they will spend their money faster, feeding on itself. When inflation is very low, people don't account for it much. The 2nd reason and perhaps the most important one is to influence the people's investment decision and be more willing to invest in government treasury bonds paying only 2, 3 or 4%.  Who would invest in a bond returning only 4% if the prices are really rising at say 6%... Very few I think. Only those who expect a deflationary event where prices plunges on the stock market and housing sector, the very thing that the central banks and governments are doing their best to avoid by using "Quantitative easing" or passing laws to help homeowners, etc. Note that Quantitative easing might sound like a very complicated financial methodology but this clips what it essentially is:

So, if you are invested in CDs or other debt instruments, you should reconsider this. You can contact us if you would like to learn more.

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