Tuesday, January 24, 2006

Beyond Keynes to Inflation

Richard Benson

Without constant monetary stimulus, the credit-based U.S. economy would die. Our current economic model is similar to the one used by banana republic countries that are running hyperinflation* and end up in hock to the IMF:

"Hyperinflations are caused by extremely rapid growth in the supply of “paper” money. They occur when the monetary and fiscal authorities of a nation regularly issue large quantities of money to pay for a large stream of government expenditures. In effect, inflation is a form of taxation where the government gains at the expense of those who hold money whose value is declining. Hyperinflations are, therefore, very large taxation schemes."

America is now extraordinarily vulnerable to the whims of foreign governments. What if our creditors demanded a higher rate of interest? Perhaps they already have, and the Federal Reserve will have to raise interest rates higher than the capital markets currently expect.

What about the housing bubble? Mr. Bernanke may be left with only one course of action: Given housing price inflation of 50 to 100 percent in some areas over the past few years, the Fed’s goal for the next several years will be how to get inflation up without crushing housing prices because of rising interest rates. A housing price crash could severely affect the financial markets in our country and take the economic system down with it. Mr. Bernanke has spent his entire adult life studying to prevent this from happening and I suspect he will do everything in his power to keep inflation going. When everything else is inflated, housing prices (at their current levels) won’t appear to be so over-valued. Getting money into the hands of consumers who can’t tap their savings (because most Americans don’t have any), or use their credit cards (because they’re over-extended - welcome to the new bankruptcy law), or draw cash from the home equity loan ATM installed on the side of their house (housing prices are stagnant or falling), will be a real challenge. To get money into the consumer’s hands, the Fed will have to print more money and encourage the creation of more debt. Mr. Bernanke’s illusion about dropping “money from helicopters” may actually come to pass as a direct way to distribute money to the consumer to service old debts and keep spending alive. The new economic model should be “inflate, or face deflationary collapse”.

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