China Threatens to Use the “Nuclear Option”

The rich rules over the poor, and the borrower becomes the lender’s slave.
- Proverbs 22:7 (NASB)

Americans ought to be furious that our elected leaders have put us in this position. China threatened Wednesday to use the “nuclear option” on the U.S. dollar if Congress succeeds in passing a trade law intended to strong-arm China into allowing its currency, the yuan, to appreciate against other currencies. 1 Many members of Congress have increasingly complained in recent years that China artificially suppresses the value of the yuan to boost exports and give it an unfair trade advantage. Many experts point to this as a big reason for the burgeoning U.S. trade deficit with China, which totaled $96 billion for the year at the end of May. 2 With its trade profits, China has accumulated vast U.S. dollar holdings, including a large amount of U.S. government debt. This makes China our creditor and puts us in some measure of subservience to the Chinese. As I have written before, the United States continues to expand its money supply, resulting in a relentless slide in the purchasing power of the dollar. Nations like China that have bought up large dollar holdings and held them in reserve have artificially propped up the purchasing power of the dollar by creating increased demand for the dollar. Without this generosity and that of other nations that do the same, the purchasing power of the dollar would be much lower than it is today and prices on the goods we all purchase every day would be much higher due to higher inflation. In other words, the accumulation of dollar holdings by the Chinese has kept inflation in the U.S. much lower than it otherwise would be. So what is China’s so-called ‘nuclear option’? Because China holds so many dollars in reserve, dumping them all at once could in a single stroke destroy the purchasing power of the dollar, driving up inflation and interest rates and sending our economy into a tailspin. Yes folks, because our federal government has refused to end the red ink, we are now in the position of hoping that China is nice enough not to destroy our economy. Would China actually follow through with its threat? Hard to say, because to some extent they rely on exports to the U.S. and a reasonably stable U.S. economy to support the financial needs of the country. However, China could eventually decide they do not need a strong American economy when their domestic economy grows to the point that it can rely less on exports. Additionally, the Chinese have already made it clear they wish to diversify out of U.S. dollar investments because they continue to lose value due to the slide in the dollar. Based on this, we can expect that China will, at some point, offload a significant amount of their dollar holdings. And we, as proud Americans, will be in the position of begging them to go easy on us.

There are a couple of important points to emphasize here. First, China is not our friend. Senior Chinese military personnel have spoken openly in the past that they believe war with the United States is “inevitable”, presumably over Taiwan. 3 A friendly country would never say such a thing, nor would it threaten to destroy our currency and send our economy into a tailspin. Second, it is our esteemed leaders in Congress and the Administration, both current and past, that have put us in this position by spending us into a hole $9 trillion deep. We once were the world’s creditor, but we have become the largest debtor in history so that we can continue to finance our consumption and government entitlements. If Congress and the Administration actually balanced the budget and kept it balanced, maybe we wouldn’t be in the position of having to hope a foreign and hostile power won’t drop a currency bomb on our economy. Third, if the dollar was still a commodity-backed currency as our Founders intended, we would not be in this position. Having a gold standard limits government spending to whatever gold exists in the Treasury. If the gold runs out, the government has to either stop spending or find somebody to lend it more gold. The government is forced to balance the books; there would be no option to fire up the printing press and kill us all with inflation or borrow endlessly from foreign powers. The dollar also would be based on the rock-solid value of gold, which has changed little throughout human history. With a gold-backed dollar, there wouldn’t be a “nuclear option”.

Folks, America needs desperately to return to the principles of limited government upon which our nation was founded. Our Founders never intended for the federal government to be so large, have so much power, and be involved in so many things. A return to the gold standard would force the federal government to balance its books and put an end to destructive inflation and endless government borrowing. It would also force it to make tough choices about its priorities, likely resulting in the abolition of countless unconstitutional federal programs. As Alan Greenspan once explained, a gold standard is essential to our freedom and independence; let us return to it and reclaim the freedom and independence our Founders intended us to have.

References

1. Unease at China’s Threat to Sell Dollar. (Aug. 8, 2007). Retrieved Aug. 11, 2007, from http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/08/09/cnfxnews109.xml
2. U.S. Census Bureau
3. Constantine C. Menges, China: The Gathering Threat (Nashville, TN: Nelson Current, 2005), pg. xv

Economic News: Yen for Oil and Paulson on the Housing Market

Bloomberg reported July 13, 2007 that Iran is now requiring Japan to pay for oil in yen instead of U.S. dollars, the traditional currency for oil transactions worldwide. 1 It might seem like a minor event in the scheme of world affairs, but it is indicative of the declining status of the U.S. dollar as the world’s reserve currency. Because of the historic strength of the U.S. economy, many nations around the world have chosen for decades to store their national savings – their reserves – in dollar-denominated assets. However, the continuing slide of the dollar has prompted central bankers around the world to begin exchanging their depreciating dollars for other currencies such as the euro and yen. China’s foreign exchange reserves are believed to be around $1 trillion or more, 75% of which is believed to be in U.S. dollars. 2 Assuming China has $750 billion in U.S. dollars, just a 1% decline in the value of the dollar will cost China $7.5 billion in the value of its reserves. No central banker would wish to incur those kind of losses on an ongoing basis, therefore China has signaled its intent to gradually move away from U.S. dollar holdings. If you are wondering why you should care about this, know that decreasing demand for U.S. dollars will negatively impact the value of your savings and investments. The yen received a boost after Iran’s announcement because the markets understand that it will likely result in increased demand for the yen. If increased demand can cause a currency to increase in value, then decreased demand can cause a currency to decline in value. If foreign central bankers start dumping dollars, it will represent decreased demand for the dollar and will put pressure on the value of the dollar, resulting in the erosion of the purchasing power of your savings and investments. China, with its massive foreign exchange holdings, has been treading very carefully on this issue because it does not want to create a sell-off in the dollar that could jeopardize the other dollar investments it must keep for now. However, they know a losing game when they see one; the Federal Reserve is continuing to intentionally undermine the value of the dollar by printing massive amounts of them to meet America’s never-ending appetite for spending. Every dollar printed results in the devaluation of every other dollar in circulation and relentlessly drives up prices. This is inflation, and in reality Americans should be suffering under much higher levels of inflation. By soaking up so many dollars and holding them in reserve, foreign central banks like that of China have artificially propped up the value of the dollar by increasing demand for it. If this changes on a widespread basis, Americans could face a rapid decline in the value of their dollars.

Paulson Thinks Housing Market Nearing Bottom

Treasury Secretary Henry Paulson thinks that the “U.S. housing market correction [is] ‘at or near the bottom’”. 3 Considering the relatively low number of people who can truly afford to purchase a 2-bedroom condo in Southern California for $500,000 or more, it seems preposterous that the housing market could have bottomed already. Inflation around the world is pushing U.S. mortgage rates higher, and with 30-year fixed rates now averaging near the mid 6% range, even fewer people can afford to buy property in high-priced areas like Orange County. It has only been a few months since it was possible to obtain a 30-year fixed mortgage in the high 5% range and every 1% increase in rates represents a $329 dollar increase in the payment for a $500,000 mortgage. If affordability decreases, demand will decrease with it, resulting in pressure on home prices. If mortgage rates continue to increase, which they likely will as inflation mounts around the world, home prices will have nowhere to go but down. And in a highly inflated market like Southern California, the bottom may yet be a long way off.

References

1. Iran Asks Japan to Pay Yen for Oil, Start Immediately. (July 13, 2007). Retrieved July 13, 2007 from, http://www.bloomberg.com/apps/news?pid=20670001&refer=worldwide&sid=aLaColVYu5LA
2. INTERNATIONAL NEWS: China tries to reassure markets on dollar. (March 17, 2007). Retrieved July 13, 2007 from, http://search.ft.com/ftArticle?queryText=china+dollar+reserves&aje=true&id
=070317000872
3. Paulson: Housing ‘at or near bottom’. (July 2, 2007). Retrieved July 14, 2007, from http://money.cnn.com/2007/07/02/news/economy/paulson_housing.reut/index.htm

Congress Raises the Minimum Wage

Congress passed the first minimum wage increase since 1997 as a part of the hotly disputed Iraq spending package finally signed by President Bush. The increase, which will raise the federal minimum wage from $5.15 per hour to $7.25 per hour over a two-year period, was hailed by Senator Ted Kennedy as “only the first of many steps we must take to address the problems of poverty and inequality”. 1 The Democrats, after taking control of Congress in November, made it a high priority to raise the minimum wage in response to the increased financial strain higher prices has had on low income workers. As prices have risen significantly over recent years for everything from gasoline to food, the nation’s lowest paid workers have found it increasingly difficult to make ends meet.

The concept of a minimum wage might seem compassionate, but it does not come without cost. Evidence suggests that increases in the minimum wage can be linked to higher unemployment. Jeff Cox, a contributing writer for CNN, notes that “national unemployment hit its highest rate since the Depression” after the minimum wage was increased in 1981. The minimum wage was increased again twice in the early 1990s and “unemployment zoomed”. 2 According to famed economist Ludwig von Mises, raising the minimum wage can contribute to unemployment because it places an artificially high price on labor. 3 Basic economics dictates that higher prices on certain goods will tend to reduce demand for those goods. Likewise, setting a higher price for labor will tend to reduce demand for labor. Companies employing workers compensated at or near minimum wage may find that it’s not worth it to pay the new minimum wage for some jobs. Other companies may be forced to reduce their workforce to compensate for higher labor costs. Either way, the workers hit hardest are those paid at or near minimum wage – workers that the wage laws are intended to benefit. Minimum wage laws are essentially price controls on labor and do not always reflect conditions in the marketplace. A market free of government interference tends to find the optimal price for any commodity, resulting in the greatest balance between supply and demand. This applies to labor markets as well; a labor market free of government interference will quickly find the optimal price for labor and achieve the maximum level of employment.

Minimum wage laws may grant a pay raise to the poor, but they are only pain medication for the true problem of incessantly rising prices across the economy. When the Federal Reserve was created in 1913 it was charged with preserving the purchasing power of the dollar while moderating downturns in the economy. It has utterly failed this mission because the dollar has since lost 97% of its purchasing power due to inflation; it takes $33 to buy today what $1 bought in 1913. The Federal Reserve has intentionally flooded the economy – particularly over recent years – with intrinsically worthless fiat dollars, resulting in the erosion of the purchasing power of every other dollar in circulation. If the purchasing power of a dollar declines, prices rise because it takes more dollars to purchase the same goods and services. The hardest hit by rising prices are the working poor, the people most likely to earn around minimum wage. The way to ease the financial strain of low income workers is not to require businesses to pay them more, but to stop the Federal Reserve from continuing to debase our currency. Doing so would benefit all Americans, not just the poor, by ending inflation and stabilizing prices.

According to CNN, twenty-eight states have already raised or are in the process of raising their minimum wages, so the new federal legislation probably will have little real impact. 4 However, the efforts of the Democrats will probably help insure the continued loyalty of the working poor. Like other socialist policies, a minimum wage hike is simply a way for the political elite to purchase the support of a constituency with the money of another constituency. Democrats might be giving them a raise, but many low income workers might end up being moved from the payroll to the unemployment and welfare rolls. Those that keep their jobs will still struggle to make ends meet as inflation continues to drive up prices. In fact, increasing the minimum wage in itself contributes to price inflation. Companies with large numbers of workers earning at or near minimum wage, such as WalMart, cannot possibly maintain their workforces and absorb a 40% increase in the cost of labor (as is the case with the new federal law) without passing it on to consumers in the form of higher prices. And who shops at WalMart? Low income workers working for around minimum wage.

*** Inflation is raging all around us. Food prices rose at an annualized rate of 3.6% in May and overall energy prices rose 5.4% in the month of May alone. 5

References

1. Congress OKs minimum wage boost. (May 25, 2007). Retrieved June 8, 2007, from http://money.cnn.com/2007/05/25/news/economy/minimum_wagedeal/index.htm
2. Minimum wage, marginal impact. (January 26, 2007). Retrieved June 8, 2007, from http://money.cnn.com/2007/01/26/news/economy/economy_minimumwage/index.htm
3. Mises, Ludwig von. Human Action: A Treatise on Economics, n.d. Ludwig von Mises Institute. 1998. Pg 764. http://www.mises.org/humanaction/pdf/HumanActionScholars.pdf
4. House passes minimum wage hike bill. (January 11, 2007). ). Retrieved June 8, 2007, from http://money.cnn.com/2007/01/10/news/economy/minimum_wage/index.htm?postversion=2007011109
5. Despite record gas, inflation tame. (June 15, 2007). Retrieved June 16, 2007, from http://money.cnn.com/2007/06/15/news/economy/cpi/index.htm

Record Dow Not As Good As It Seems

The Dow Jones Industrial average closed Friday at 13,264.62 – another record high. According to CNN, Friday’s session made this the longest bull run in 80 years. “The Dow has now risen in 23 of the last 26 sessions, marking its longest bull run since the summer of 1927, when the indicator ended higher in 24 of 27 sessions”, reported CNN. 1 As investors cheer, it is worth noting that the numbers are not as great as they sound. The Dow may be hitting new records, but believe it or not, it has actually been a losing investment since the end of the 1990s. Yes, that’s right. If you had invested your money in the companies composing the Dow in 2000, your investments probably gained in dollar terms but they have lost purchasing power. Your investment dollars buy less today than they did in 2000. The reason? Inflation.

The best way to measure wealth is in terms of purchasing power, not dollars. One may have more dollars, but if it takes significantly more of them to purchase the same things, one cannot necessarily be considered wealthier. Take for instance gasoline prices, which have doubled since 2000. 2 Unless the average American’s income has doubled over the last 7 years, it is a pretty safe bet that a larger percentage of the monthly budget is going to gasoline. This is also true for other expenses, such as housing, insurance, and food. Dollars just aren’t going as far as they once did. If inflation is driving up prices faster than wages, people are getting poorer because their money is losing purchasing power. The main culprit behind inflation today is the rapid expansion of the money supply by the Federal Reserve. Every dollar added to the money supply devalues every other dollar in circulation, and the money supply has nearly doubled in just the last 10 years to nearly $10 trillion today. 3 With so much money supply expansion, it is no surprise that inflation is seriously eroding the purchasing power of the dollar. The Dow may be hitting new records, but the picture looks significantly different when inflation is taken into account.

Figure 1. Gold prices show that the Dow peaked around 2000 and has been declining ever since. Dow represented by annual closing value. Gold represented by annual London afternoon spot gold closing price. Source: CNN Money (Dow Jones Data) and www.onlygold.com (Spot Gold Prices). 

The best benchmark to measure the impact of inflation is the price of gold. Anybody that watches the price of gold knows that it has increased significantly over recent years, climbing from about $270/oz at the end of 2000 to nearly $700/oz today. This increase is not because gold has gained in value, but because inflation has eroded the purchasing power of the dollar. The value of gold is largely static; an ounce of gold buys about the same basket of goods today that it did 100 years ago. This remarkable stability is the reason it serves as a good benchmark to measure the value of other things, such as the dollar and investments denominated in dollars. Despite continually hitting new records, gold prices show that the purchasing power of investments in the Dow peaked around 2000 and have been declining ever since. As Figure 1 shows, it took about 43 ounces of gold to buy the Dow in 2000 and it only takes 19 ounces of gold to buy it today. 

The media can hype the record closings of the Dow all they want, but the numbers speak for themselves. The Dow may be worth more dollars than ever, but inflation shows a Dow in decline.

References

1. Dow: Longest Bull Run in 80 Years. (May 4, 2007). Retrieved May 7, 2007, from http://money.cnn.com/2007/05/04/markets/markets_0530/index.htm?postversion=2007050417
2. U.S. Bureau of Labor Statistics Consumer Price Indexes. U.S. Bureau of Labor Statistics. Retrieved May 7, 2007, from http://www.bls.gov/cpi/
3. Federal Reserve Bank of St. Louis M3 and Components. Federal Reserve Bank of St. Louis. Retrieved May 7, 2007, from http://research.stlouisfed.org/fred2/categories/28

A Case Study In Buyer’s Remorse: How Easy Credit Will Push One Homebuyer to Financial Calamity

Cheap credit and loose lending guidelines fueled by record-low interest rates will likely result in financial calamity for many subprime homeowners.

Bruce and Gina, a young couple from Olympia, Washington, bought their first home in April 2006 and recently contacted me to help them refinance their mortgage and obtain a lower mortgage payment. Because of their dismal credit and high debt load, I knew pretty quickly there would be nothing I could do for them but I was curious to know how they managed to buy their house in the first place. Bruce was working as a technical support analyst for a computer firm and Gina had a job as a teacher’s assistant at a local school. Combined, the couple grossed $50,000 per year. Because they didn’t have the savings to make a down payment, they financed the entire purchase price of $210,000 and took on a mortgage payment of $1850 with taxes and insurance – a payment much too high for their combined income and debt load. Bruce’s credit rating was terrible, far below the bare minimum required to qualify for even a subprime home loan, so the original purchase loan had been underwritten under Gina’s name only, using just her income and credit (which wasn’t that great either). Knowing that Gina grossed just over $1300 per month, I wondered how it was possible for her to obtain a loan with a monthly payment of $1850. As it turned out, the answer was a fraudulent mortgage application and loose lending practices. I confirmed with Bruce that Gina had “qualified” by obtaining a stated income loan – a loan that requires only that income be declared and not proven. Originally intended for those who can’t truly document their income (such as the self-employed and those who get tip income), today’s promiscuous lending environment has made stated income loans a common vehicle to “qualify” borrowers who don’t make enough to qualify by fully documenting their income. As the refinance boom unfolded over recent years, lenders loosened underwriting guidelines in an effort to qualify a greater number of borrowers and capture a larger share of the mortgage lending market. Stated income loans were increasingly made available to borrowers previously considered high risk. It is hard to say who actually did the income “stating” in this scenario, but the most likely culprit was the mortgage broker. To make the numbers work, I figured that he probably had to declare Gina’s income on the mortgage application to be about $70,000 per year for her to “qualify” with her debt load at the time. Though income is not verified, stated income lending guidelines typically require verification of employment. Because no reasonable person would believe that a teacher’s assistant makes $70,000 per year, it is likely that the loan underwriter either didn’t verify Gina’s position at all or chose to disregard that her declared income was unreasonable for her position. Even worse, Bruce and Gina elected to obtain an adjustable-rate mortgage with a 2-year teaser rate. Known as 2/28s, such loans have a fixed rate for the first two years of the term and an adjustable rate for the remaining twenty-eight years. Once the 2-year fixed period is over, Bruce and Gina will likely be hit with an increase in their payment of at least several hundred dollars as their rate adjusts to prevailing market conditions. Selling is not an option either. Home prices are stagnant or falling and because they didn’t put any money down, they will likely have no equity with which to pay for selling costs. This financial disaster in the making will likely end in foreclosure, resulting in shattered dreams of home ownership and a loss for the mortgage bank. And all of it could have been prevented with more prudent lending guidelines and practices.

Incredibly, the headlines are proving that Bruce and Gina’s story is not an isolated case. HSBC recently announced that losses due to subprime loans in 2007 were going to be “about $1.8 billion higher than expected (emphasis mine)” 1 Irvine, CA-based New Century Financial, one of the largest subprime mortgage banks in the country, announced it would have to restate 2006 earnings “to account for losses on defaulted loans it would be required to repurchase.” 2 New Century is also facing class action lawsuits, regulatory investigation, and possible bankruptcy due to the bad loans it has made. According to RealtyTrac, foreclosures are running 25% higher than last year:

We don’t have high unemployment, high interest rates or a slowing economy, but we’re seeing the number of foreclosure filings pushed above historic averages,” says Rick Sharga, a marketing exec for RealtyTrac. “You can’t underestimate the effect of higher risk loans.” 3

Loans for borrowers with good credit ratings appear to be performing well, so clearly the problem is in the subprime underwriting practices and guidelines. The bottom line is that banks are lending to people who are bad credit risks and the day of reckoning has arrived. Few would probably disagree that things obtained easily and cheaply are seldom valued. That certainly has been the case over the last few years as the Federal Reserve, by lowering interest rates to record lows, has made credit so cheap and abundant that just about anybody can get it. The party was fun while it lasted, but now it’s time to clean up the mess.

References

1. Mortgage Defaults: Latest Woe for Housing. (February 12, 2007). Retrieved March 7, 2007, from http://money.cnn.com/2007/02/12/news/economy/subprime_realestate/index.htm
2. Ibid.
3. The Risk in Subprime. (March 1, 2007). Retrieved March 7, 2007, from http://money.cnn.com/2007/02/28/magazines/fortune/subprime.fortune/index.htm

Bye-Bye M3?

The fortunes of empires tend to be predicated by the fortunes of their currencies. – A. E. Fekete

The Federal Reserve announced on November 10, 2005 that it intends to stop publishing the M3 monetary aggregate after March 2006. Most people would probably respond to such an announcement with a puzzled “huh?”, then turn the page of their Newsweek and not give it another thought. I too was clueless until just a few days ago. Since then, I have discovered that the M3 is the broadest measure of America’s money supply, which in recent years has been increasing at a furious rate. The consequences of this increase affect every American’s paycheck and life savings and it concerns me that the government would see fit to stop publishing such an important economic vital sign. Why would they do that? Are times not as good as they say? Does our government not want us to know some vital truths about the health of the American economy?

Figure 1 shows the M3 over the last 45 years of our history. Notice that the money supply has doubled from around $5 trillion just a decade ago to nearly $10 trillion now. This is a huge increase in the money supply, especially since it happened only within the last 10 years. Now why would it be a bad thing to have more money in the economy? After all, more money in circulation means that there is more to go around, right? Sure, but more money in circulation results in a devaluation of all money in circulation. In other words, every dollar added to circulation results in a devaluation of every other dollar in circulation. When the dollar is devalued it is called inflation, and the result is that it takes more dollars than before to buy things such as a gallon of gas or a carton of milk. Inflation is defined as follows:

A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services. 1 

In other words, when money is created at a rate that outpaces growth in goods and services inflation results. More dollars are chasing around fewer goods and services, so every dollar in circulation is worth less and the prices of goods and services increase. Figure 1 shows that the increase in the money supply over the last ten years is nearing 100%, astronomically higher than the growth in the GDP, which has averaged around 5% for the same period of time. Clearly, the growth in the money supply has greatly exceeded the growth in the economy.

Now why exactly would the Federal Reserve want to add to the money supply? It does this because the money added is in the form of credit that can be used to finance economic expansion. If credit is abundant, businesses can borrow to expand their operations. If businesses are expanding, more people are employed and accumulating wealth and more people are consuming and starting up new businesses. The theory is that as long as the Federal Reserve provides abundant credit, the economy will expand. How does it do this? Where does the money come from? It comes from the printing press (or the computer). The Federal Reserve simply creates the money needed to meet the demand for credit out of thin air.

It used to be back in the old days that market forces would regulate the cost of credit, which is reflected in interest rates. If the amount of credit available for new loans becomes more limited, the cost of credit climbs. It is a simple law of economics: limited supply results in higher prices. If outstanding loans are repaid quickly, more credit becomes available and the cost of credit drops. Well, the Federal Reserve was created in 1913 to do away with the problem of a finite amount of credit in America. You see, some people noticed that limited credit usually translated into slower economic growth. If somebody could come up with a way to provide limitless credit to the economy, businesses would always have the money needed to expand and the economy would always grow. So, the Federal Reserve was created to provide limitless credit. 2 Now it’s one thing to provide credit, but another thing to get people to borrow it. Instead of allowing market forces to dictate the cost of the credit, the Federal Reserve intervened by regulating interest rates itself. If the Fed lowered rates, credit would cost less and consumers would borrow more. If it raised rates, credit would cost more and consumers would borrow less.

Most Americans have heard about the Fed adjusting interest rates, but few probably know what really is happening. The rate the Fed adjusts is the federal funds rate, which is the interest rate charged by the Federal Reserve for the use of its funds. When the Fed cuts rates, the intent is to inject more credit, or liquidity, into the economy to fuel economic expansion. Because the federal funds rate is lower, it is less expensive for banks to borrow money from the Federal Reserve to make new loans. The banks pass the lower costs on to the consumer by charging lower interest rates on loans. Because the cost of credit in the economy is cheaper, demand for credit increases, and to meet the increased demand, the Federal Reserve simply fires up the printing presses. New dollars are created out of thin air to meet the increased demand for cheap credit, resulting in an increase in the money supply and a devaluing of all dollars in circulation due to inflation.

The danger of limitless, cheap credit is that it can result in speculative booms that can send inflation through the roof. If a borrowing frenzy ensues, such as in the white-hot real estate market of the past few years, the Federal Reserve finds itself in the position of having to create astronomical amounts of money to meet the demand for credit. It cannot simply shut down the printing presses because that would cause credit to dry up very quickly, resulting in a shock to the economy. The Fed has to ease demand by gradually raising interest rates. The danger here is that if it raises rates too quickly, economic expansion could halt and a recession could result. If it raises rates too slowly, inflation could increase. The challenge is for the Fed to strike a balance between economic expansion and inflation, achieving the maximum expansion for the minimum inflation. History demonstrates that it has not always been successful at finding that balance.

High inflation is a danger to the stability of our economy. It results in the devaluation of the dollar, making goods and services cost more. It undermines the confidence in our economic system that is absolutely essential to the continued financing of America’s huge deficits. It is politically damaging to the ruling class because Americans have demonstrated that they vote with their wallets. But increasing inflation also would be a sign that the health of the economy is deteriorating. Because of an astronomical debt burden, increasing, out-of-control inflation could be a sign that the American economy is headed for very turbulent waters. This American is cynical about the intentions of the Fed with regard to the M3. Many have already made a strong case that the government is understating inflation. The decision to stop reporting the M3 seems to be another way to mask the true picture of inflation.

References

1. http://education.yahoo.com/reference/dictionary/entry/inflation
2. Alan Greenspan. Gold and Economic Freedom. (1966 Speech). Retrieved November 24, 2005, from http://www.321gold.com/fed/greenspan/1966.html