Inflation and Our Grandchildren

There is a constant accusation against the current (Dec.2008) wave of government rescue plans, TARPs, bailouts, recapitalizations, economic stimulus and whathaveyou, along the lines of - Who is going to pay for all this? - followed by the answer, Our Grandchildren. This is coming from politicians, reporters, commentators and talk show hosts, a whole mess of people who ought to know better. I presume they do know better and for some odd reason are trying to mislead the general public. (And from some of the comments I have heard, I believe they are succeeding!)

I want to know what anyone can gain by misleading the public in this fashion. World War II must have been the largest public works program of all time. I'm not sure how much in dollar terms WWII cost and how that compares with today's government expenditures, but I am certain that the proportion of GDP spent on that war was many, many times more than what is being spent today on the various bailouts. Everybody on this forum is either a child of or a grandchild of the war generation. Are we, now, paying for World War II? If today's government expenditure is going to be paid by our grandchildren, then, by the same argument, the government expenditure of the 1940s is being paid for by us! I don't feel I am paying for WWII - do you? Is there anyone here who feels the taxes they are paying today are to pay for the second World War?

I ask these questions in an attempt to prove false the current notion that the government rescue plans, bailouts, etc. are going to be paid for by our grandchildren.

1. The idea that these rescue plans are a deficit is, in my view, false.

2. The idea that anything has to be "paid back" is also false, in my view.

3. The idea that this will be in any way detrimental to our grandchildren is not only false, but simply ludicrous, in my view.

My purpose is to dispel this negative propaganda and these errors in thinking in order to replace them with something positive. I think we are on the brink of a fantastic economic future. I am sure that we can take better advantage of the opportunities with which we are soon to be presented, if we anticipate them than if we are surprised by them.

 It has been suggested that the inflation we have experienced since the 1940s is either a result of WWII costs or government spending to overcome the Great Depression that preceded it. Or both.

It seems to me that the costs of WWII and the 1930s Depression have long since been paid and it is obvious to me that we (the grandchildren of the WWII generation) are not paying for it now. I thought that would be abundantly clear to any thinking person and thus stand as proof positive that our grandchildren would also not have to pay for today's expenditures. However, it seems the gloom-and-doom brigade are having a far greater impact on the belief system of the nation at large than I had supposed. Still - never mind! If people wish to believe that what is good is bad, what is an asset is a liability and what is up is down, then I will be content to reach for the opportunities alone.

Government releasing more and more money into the markets only reduces the value of that money

Not true! Faulty thinking! This is to do what many people are doing - thinking of government money as if it were personal money. An individual cannot create money, therefore, for an individual, there is only so much money available. But the government creates money, and can do so without limit. When it adds money to the system, it stimulates economic activity (more jobs, higher wages, more business for you and me) which adds value to the system. Adding money = adding value.

Let's try to Understand this

Consider a very simple case only presented to clarify---

A. Total physical resources - $1,000,000

Total cash - $1,000,000

The dollar is worth $1 .....right? (1,000,000 / 1,000,000 = 1)

B. Total physical resources - $1,000,000

Total cash - $1,100,000 - an increase of $100,000 in the money supply.

The dollar is worth $0.91¢ ..... (1,000,000 / 1,100,000 = 91¢ ) that's what concerns us, right? Government issuing more money.

What about this --

C. Total physical resources - $1,200,000 - an increase of $200,000 because factories made things and buildings were built, etc. In other words, economic activity.

Total cash - $1,100,000 - an increase of $100,000 in the money supply.

The dollar is worth $1.09 .... (1,200,000 / 1,100,000 = $1.09) Now the dollar is worth more, even though there has been an increase in the money supply. Increasing the money supply does not automatically decrease the value of the dollar or increase prices (which is the same thing, of course.)

D. In a case like Zimbabwe's (keeping it very simple) there has been a tremendous contraction in the Total Physical resources and a phenomenal contraction in economic activity. Even if the money supply remained the same--

Total physical resources - $500,000 - a decrease of $500,000 because factories stopped making things and buildings were left to collapse, etc. In other words, economic activity decreased.

Total cash - $1,000,000 - no change in the money supply.

The dollar is worth $0.50¢ .... (500,000 / 1,000,000 = 50¢) = tremendous inflation and the money supply hasn't been touched!

So, Where does that get us?

I started off talking about the fallacy (as I see it) of believing that today's government expenditures will have to be paid back by our grandchildren, as is being constantly asserted. If I understand the position correctly, many people believe our grandchildren are being burdened with today's expenditures. And that belief has something to do with inflation. Supposedly, the argument goes like this-- Government bailouts amount to extra money being pumped into the system and this will cause inflation so our grandchildren will pay higher prices for everything. So, it's not that our grandchildren will have to pay taxes to "repay" the money - it is that inflation so caused will erode the value of their dollars.

Flooding the market with cash at an ever increasing rate is a bad thing

First, I do not interpret the current government expenditures as "flooding the market with cash" and, if it were, I might consider it a bad thing, too. It is certainly nowhere near levels that could induce hyperinflation, as some people have projected.

 Let us understand that while government is the only entity that can *print* money, it is not the only entity that *creates* money. In fact, government-created money is only a tiny portion of the total money in the country. Most of the money is created by banks - which are private institutions. The prime function of the Federal Reserve (and possibly other central banks) is to *control* the money supply - not print it, not create it - *control* it. Which it does, of course, by raising or lowering the base interest rate. Banks, as prime creators of money, do this by adding money to the system (making loans.) They are equally capable of taking money out of the system (by not making loans and even calling in the loans they made earlier.)

Over the past year, at least, banks have been taking money out of the system. This came to a head with the recent failure of the banking system. The banking system had so reduced the amount of money in the system that the whole financial system ground, more or less, to a halt. To counteract this, the government has been adding money to the system to replace that which the banks had withdrawn, in order to get the economy moving again. This is not additional money on top of what was there before - it is an attempt to replace that which was removed. I think even now, with the massive injections. we have less money in the system than we had previously. As a result, we are still in danger of deflation, and to prevent that, more new money still is needed.

The negative comments and errors in thinking are creating a very gloomy picture. I think that is a shame. I believe this country and the world is on the brink of a very bright economic future. By recognizing the opportunities that lay before us, we can prepare for them and take advantage of them. The meek may inherit the earth (although I have my doubts) but I am convinced the bold will be streets ahead over the coming months.