President Biden Doesn’t Understand the Nature of Inflation (part 2)

Apparent inflation is created by an excess of demand over supply (or a decrease in supply) of some goods and services, i.e. their shortage, in some special circumstances (war, natural disaster, epidemic, speculation, insufficient production).

Hidden inflation is created by central banks by constant growth of money supply because of inflation targeting policy of the state authorities. Economists, the Fed, and government must see both kinds of inflation, but they show only the apparent one to the people.

Why? To avoid responsibility for the fall of the standard of living of their citizens because of the constant depreciation of money caused by permanent inflation. Not surprisingly, Americans consider the inflation as something natural and unpredictable – like natural disaster or capricious weather.


An economist Milton Friedman said: “Inflation is always and everywhere a monetary phenomenon.” He spoke about hidden inflation.

Monetary policy is a set of tools that national central bank has to promote sustainable economic growth by controlling the overall supply of money that is available to the nation's banks, its consumers, and its businesses.

Central bank of the US is The Federal Reserve. It is independent financial institution that makes its own decisions on the country's monetary policy because “its monetary policy decisions do not have to be approved by the President or by anyone else in the executive or legislative branches of government”.

One of the tasks of the Fed is “maintaining the stability of the financial system”. Following the Keynesian inflationary doctrine the Fed adds around 2% of money into the US financial system yearly. The by-product of this is inflation and debasement of USD at the targeted speed of around 2% a year. It seems not much, however it is a geometric progression with a common ratio of 1.02 and compounding effect over time. That’s why $100 in April 1972 had the same buying power as $696 in April 2022 according to CPI inflation calculator.

Thus, the source of hidden inflation and the biggest (and legal!) counterfeiter of US dollar is Federal Reserve. It debases USD for the US and for the whole world since US dollar is the world's reserve currency.


There is another important factor, which is also related to the monetary policy: the loans. Loans are money, too. By encouraging borrowing to buy a house (mortgage) or to attend the university, the US government creates and puts into circulation extra money, i.e. it is also extra money supply.

While lending money to commercial banks or the US government to help Americans during a pandemic, for example, the Fed doesn’t take existing money out of the circulation, but creates additional money out of thin air. I'm not an economist and don't know how this is technically done, but I think it's very simple. The Fed simply credits any amount agreed upon by politicians to the account of some government department, fund, or commercial bank for certain project. For example, paper stimulus checks (coronavirus relief payments) in 2020 have been issued by the US Treasury Department and mailed to all eligible taxpayers.

This is how modern fiat money functions. It is simply written out of nothing and there is no any value behind it. Your money now is just an electronic record in the computer system of your bank and the government can give it, take it away, debase or abolish (!) it easily at any time. It’s a total control of energy of the country. That’s why Mr. Biden's $1.9T American Rescue Plan passed in March 2021 really depreciated the USD by about 10%, because M2 Money Supply in the US in March 2021 was around $19.85T. The current 8.3% inflation in April 2022 is particularly a consequence of this plan and the Fed's erroneous monetary policy in general.

Likewise, student loan forgiveness will also increase the hidden inflation and debase the USD more by roughly 8% since the student aggregate debt is around 1.75T and M2 Money Supply is 21.73T as of April 2022 . The authorities are now about to decide to implement that. Student loan forgiveness will simply shift student debt onto the shoulders of the entire nation.


Normally the Fed "controls" the rate of inflation by lowering or raising the federal funds rate to speed up or slow down the economy while keeping its inflation targeting policy of 2% a year. Federal funds rate is the benchmark for the interest rates, at which commercial banks and any other commercial entities lend out to each other and to people. When the Fed lowers federal funds rate, loans become cheaper, people borrow more, economic activity and employment in the country grows, but so does the inflation (because loans come out of nowhere and are put into money circulation). When the Fed raises the federal funds rate - loans become more expensive, people borrow less, economic activity in the country slows downs, unemployment increases, and inflation decreases because there are less loans taken.

The Fed can influence the unemployment rate just in this way, but sometimes the manipulating of federal funds rate and/or targeted inflation gets out of control, the inflation rises, economic "machine" accelerates rather quickly and that may end up with financial crisis. A real brake (deflation) would have to be used here, but the followers of Mr. Keynes who now determine economic policy of different countries are very much afraid of slowing down their economies. They believe that the economy should grow continuously and try to achieve that, although it is obvious that permanent growth of whatever is impossible.

This is how we go, creating crises for ourselves time after time by pressing the inflation accelerator, without brakes (deflation) and understanding that the additionally issued money devalues the existing money in circulation. Modern fiat money are completely devoid now of sense of the existence as universal equivalent. Real universal equivalent shouldn’t be permanently adjusted by the inflation index.


The cause of almost any financial crisis in any country is the inane monetary and fiscal policies of the authorities such as the issuance of additional money in the form of money itself and/or loans. A good example of such short-sighted policy and the power of hidden inflation is the US financial crisis of 2007-2008 which escalated into the Great Recession 2007-2009 and became a significant precondition for multi-year European debt crisis.

The housing bubble at the US real estate market began to inflate because the Fed wanted to increase economic activity in the country. From 2001 to 2003 the federal funds rate went down from 6.4% to 1% and many Americans rushed to take cheap loans (mortgages) to buy houses. Real estate prices in the US soared and the Fed as the main regulator of the financial market hadn’t controlled the banks which were engaged in blatant predatory lending. Mortgages were often given to people who were not creditworthy: in 2004 69% of borrowers were from subprime lending.

By 2006 the Fed raised the federal funds rate to 5.25%, the real estate market saturated (real estate prices can't go up forever), and borrowers with adjustable-rate mortgages have found that they owed more on their 2001-2005 mortgages than their homes were worth in 2006. There were many such people, they were unable to repay their mortgages, and the banks began to seize their homes through foreclosure procedure and put them up for sale at dumping prices. Real estate prices in the US collapsed.

Mortgage-backed securities (MBS) tied to American real estate, as well as a vast web of derivatives linked to those MBS, collapsed in value. Financial institutions worldwide who invested in those instruments have suffered severe damage especially with the bankruptcy of Lehman Brothers Investment Bank in September 2008, and a subsequent international banking crisis started.


The Fed fought the effects of 2007-2008 crisis by dropping the federal funds rate close to zero in November 2008, massive bail-outs of financial institutions and unconventional “quantitative easing” policy. “Quantitative easing” is used in crisis times and carried out by purchasing longer-term governmental bonds and mortgage-backed securities for newly emitted electronic money (i.e. creating money out of a thin air), spurring the inflation.

There were 3 rounds of the Fed’s Quantitative Easing program: QE1 in November 2008, QE2 in November 2010 and QE3 in September 2012. A lot of extra money has been issued during that time, but that helped the economy then.

In 2016, the Fed felt that economic activity in the country had recovered sufficiently and raised the federal funds rate from 0.4% to 2.4% in May 2019.


At the beginning of 2020, the COVID-19 pandemic broke out in the world. Many countries imposed lockdowns, almost stopped their production lines and a shortage of some goods occurred, especially made in China. There are quite a lot of Chinese goods in the US, the prices of these goods, of course, began to rise and there was a rush demand for some of them. Americans may remember how they couldn't buy the face masks, paper towels, disinfectants, etc. for any money in spring-summer of 2020.

A lot of businesses stopped working in the US, unemployment increased and the Fed lowered again federal funds rate close to 0% in April 2020. Thus the Fed tried to stimulate economic activity in the country and reduce unemployment, but the usual growth of money supply (hidden inflation) continued. In March 2020 the Fed began conducting its fourth round of Quantitative Easing (QE4) since the 2007-08 financial crisis: it announced the purchasing of assets for approximately $700 billion to support US liquidity.

And then there were shortage of various goods in different countries due to under-supply of imported parts, the world economy slowed down much as partial lockdown measures had affected almost 2.7 billion workers in the world or about 81 percent of the global workforce. Thus, apparent inflation intensified the hidden one in a way that everyone in the US began to notice that since approximately the end of 2021 by the substantial increase in food and fuel prices.

However, just apparent inflation is presented by the most economists as the main and the only one. Leaders of various countries base their conclusions and actions on that halved vision and promote this erroneous opinion to the people. The people dislike all that, but cannot complain about a natural disaster or bad weather. Unfortunately, the Americans have neither desire, nor time to realize that this "weather" is mostly created by their government and the Fed for them.

The Fed has artificially created and injected into the US economy to overcome crises almost $14 trillion in total from the beginning of QE1 in November 2008 (M2 Money Supply was $8.015T) to April 2022 (M2 Money Supply became $21.728T). It is a time bomb planted by the Fed and the government under the US (and world) economy that has not yet exploded.

The official inflation increase of 8.3% from April 2021 to April 2022 is a consequence of all those financial injections. Inflation is going to be higher in the future because the Fed keeps pouring extra money into the US (and world) economy.


The Americans (and all people in the world who keep their savings in USD) became officially 8.3% poorer during last year. To maintain your 2022 standard of living in 2023, you must earn $108.3K instead of $100K, for example. And you cannot save anything at this rate of inflation because savings in modern currencies are devaluated faster than you accumulate them. The US dollar (and other modern national currencies) has long ceased to fulfill one of the basic functions of money - being a store of value because of the constant injections of liquidity into the US financial system by FRS. The same is being done by European Central Bank, Bank of England and many more central banks in their countries.

Saving in modern currencies is senseless. This fact becomes more noticeable in times of crises. That is why Bitcoin and other cryptocurrencies are so popular. There is a lot of work and spending of real money behind the creation of cryptocurrency (the “mining” process) and there are only government's words and the ability to create trillions from nowhere with the stroke of a pen behind the fiat money.


Many countries in the world (including the US) follow Keynesian inflationary economic model and are gradually falling into decline, because it enriches the national elites and impoverishes the people, thus creating internal conflict between rich and poor and dividing the nations.

Money is the energy. It is also the lifeblood of the economy, which became a surrogate after the USD was disconnected from gold in the 1970s. Thus the international monetary system has lost its basis. People's personal finances, the economies of different countries and the world economy as a whole are suffocating since the surrogate cannot bring them the energy they need.

And the national elites are constantly borrowing money from other countries, IMF, World Bank and their own citizens. Many so-called developed countries owe more than they earn yearly: the USА, for example, owed 133.92% of its GDP in 2020, Great Britain - 104.47%, Japan - 254.13%, France – 115.08%... Incurring debts usually ends badly and many countries will (have already become?) bankrupt because of the greed and stupidity of their own elites and the ignorance of their people, not because of a coronavirus, supply chain disruption or wars.

This is why nations (both socialistic and capitalistic) fail and decay, not because of a lack of democratic institutions. As many developed nations degrade, so does the entire human civilization. А global debt approached $300T in September 2021 and will be increasing until the collapse of the global financial system.

Only the people of different countries can stop this process by their correct understanding of the problem and the correct voting.



P.S. Dear Reader! I am very much interested in your opinion on the subject of this article. Please, write a comment or ask a question if you want to clarify something.
Yours,
Igor Chykalov