Thursday, April 10, 2008

Power, Inflation, and the “Reset Button”

Proverbs 22:7: "The rich rule over the poor, and the borrower is servant to the lender."

Inflation is the natural enemy of cash. Hyperinflation is a nuclear strike on your bank account; though it is unlikely to happen, those long on cash ought to be wary. In any case, it will be a necessary concept when it comes to discussing the middle ground.

If as Mises says, at the end of a credit bubble, policy makers must choose either deflation or hyperinflation, the latter would be hitting the reset button on the economy. The system would have to start again from scratch by recreating a money supply that has value. All existing debt is effectively erased by hyperinflation. So… who wouldn't want to hit the reset button on the economy?

Those who benefit from the “reset button” would be people heavily in debt, like with large monthly mortgage payments. The government is heavily in debt too, so does it want to hyperinflate? No. The “government” is not a thinking entity with no motivation of its own and so does not care or is even cognizant of the amount of debt it owes. Rather, the “government” is a system of many politicians that decide on laws and how tax dollars are spent. So would the body of politicians want to hit the reset button on the economy ever?

One cannot speak for all politicians, and every politician has complex motives that drive him or her. They need to keep their electorate pleased, as well as keeping their contributors happy. That is just the reality of politics, the game that every one must play. Thus, we live in a mixed democracy/plutocracy (each at odds with the other), where the wealthy and powerful have a disproportionately greater say over political affairs than the common voting citizen.

Say 51% of the electorate has a toxic mortgage, and want to pay it off easily with hyperinflated currency and hold title to their house almost free. Does that mean the government will start printing away since it benefits a democratic majority? Probably not.

In terms of whom our financial regulators see fit to benefit, not everyone is created equal. In a recent example, we see the Fed has overstepped its authority to bail out Bear Stearns bond holders. Conversely, we see no concern they have for Bear Stearns share holders whose stock values plummeted from about $30 to $2 as a result of Fed action (it settled at $10). In essence, we have an example of the Fed using its regulatory power to benefit debt (bond) holders over asset (stock) holders. The key for us outsiders is to guess who or what it is the Fed will be treating preferentially with their regulatory measures, and invest accordingly.

But say the reset button is hit. Say the Fed rev’s up the printing presses full power. Treasuries are zero’d out. Mortgages are zero’d out. Superbowl bets that haven’t been paid up yet—those are zero’d out. Those who owed more money than they possess are happy—they are now richer, having no money, rather than debt. Those who have lent out money would be displeased, since they have lost what was owed to them. For every dollar borrowed—by government, businesses, or individuals—there is a bond holder somewhere expecting to be paid back.

Now, of the two, of borrowers or lenders, who would it be that contributes to politicians campaigns? Who would have the most say over the direction regulators take?

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