Below is an
excerpt from a commentary originally posted at www.speculative-investor.com on 10th January, 2010.
A deliberate policy, not the natural way
US Federal Reserve ("the Fed") was created in 1913. All the shares
of the Fed are owned by private banks (every bank operating within the
Federal Reserve system must have equity in the Fed), so it can be said that
the Fed is privately owned. However, the shares held by the private banks
confer almost none of the normal ownership privileges, and control of the Fed
is almost completely within the hands of the US Government. It is therefore
more accurate to consider the Fed a government agency -- an agency that
operates for the benefit of the government and the banks.
Fed's main achievement during its existence has been massive inflation of the
US dollar supply, the bulk of which occurred after the loosening of the 'gold
shackles' in 1934. And one of the most obvious effects of this monetary
inflation has been a 95% decline in the dollar's purchasing power (one dollar
today buys roughly what 5c bought in 1913). Furthermore, the loss of
purchasing power has transpired in such a relentless fashion that almost
everyone now perceives rising prices to be the natural way of things. Few
people realise that during the 100-year period prior to the Fed's creation --
a period during which the US economy made exceptional progress -- the dollar
lost none of its purchasing power.
reality is that a long-term DOWNWARD trend in prices is the natural way of
things in a FREE economy. In the absence of government manipulation of the
money supply, prices will naturally fall over the long-term due to increasing
productivity. This means that in the absence of government manipulation of
the money supply there would be no need for a person to speculate in order to
secure his/her financial future. A person could simply save cash, safe in the
knowledge that the cash will buy at least as much in the future as it does in
the present. In other words, monetary inflation forces everyone to become a
speculator, an endeavour at which some will succeed and most will fail.
smart people are presently anticipating deflation. We certainly see the
appeal of the deflation view given the present economy-wide debt burden, but,
unfortunately, such a view flies in the face of both logic and history (the
history of the past 75 years and the history of the past 15 months). We say
"unfortunately" because a period of deflation is needed to
establish the foundation for a sustainable economic expansion, whereas more
inflation will only make a terrible situation even worse.
than deflation, chances are that the US government, via its tool known as
"the Fed", will continue to borrow and spend enough new money into
existence to more than offset the private sector's desperate attempts to
repair its collective balance sheet. In the process they will probably end up
eradicating much of the remaining 5% of the dollar's purchasing power.
in the past has the choice of monetary aggregate (TMS, M2, M3, etc.) been so
important, because rarely have there been such large differences between the
rates of change of the different money supply measures. For example, the
following chart reveals a dramatic divergence over the past 12 months between
the year-over-year (YOY) growth rates of M2 and TMS, such that we now have
M2's YOY growth rate at a 10-year low at the same time as TMS's YOY growth
rate is near a 10-year high. Moreover, some measures of US money supply --
most notably, the M3 calculation at http://www.nowandfutures.com/key_stats.html and Frank Shostak's AMS calculation --
currently show outright monetary deflation!
TMS diverges markedly from M2 and M3 we can be confident that TMS reflects
the true situation. The reason is that M2 and M3 have components that are not
money, and when divergences occur they are caused by changes in the
non-monetary components (Money-Market Mutual Funds and Time Deposits,
primarily). The current situation contains an additional complication,
though, because TMS has also diverged markedly from the Austrian Money Supply
(AMS) calculation done by Frank Shostak. As discussed in the 21st December
2009 Weekly Update, this particular divergence is mostly due to the treatment
of the US Treasury's Supplementary Financing Program (SFP). Specifically, Dr.
Shostak's decision to treat the SFP account at the Fed as "money"
distorted the year-over-year numbers in his AMS calculation by creating a
huge upward spike in money-supply growth during September-November of 2008
and then a plunge in money-supply growth as the program was unwound during
reason we are harping on this subject is that over the next few months you
will very likely read articles in which money-supply charts are used to
'prove' that DEFLATION is occurring and other articles in which money-supply
charts are used to highlight an INFLATION problem. It is important to
understand how such contradictory conclusions could be drawn about something
that should be straightforward.
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