Thursday, April 9, 2009

The Coming Collapse of the Dollar

Most Americans hear about inflation on the news and they really don't understand much about it, except that it is associated with rising prices. Rarely, if ever, does a news report explain why prices rise, and thus mischaracterize its meaning.

Inflation is actually an increase in the supply of money. It can happen naturally, like say for instance if a factory opens up in a local town and creates jobs, thus increasing the local supply of wealth. More commonly, especially as more and more of our production jobs are shipped overseas or simply collapse and fail, inflation is generated by the Federal Reserve and its printing press.

The reason inflation causes a rise in prices is simply relative to the law of supply and demand. Resources are always scarce, so a higher demand creates scarcity which drives up prices. More wealth, in general, increases demand and so prices must rise. In our local town, this wouldn't be so painful, since the inflation would generally be associated with a rise in the standard of living. But when generated by the Fed, this wealth arrives first into the hands of already wealthy elites favored by the government, such as banks, health care giants, and the military industrial complex (Boeing, Halliburton, etc). Of course eventually this money gets passed on and distributed throughout the rest of the economy, but by the time it affects the average person prices have already risen and it does none of us much good to receive it. Inflation is a hidden tax on middle and lower class Americans, especially those on fixed incomes. So when the Fed announces it has created a trillion dollars out of thin air, this should concern us far more than it general does, because so few of us understand economics. What's sad is, it's not as difficult to understand as they lead you to believe, and certainly not as boring (you're being ripped off - how can that be boring?!). But I digress.

What should concern us all in the midst of this crisis is China and other foreign countries like Russia and the oil producing gulf states that purchase our debt. When we borrow money off them, they purchase a treasury bond. When the bond matures, we have to buy it back with interest. But since we produce so little of value we have little recourse but to borrow more money just to pay off our previous debt. This is why Secretary of State Clinton went to China: to beg them not to cash in our treasury bonds and pocket the money.

But the day will soon come when China figures out its workers are merely slaves to the American consumer, because the wealth they actually produce is loaned out to Americans just so we can buy the products they make. And China will cash in our treasury bonds and they'll want a straight up payment, and we're not going to have a way to pay them, considering our massive spending and budget deficits, except to either drastically raise taxes, and not just on the wealthiest 2% or whatever, but on every American who actually still has a job at that point, or, more likely, they'll just print it up at the Fed, which will increase the money supply and weaken the dollar further. In fact this has already started to occur - the trillion dollars the Fed just created was used to buy, among other things, treasury bonds. Not only does this weaken the dollar, but it will precipitate a flight from the dollar that will prove fatal to our economy.

And there will come a day when Americans cannot afford to buy basic necessities because our currency will be worthless. The government, in typical government fashion, will attack the symptoms of the inflation and not the cause. They'll implement price controls, oblivious to the law of supply and demand, which will create shortages, because nobody is going to want to sell anything they can't actually make a profit off of. From then on you can only imagine the horrors that will ensue, as Americans continue to lose the ability to support themselves and their families. One way or another we are all going to realize, through much suffering, that a fiat economy can only lead to ruin.

This may sound like some ridiculous scenario that only happens in other countries, or that society has progressed to the point where these kinds of things are impossible. But the laws of economics do not evolve over time, nor is America invincible to the consequences of trying to overcome economic law, and neither does the market care if it destroys America or Zimbabwe or the Wiemar Republic, etc. All the rousing rhetoric of hope, all the adoring throngs of fans, all the chest-thumping American triumphalism, will be humbled before the market. And having foreknowledge that that day will come gives me little solace. I am very fearful of the suffering they are going to cause. If you don't care, if you're not interested, you should be.