Inflation May Follow Recovery

Many people believe higher inflation is just around the corner, especially with the U.S. government flooding the market with new money. It’s worth keeping a keen eye on several factors that could ignite inflation.

More good news is finding space on the financial pages as the global economy continues a slow recovery.

World trade flows have been rebounding, and business inventories continue to decline. Even unemployment, a lagging indicator of economic upturn, appears to have peaked and is showing signs of improvement.


But the 12 regional banks of the U.S. Federal Reserve have supported the recovery by printing more and more money. Many economists believe this may lead to another round of inflation similar to what happened in the 1970s.

Inflation is a sustained increase in the general level of prices for goods and services. With the huge debt our government has created (in excess of $10 trillion!), many investors believe the value of the dollar is declining.

Forces Feed Beast

Nobel Prize Economist Milton Friedman (1912-2006) defined inflation as “too much money chasing too few goods.” For the last decade or so, however, inflation has been unusually low. And, until very recently, there has been too little money chasing too many goods.

Historically, inflation doesn’t suddenly appear as a beast out of thin air. There are three different forces that drive inflation.

The first requirement is a surge in demand in an overheating economy.

In an overheating economy, the government, corporations and households try to buy more goods and services than can be produced, trending prices higher. That’s not a problem right now since there’s plenty of slack in the global economy. The world’s factories are running well below capacity.

Inflation also requires a significant increase in consumer income. High employment has kept wage increases well below their long-term average. A big increase in wages will not likely occur until there is full employment.

The third requirement is an increase in the money supply and credit growth. The Federal Reserve’s historic money supply increase has certainly stoked inflationary fears.

But WMB believes it will take more than the Fed pumping money into the system to ignite inflation.

Banks must also open the floodgates of credit. To date, we still are not seeing an easing of bank credit. Banks haven’t increased lending levels to their pre-crash highs and many are still recovering from their last credit binge.

Looking Ahead Now

All three factors – demand, wage growth, and money and credit growth – must rise simultaneously for inflation to take hold, according to most financial experts.

That’s only likely to occur only after we’ve had a full recovery and a complete healing of the financial system.

WMB believes that although there has been recent growth in our economy, a full recovery is still far down the road. And, a full recovery of the banking system is likely even further away.

But the borrowing continues, and policy makers may be tempted to take the easy way out by printing new money, which could fuel inflation worries.

WMB believes that over the near term, a small increase in inflation wouldn’t be entirely unwelcome — it would be a sign the economy has finally recovered. Higher inflation may or may not hit us hard at some point in the future.

In the meantime, we should continue to keep all eyes focused on the 800-pound gorilla known as inflation. Feed it too much and suffer the consequences across the board, from industry to consumers.

This post is by TechMan, WMB co-author who blogs about trends, issues and ideas affecting industry, business, technology and consumers. If you like this post, please share it.

The Fed Spins Big Financial Web

Whether it’s Alan Greenspan or Ben Bernanke, the markets pay close attention when the chairman of the Federal Reserve, the central banking system of the United States, has something to say.

The Fed says it's worried about the weakness of the U.S. recovery and is ready to take further steps to boost the economy if needed, the Associated Press reports. Fed officials also say they are concerned that sluggish economic growth could prevent prices from rising at a healthy rate.

But the Federal Reserve Board of Governors announced no new steps to try to boost the economy and decrease unemployment. Instead, the panel hinted that it's prepared to see if the economy can heal on its own, according to Jeannine Aversa, AP Economics Writer.

Tuesday’s Fed session was the last for the chief policymaking group before the Nov. 2 midterm elections, with voters clearly focused on the battered U.S. economy and the jobs crisis, Aversa notes.

To fully grasp the Fed’s key role today, one must look to its controversial roots in the past, specifically to a secret meeting on an island off the coast of Georgia.

The Federal Reserve System was formed in 1913 with the enactment of the Federal Reserve Act, and was largely a response to a series of financial panics, particularly a severe panic in 1907, according to Wikipedia.


Over time, the roles and responsibilities of the Fed have expanded and its structure has evolved. Events such as the Great Depression of the 1930s were major factors leading to changes in the system.

The Fed's duties today are to conduct the nation’s monetary policy, supervise and regulate banking institutions, maintain the stability of the financial system, and provide financial services to depository institutions, the U.S. government, and foreign official institutions.


The Federal Reserve System’s structure is composed of the President-appointed Board of Governors (or Federal Reserve Board), the Federal Open Market Committee, 12 private U.S. member banks, and various advisory councils.

The FOMC is the committee responsible for setting the monetary policy and consists of all seven members of the Board of Governors and the 12 regional bank presidents, though only five bank presidents vote at any given time.

The division of responsibilities of the central bank falls into several separate and independent parts, some private and some public. The result is a structure that is considered unique among central banks. It also is unusual in that an entity (the U.S. Department of the Treasury) outside of the central bank creates currency used.

According to the Board of Governors, the Federal Reserve is independent within government because “its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government.” However, its authority is derived from the U.S. Congress and is subject to congressional oversight.

Additionally, the members of the Board of Governors, including its chairman and vice-chairman, are chosen by the President and confirmed by Congress. The government also exercises some control over the Federal Reserve by appointing and setting the salaries of the system’s highest level employees. Thus, the Federal Reserve has both private and public aspects.

The U.S. Government receives all of the system’s annual profits, after a statutory dividend of 6% on member banks’ capital investment is paid, and an account surplus is maintained. The Federal Reserve transferred a record amount of $45 billion to the U.S. Treasury in 2009.

The controversy behind the Fed is spelled out in G. Edward Griffin’s "The Creature From Jekyll Island." Griffin(upper right) writes that the basic plan for the Federal Reserve System was drafted at a secret meeting in November 1910 at the private resort of financier J.P. Morgan (1837-1913) on Jekyll Island off the east coast of Georgia. The seven attendees represented about 25 percent of the world’s wealth at that time.

Griffin writes that all the money in the banking system has been created out of nothing throughthe process of making loans. A defaulted loan, therefore, costs the banks little of tangible value, but it shows up on the ledger as a reduction in assets without a corresponding reduction in liabilities. If the bad loans exceed the size of the assets, the bank becomes technically insolvent and must close its doors.

The first rule of survival, therefore, is to avoid writing off large, bad loans and, if possible, to at least continue paying interest plus fresh funds for new business.

The final solution on behalf of the banking cartel is to have the federal government guarantee payment of the loan, should the borrower default in the future. This is accomplished by convincing Congress not to do so would result in great damage to the economy and hardship for the people.

From that point forward, the burden of the loan is removed from the bank’s ledger and transferred to the taxpayer. Should this effort fail and the bank be forced into insolvency, the last resort is to use the Federal Deposit Insurance Corp. to pay off the depositors. The FDIC is not insurance, because the presence of “moral hazard” makes the thing it supposedly protects against more likely to happen.

A portion of the FDIC funds is derived from assessments against the banks. Ultimately, however, they are paid by the depositors. When these funds run out, the balance is provided by the Fed in the form of freshly created money.

This pours through the economy and causes the appearance of rising prices but which, in reality, is the lowering of the value of the dollar. The final cost of the bailout, therefore, is passed to the public in the form of a hidden tax called inflation.

WMB believes that we, the taxpayer, ultimately pay for the manipulations as evidenced by both the government and the banking system. The taxpayer must foot the bill of the usually ill-conceived gyration created in our present monetary system.

The bottom line: We don’t have fiscal control as a country. All one can do is to follow the trail of money or debt to understand where the geopolitical tensions of the world exist. It’s a simple equation, not fuzzy math, but it has consequences for our wallets.

This post is by TechMan, WMB co-author who blogs about trends, issues and ideas affecting industry, business, technology and consumers. If you like this post, please share it with family, friends and colleagues.