This is the growth of the Monetary Base, as reported by the Federal Reserve Bank of St. Louis. As you can see, the money supply has grown steadily over the years. But in the past 18 months it has more than doubled.

What are the implications of this?

The title refers to the creation of the US Federal Reserve Bank, which took place at a then-secret meeting in 1910 (later confirmed by the participants), at a resort on Jekyll Island, just off the coast of Georgia.

Most of us grew up thinking of the Federal Reserve as a quasi-government organization that helps stabilize our money supply. How it does that is often a bit of a mystery, although it involves interest rates, and possibly reserve requirements. And it isn’t always clear what the relationship is between the Federal Reserve and the US government.

Griffin argues that, in point of fact, the Federal Reserve is a private cartel created by the banks, with the sole purpose of maximizing bank profits. Inherent in its design are the seeds of periodic financial disaster (and inevitable, eventual collapse), which result in a massive transfer of wealth from depositors and taxpayers to bank executives. This is not an accident; it is the way the system is designed.

While this may seem an extreme view, Griffin’s evidence is undisputed, his logic is sound, and his arguments are highly convincing.  Much of the banking system which is ordinarily difficult to understand becomes extremely clear and transparent when viewed through this lens.

It’s a pretty ignominious accomplishment. And since the year is not yet over, and the US continues to spend, the debt is continuing to pile up. Based on current spending projections, this year’s debt is expected to hit nearly $2 Trillion by October.

How much is $2 Trillion? It’s about $6,500 per person in the US. For a family of four, that’s about $26,000 in debt accumulated this year.  That’s on top of all previous debt, as well as any consumer or household debts.

But does it really matter? It isn’t like the taxpayers will ever have to pay this debt, right?

Wrong.

The US government’s credit rating is so good it is considered “risk free” by most of the world. The people who loaned the US this money absolutely expect to be paid back. If they are not, it will rock the worldwide financial markets so strongly it will make the recent financial crisis look tame by comparison.

The only ways the US government can pay back that debt are 1) by raising taxes and / or lowering spending, or 2) by devaluing the US dollar through inflation. Higher taxes means less money to hire employees, and less money for those employees to take home and spend.  Inflation makes the dollar worth less relative to other commodities, goods, or services. But while it makes the US debt effectively smaller, it also lowers the value of everyone’s existing savings, investments, and retirement funds.

Given the politics of Washington, DC, which do you think is the more likely scenario?

Inflation is one of the least-understood concepts in economics.  And with good reason: in the US, we haven’t seen terrible inflation for the last couple of decades, so it hasn’t been all that important.

But we’re starting to see it now.

The Silent Tax

Inflation is a tax.  But it’s the tax you never voted for.  Inflation is the result of the government creating more money, then using the excess money to pay their bills.  If the government does this a little, you don’t really notice it.  But if they do it a lot, pretty soon there’s a lot of extra money floating around.  And money is like any other commodity: if there’s more of it, it goes down in value.

Think of the creation and destruction of money as a balancing act: money gets destroyed all the time, and so it needs to be replaced with new money.  Likewise, as the population increases, money needs to be created so that there is sufficient money to go around.

The tax effect of inflation is a funny one to understand.  After all, if everyone has more money, then did anything really change?  If everyone who had $1 were suddenly given another $1 to match the first one, and this all happened at the same time, nothing really would change.  Prices would double, but everyone’s relative wealth would remain unchanged.

But that isn’t how inflation works.  What really happens is that the money is created and paid to people who work directly for the government – as employees, contractors, or whatever.  So those people have money which previously did not exist, and they can use it to buy things that they previously could not afford.  The money works its way out from the government into the marketplace.  The farther you are down that chain – i.e. the farther you are from the government – the longer it takes the extra money to reach you.  In the interim, other people are able to buy goods and services using the new money.  Its worth noting that the money also dilutes as it moves farther from the government, so the effect diminishes, and is not as obvious to see.

So in a sense, the inflationary tax is really a tax on being less dependent on the government, and farther into the marketplace.  People closer to the government are the recipients of this tax; people farther from it, the payers.

Unfortunately, the US Government has been borrowing an extraordinary amount of money from other countries.  Sooner or later, they have to pay that money back.  One way the government has dealt with it in the past is to simply borrow yet more money, and use the new debt to pay off the old.  And this actually works, as long as the population of taxpayers is increasing at about the same rate as the acquisition of new debt.

The Baby Boomers

But now we have a problem, and it relates in part to the Baby Boomers.

You see, we’ve been increasing our debt level faster than the typical growth of new taxpayers.  The Baby Boomers represent a huge population bubble.  So as the Baby Boomers retire and start to draw money out of the system through social security, medicare, and other social services, they aren’t being replaced by new taxpayers fast enough to keep the system afloat.  This means either a dramatic reduction in social services for the Baby Boomers, or, more likely, a dramatic increase in borrowing to finance the Baby Boomers’ lifestyles.

And unfortunately, a dramatic increase in debt, on a per-taxpayer basis, is unsustainable.

One way to reduce that debt is to pay it using newly created money.  The US Government prints more money, uses it to pay down the debt, and voila!  Debt paid off!

But that means there’s more money floating around, and that means inflation.

Prices Adjust for Other Reasons, Too

Unfortunately, many people mistakenly think that rising prices are automatically inflation.  They are not. Prices fluctuate all the time – particularly prices of commodities such as oil, rice, corn, and copper.  A bad weather cycle can reduce crops, raising prices of certain food groups.  That is not inflation, that is simply the market working to adjust supply and demand.  Likewise, political, environmental, and technological factors can cause a rise or fall in energy prices, which in turn affect the prices of many other goods and services.  But that is also not inflation; it is the market setting prices to do what markets do best: namely, allocating scarce resources to the most valuable purpose.

Signs

Here as some signposts we might expect to see if inflation is coming:

• A significant rise in core commodity prices across the board that cannot be tracked back to a single set of issues.
• An decrease in value of the US Dollar relative to other world currencies.
• An increase in salaries and wages, particularly when coupled with a falling dollar.
• A continual “redefining” of inflation to eliminate items whose prices are rising most dramatically (in an effort to reduce the visibility of inflation).
• A continual “redefining” of the money supply to make it look like it isn’t increasing faster than the population.

Sometime in the future we’ll compare the official US government inflation rates with some calculations by an independent organization.