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March 06, 2008

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Jim Fleming

In a now famous speech, current Fed chairman Ben Bernanke affirms his awareness that the engine of inflation is the printing press.

Here's what he said, "Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services" (Ben Bernanke. November 21, 2002).

Randy

It's interesting that speech was made in 2002 when the price of gold was around $300, and today it is close to $1000. Since gold generally moves inversely with the value of the dollar, that doesn’t speak well for the dollar. Also, isn’t interesting that the mainstream economists never seem to predict a recession until we are firmly established in one. Until that time arrives, they don’t predict anything beyond a 50%, which basically means nothing anyway. It’s like your physician telling you that you have a 50% chance of surviving a terminal illness in the next 6 months. The reality is it’s either 0% or 100%, but he’s not going to go out on a limb and tell you. There is one guy, however, I came across that seems to make a lot of sense with respect to the state of our economy, although his outlook is pretty grim. His name is Peter Schiff. You can do a Google search on him and get lots of info. Jim, you could easily be one of his financial disciples. Of course, I'm sure you could set him straight on more spiritual matters.

Alex Marshall

Interesting quote by Bernake. Thankfully, he is very much like Greenspan in that he is an inflation hawk. Given that the Fed effectively controls the money supply, he is likely to continue the policy of keeping pretty tight reigns on it to keep inflation low.

At the moment, my knowledge of economics doesn't cause me to be overly worried about our current deficit spending. The government has very often acted out of a deficit, as have many others. This is not inherently a bad thing, in theory, it should balance out. The deficit spending should stimulate the economy, which then increases tax revenues, which balances out the deficit. Not always worked out that way in practice, but generally economists say that a deficit that accounts for less than 5% of our GDP is fine. So far, the Bush administration's deficit spending has stayed in those boundaries (even though the numbers are enormous, other economic numbers are even more so, so percentages are far more helpful in analyzing this). What is far more worrisome to me is the looming retirement of the Baby Boomer generation, which not only threatens to increase deficit spending (because of entitlements) to about 15-20% of our GDP (which is larger than the entirety of government spending right now), but could also have very negative implications for our economic growth and employment. The effect of that is probably going to begin to be seen during the next presidential administration (assuming they are in office for eight years).

Randy

Yes, it is possible to inflate our way out of a deficit, that is to pay back loans later with money that is worth less, but it also causes lots of problems with the foreign countries who made the loans to begin with, not to mention you and me who may end up paying $5 for a gallon of gas and $10 for a Big Mac and fries! Unless real wages keep pace with inflation and there are wages to be had, this is what worries many about the huge deficit we amassing as a country. Without tough monetary policies to control inflation, the fall out will occur much sooner than when the Baby Boomers reach retirement.

Alex Marshall

There are a lot more factors at work with inflation than just the national debt. Overall inflation is basically a product of the amount of money in circulation (which can be affected by increases in wages, but thankfully is largely controlled by the Fed's monetary policy), the prices of individual products is primarily the result of supply and demand. For example, gas prices are increasing because of increased demand for oil. America guzzles gas at an incredible rate, and now we've got to compete with an ever-growing China for the gas (/oil) supply. The result in an consistently increasing price of gas. The only way that is going to change is if we decrease our consumption of gas, but that doesn't seem likely to happen until gas hits at least $5 a gallon many economists are saying.

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