Tuesday, May 19, 2009

The inflation solution

There is a situation developing that I believe is inevitable, that people should be aware of, and that the government will not tell you about. It's not a conspiracy. It's just very unpleasant, very unfair and unavoidable. They have to maintain "plausible deniability". That is, when it comes to pass, they have to be able to claim they didn't see it coming, or better yet, blame it on the other party. The good news is, as painful as it may be, it will not be the end of the world as we know it.

I'm referring to inflation. Not garden variety inflation, but hyper-inflation. The government currently owes about 8 times what it collects in revenues in a year. This year, they will spend more than twice what they take in, further adding to the debt. That's like a household that takes home $50,000/year after taxes, carrying $400,000 in debt and adding more than $50,000/year in additional debt. Such a household would eventually declare bankruptcy. The government doesn't have that option. There is no entity large enough to absorb a $12 trillion loss on our behalf. Raising taxes would result in a smaller number of people paying higher tax rates on less income. The net return to the Treasury would actually fall. That's not going to work. We could drastically cut government spending, but we already have so much mandatory spending in the form of entitlements already owed, that that's not a workable solution either. The final option, the only one left, is to devalue the currency to the point that $12 trillion is no longer a big number.

Here's how it works. Let's go back to our $50,000/year household. Now let's assume that their income keeps up with inflation and that they are able to stop or slow their accumulation of new debt. Now inflation goes ballistic; let's say 1,000% in a year. Now the household income is $5 million/year and the debt is still around $400,000. Their financial situation is much more manageable. Sure, a loaf of bread now costs about $1,000, but as a percentage of their income, it's about what it was last year. That's the government's out, although you will never hear them say it out loud. I don't know exactly when, but it's going to happen because there's no alternative.

Of course most people's income will not keep up with inflation. Therein lies the pain and the injustice. Under such a scenario, people on a fixed income and people who cannot simply demand a raise and get one, would essentially experience a cut in pay every payday until the inflation cycle is over. None of this was their fault, yet they will take the brunt of the damage. That's why you will not get "fair warning" from the government.

The good news is, hyper-inflation can come and go relatively quickly. Eventually, the government's balance sheet will become sustainable and the money supply will be brought back under control. Wages and prices will adjust and we can move forward again. It's a bit like discovering that the only way to get back to the tropical beach is by wading through a half mile of four foot deep hot tar. It's not going to be pleasant, but we'll get there, because that's where we want to be. In the meantime, we can face what's coming without fear, do everything we can to ensure everyone makes it across and it would be helpful if our elected and appointed officials would quit blowing smoke and treat us like full grown adults, capable of handling the truth.

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