If you pay much attention to the financial news, you will hear how we (meaning Americans) don’t want to end up like Japan of the last 10 or 20 years.  If the American economy, in the next ten years, is like Japan’s economy of the last ten years, we will be lucky.

We hear that Japan has been trapped in a deflationary spiral that it can’t get out of.  First, it is hard to call it deflation.  There have been a few times where the price index reports show a slight drop.  Basically, Japan has experienced stable prices over the last couple of decades.

But even if Japan really did have deflation (monetary or price), it is a myth that it is trapped.  The Japanese government has had some horrible policies in the past.  It has done its fair share of stimulus packages and the debt to GDP ratio is near 200%, bigger than any major country.  The one thing it hasn’t done is gone crazy creating money out of thin air (at least relatively speaking).

Any central bank that wants to avoid a “deflationary spiral” can do so.  The Federal Reserve or any central bank can buy assets at any time.  The Fed could buy more bonds.  That is the most typical method.  It could buy mortgage-backed securities as it did in 2008.  It could buy stocks.  It could buy baseball cards and used furniture.  Bottom line, the Fed can create money out of thin air any time it wants.  It doesn’t do this because it could eventually lead to hyperinflation.  The Fed is walking a tightrope right now, but it can cause high price inflation at any time.  Bernanke has said so himself.  The Fed just has to credibly threaten to dramatically increase the money supply.  It could also force banks to lend.

The purpose of this commentary is not to predict inflation, but just to make you aware that the Fed and any other central bank can inflate at any time.

It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so.
~Mark Twain

This site is to help you not do things as much as it is to help you do things.  It is always amazing how you can give a set of facts to ten different people and they will all come away with something different.

Investing is difficult.  You should know what you are doing and what your risks are.  There are so many people that will read a particular story or look at some data and think that they have an investment that can’t go wrong.  If you think it is impossible for it to go wrong, it will.

If there is one thing you should take away from this site, it is that you can’t predict the future with certainty.  You can take good guesses and manage your risk accordingly.  If you study the Austrian school of economics, you should know that the market is made up of millions of people acting according to their own wants and needs.  It is impossible to predict the behavior of everybody.  It is almost impossible to predict the behavior of just one person, even yourself.

Remember that economics is really the study of human action.  Perhaps you are certain that interest rates should go up or that gold should go to $5,000 an ounce.  But you can’t be certain and you should realize that it is impossible to predict with absolute certainty.  The rest of the people on this planet may act differently than you expected.  You should take this into account when you invest your hard-earned money.

There is a lot of talk about the Bush tax cuts.  The “Bush tax cuts” has this name for the same reason that “Obamacare” has its name.  Bush spent a lot of time promoting these tax cuts (even though they were only temporary).  It was probably the only significant thing that Bush did during his presidency that libertarians can compliment him on.

The debate now is whether the tax cuts will be extended.  They are set to expire at the end of the year.  The question is whether they will be allowed to expire or perhaps expire for just the “top one percent”.  This will only get more coverage as we get closer to the end of the year.

While the debate is not completely irrelevant, there is too much weight put on it by both sides.  The Republicans act as if the economy will be destroyed if they aren’t extended.  They might be right, but the economy is in ruins due to many other factors, many of which can be blamed on past spending by Republicans.

The Democrats act as if the budget will all of a sudden be in balance if we can tax the rich.  It won’t.  It won’t even be close.  The supply-siders and the Laffer curve have it right on this point.  Raising taxes could actually lead to less taxes collected by the government.

While letting the tax cuts expire (for any group) would be harmful, it is not as significant as it sounds.  Tax rates were higher in the 90’s and it didn’t completely destroy the economy.  The spending levels and the Federal Reserve are far more significant issues.  Tax rates can go up and down like crazy, but as long as the government is spending 4 trillion dollars a year, we are still in trouble.  Anything not collected by taxes will be printed or borrowed.

In conclusion, while the tax rates are not irrelevant and we would certainly rather see them lower, it isn’t the big issue.  Keep your eye on the ball.  Watch overall spending and watch what the Fed does.

While it probably isn’t important to pay too close attention to the political scene, it is important to understand what is going on.  Politics affects how much and in what ways the government will take and spend your money.

It is looking more likely that the Republicans will win the majority in the House of Representatives in the fall election.  Will it have a big impact?  Probably not.

The Republicans will slow things down a bit.  Obama will not be able to hammer through legislation like he did with the “stimulus” or Obamacare.  But we will not see a reduction in spending.  The only things that can reduce spending at this point are economic laws and a citizen revolution (and both seem likely at this point).

Greece was somewhat forced to cut back on spending, although not nearly enough because it was bailed out by other countries.  But Greece is more like a state in the U.S.  It cannot print money.  It could only ask the other countries to print money since it uses the euro.  The federal government of the U.S. can print dollars.  That is why states have been forced to start making some tough decisions and to at least show some kind of concern for spending.  States don’t have a Federal Reserve.

This is why the U.S. government is out of control.  They don’t have to raise taxes directly.  They can keep deficit-spending because they can print money.  Until there are severe consequences imposed by the voters or until the laws of economics really kick in, there will be no significant spending cuts.  The Republicans will oppose Obama, but they will not control spending.  They already proved that from 2001 to 2009.

The U.S. dollar has been down quite a bit over the last several weeks.  It has had the effect of causing the U.S. dollar price of gold to go up.  But gold has not exploded and it will not explode until a major event happens or until price inflation becomes a more obvious threat.

It is always interesting to keep an eye on the dollar.  Just remember that you are comparing it to other fiat currencies.  Everything is relative.

If the U.S. economy hits another major downturn (which looks likely), then don’t be surprised to see the dollar strengthen as it did in the fall of 2008.  There is still a mindset that when there is fear in the economy, the place to go is to the U.S. dollar.  The tide will have turned when fear in the economy causes people to get out of dollars and into something that can’t be created out of thin air, such as gold and silver.

The stock market went down significantly today, a day after the Fed announced that it would rollover some of its previous purchases to buy government bonds.  The market decided a day later that it wasn’t all that good of news.  Of course, the stock market investors really wants to hear something more drastic from the Fed and they aren’t getting it right now.

Until the Fed announces something significant (like forcing banks to lend excess reserves), then we will likely continue to see stagnation or worse.  It looks like the only thing that will send stocks straight up at this point is some massive money injections (which we obviously don’t want).  Unemployment remains high and interest rates remain low.  People are scared and rightly so.  The government has created massive malinvestments in the economy and it isn’t letting the problem fix itself.  As long as the government continues to spend like crazy and bail out failed businesses, the economy cannot flush out all of the bad investment.

The Federal Reserve met today and announced that it would spend a relatively small amount of money buying more government debt.  The Fed is not sounding as optimistic as it did a couple of months ago.  After the announcement, the stock market recovered some of its losses and the interest rates on bonds went down further.  You can now get a 30 year fixed-rate mortgage for 4.5% or less.

While this announcement was not insignificant and it certainly symbolizes that the Fed is still worried about the economy, it was not a drastic move.  A drastic move would have been an announcement that the Fed would start forcing banks to lend their excess reserves.

This whole thing goes to show that hyperinflation will probably not happen.  The word hyperinflation is thrown around casually quite a bit these days.  Hyperinflation basically means the destruction of a currency.  In our modern world, with a high division of labor, hyperinflation could mean death and destruction if there are no competing forms of money at the time (as is the case now because of legal tender laws).

The Fed and the people working there may be stupid, but they aren’t that stupid.  They could force the banks to lend and all of this talk about deflation would go out the window.  We would see massive inflation in a short period of time.  The Fed is not ready to go there yet and it may never go there.  While the Fed tries to accommodate the politicians and the bankers, it probably will not risk destroying the currency.  If the Fed destroys the currency, it destroys itself along with it.

Prediction:  The Fed will inflate and we will see high price inflation, but just like the late 70’s and early 80’s, the Fed will tighten up and let interest rates rise.  We will see a worse recession/depression than the early 80’s.  We will not see hyperinflation.

If the above prediction is wrong and we do get hyperinflation, then the people at the Fed really are that stupid and we will all pay for it dearly.

The best way to hedge against inflation is to buy “stuff”.  You wouldn’t want to buy bonds or an annuity, as you will get paid back in depreciated dollars.  When you buy stock, you are buying a very small piece of ownership in a company.  Some of this represents buildings and other equipment that the company may own.  But buying stocks is certainly not a very good way to hedge against inflation.  In an inflationary environment, the economy may be in very poor condition and, hence, company profits also do poor.

Gold is still one of the best hedges against inflation.  In a mild inflationary environment, gold may not do all that great.  But if price inflation starts going at 10% per year or higher, gold will likely do well.  Not only will it keep up with the price increases, it will probably go up much higher in real terms.  If prices start going up at a 20% annual rate, you could easily see gold going up at 50% or 100% per year.  That is what makes it a great hedge.  You can have just 25% of your portfolio in gold and it will protect your entire portfolio from inflation as demonstrated in the above example.

There is also another way to hedge against inflation, and you may already do this a little bit.  It is not nearly as good as buying gold and it should not replace buying gold, but it is easy.  If you have some extra space where you live, you can buy things that you know you will use in the future.  Perhaps you are going to need a new appliance of some sort.  Maybe it is better to get it now before prices go up.

There are many bad things that Federal Reserve inflation causes.  It allows for big government politicians to spend more.  It causes boom and bust cycles.  The obvious bad thing is that it causes prices to rise.  You can buy things now instead of later when the price goes up.  This goes even for small things.

You obviously can’t buy milk right now that you are going to use next year, but there are a lot of things that don’t have near-term expiration dates.  You can buy toilet paper, razor blades, canned soup, soda, paper towels, soap, laundry detergent, etc.  All you need is a little extra space to store it.  If you see a good sale at the store, why not buy a few extra things if you have a little extra cash laying around?  Just make sure you use the FIFO method of accounting (first in, first out).  In other words, use the older stuff first.

Again, this isn’t to replace gold or anything else as an investment hedge.  But it could save you a few depreciated dollars in the future.  If you knew that dishwashing soap would cost 8 dollars next year and you can buy it for 3 dollars this year, why wouldn’t you buy a few extra now, especially if you have the money to buy now?

One topic that libertarians/Austrian economists discuss is the definition of inflation. Inflation is generally defined by Austrians as an increase in the money supply. This was the original definition of inflation. Now, when people use the term inflation, they are usually referring to a general rise in prices of goods and services. The statists have changed the definition over time to suit their agenda.

When inflation is defined as a rise in prices, then it is easier to blame big business, speculators, greed, etc., rather than blaming the actual culprit, the Federal Reserve. When inflation is defined as an increase in the money supply, then it is obvious that the Fed is to blame, since the Fed is solely responsible for creating money out of thin air.

It is important to differentiate between monetary inflation and price inflation when necessary. With that said, monetary inflation will usually lead to price inflation. The only thing that can offset an increase in the money supply is having the banks increase reserves (which is happening now) or to have an increase in the demand for money (which is also happening now). If people decide not to spend as much money, then prices could still go down or remain the same, despite an increase in the money supply. People might do this because they are fearful of the future or perhaps they expect the money supply to tighten up in the future.

It is also important to note that when there is price inflation, it is not necessarily uniform. From the late 1990’s to about 2006, prices were going up, but housing prices were going up much more. After that, housing prices went down (when the bubble burst) even though most other prices were not going down (think food).

If you are ever talking about inflation, make sure to differentiate between monetary inflation and price inflation if it is relevant to your discussion. Although they are often related, they are not the same thing.

It is always dangerous to make predictions. All we can really do is take our best guess based on the facts that we have. It really is amazing how many people make crazy predictions though and they are things that are completely beyond our control. It even happens with libertarians.

If you have a basic understanding of Austrian economics, then you should understand that economics is really a study of human action. Human Action is the name of Mises’ biggest and most famous book. You should understand that economic activity is made up of the decisions of millions of different people acting in their own way.

If we are going to make predictions, they should be reasonable. For example, if the money supply goes way up (and the money doesn’t sit as excess reserves at banks), then it is reasonable to predict there will be price inflation. But we should realize that this isn’t even a guarantee. It is likely, but not a guarantee. The money supply could double, but it is technically possible for the demand for cash to increase dramatically and for prices not to go up.

It is also reasonable to predict that politicians will continue to try to spend more and more money and make government bigger and bigger. It is generally a safe bet. But again, you are predicting the behavior of individuals. It is possible that a bunch of politicians will see the light and become honest and make government smaller. It is highly unlikely, but not necessarily impossible.

But then you get completely ridiculous predictions. There are predictions that we will have hyperinflation, or war with Iran, or a new world order, or a new currency in the next year. There wouldn’t be anything wrong with these predictions if the people making the predictions admitted that it is only their best guess based on the circumstances. But for some people to make it sound like it is an inevitability is crazy. If it were Ben Bernanke predicting hyperinflation, we might want to listen because he might be able to make it happen. But everyone else is predicting human behavior and they shouldn’t be so certain about their predictions.

If someone makes a prediction and says it like they are guaranteeing the outcome, you should think twice about listening to what they are saying. You can take a guess at human behavior, but you can never be certain.