By Patrick A. Heller
Commentary on Precious Metals Prepared for CoinWeek.com …..
Let me present two examples that may help you better understand what inflation of the money supply (now called quantitative easing by the US government) does to the economy.
First, picture in your mind an economy that has a particular quantity of goods and services and a particular amount of currency. Now, double the amount of currency without any change in the quantity of goods or services. In this economy, are the people any better off?
Of course not.
For the second example, think of this same economy with a particular quantity of goods and services and a particular amount of money. Now, imagine that through gains in productivity and innovation that the quantity of goods and services has doubled while the amount of currency is unchanged. In this situation, would the people be any better off?
Absolutely they would.
If you think about just these two examples, I believe you will come to understand that it is the supply of goods and services that determines wealth, not the size of the money supply. Further, it is the supply of goods and services per capita that is most important because populations change. As long as the quantity of goods and services increase faster than the population, the economy will prosper.
The absolute size of the money supply does not represent the wealth of the economy. However, changes in the money supply do influence the actions of people. Let’s look at what happened in American history for examples.
From early American history up into the late 1920s, the general trend in America was for the available supply of goods and services to increase faster than the rise in the population. This did not occur because people toiled longer hours. Instead, technological innovations and the use of tools multiplied the results of worker’s time. These innovations were encouraged in a land where people were free to benefit from the fruits of their labors. In general, and with a number of temporary exceptions, as people became more prosperous prices declined. This happened because the increase in the money supply lagged the increase in goods and services that were produced. Financial writer Peter Schiff estimates that the purchasing power of a US dollar roughly doubled during the 19th Century.
Then we come to 1913, the year when the Federal Reserve was established.
Initially, the Federal Reserve’s mission was mostly to keep its hands off of the economy. It pretty much restricted itself to supplying bank clearing and other services to banks.
When the Great Depression hit in 1929, the purpose of the Federal Reserve expanded, eventually becoming an integral part of government policy. Today, instead of just providing services to banks, the Federal Reserve sets interest rates to “stimulate” the economy, and helps bail out troubled banks rather than let them suffer the consequences of their mismanagement.
Perhaps worst of all, the Federal Reserve inflates the money supply without any regard as to its effect on the economy. When the US economy is expanding, the Fed inflates. When the US economy is contracting, the Federal Reserve inflates the money supply even more. In general, not since the 1920s has the Fed genuinely contracted the money supply.
The inflation of the money supply leads to distortions in the economy. Those who receive extra funds early, such as the US government, are able to purchase goods and services before prices rise. The last people to receive greater cash flow, and most retirees fall into this group, see their expenses rise before they benefit from receiving more money.
Since the Great Recession of 2007 to 2009, most of the massive inflation of the US money supply has gone onto the balance sheets of banks or into investment funds. The extra funds that the banks received have mostly been loaned right back to the US Treasury or Federal Reserve. In this manner, the inflation of the past several years has mostly benefitted banks, especially the largest US banks, and the US government.
The investment funds used their money infusions to bid stock prices higher and higher, often without regard to profitability and financial well-being of the underlying companies.
Today, the Federal Reserve is trapped, with no way out. The Fed could continue as they have in the past few years by inflating the money supply by well over one trillion dollars per year. The way these funds get dispersed will mean that the large banks will get even larger as they keep loaning these new funds back to the US government and that stock prices will continue to rise as companies are valued at greater multiples of profitability. Like it or not, the US government is using these results to pretend that the American economy is recovering.
But, such inflation cannot continue forever, as the experience of Germany’s Weimar Republic after World War One or Zimbabwe within the past decade prove. Eventually, the inflation of the money supply soars to such high rates that the economy crashes.
On the other side, if the Federal Reserve now tried to just slow down the inflation of the money supply, much less go all the way to contraction of the currency, the US government would lose a major source of funding its budget deficits and the American housing market and stock prices would collapse.
This is why I say that the Fed is trapped. It can either trigger a collapse of the American economy now or even worse later. There is no alternative left that enables the economy to grow and create jobs without first going through a lot of financial pain.
Last week, I explained how my expectations were that the Federal Reserve would not “taper” its quantitative easing program at last week’s meeting. Let me now further stick my neck out again and predict that politicians will almost certainly not only continue the current program of inflation of the money supply but that they will eventually expand it further. There may be a brief period where the Fed pretends to reduce quantitative easing, just as the earliest of these programs came to short-term halts. But this “reprieve” won’t last long.
The end result, whichever way the Fed goes, is for the US dollar to fall in value to gold (and silver). The Federal Reserve has long since passed the point of no return, where the US dollar could have been saved.
Patrick A. Heller was honored with the American Numismatic Association 2012 Harry J. Forman Numismatic Dealer of the Year Award. He owns Liberty Coin Service in Lansing, Michigan and writes Liberty’s Outlook, a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Numismaster ( under “News & Articles) and at CoinInfo. His award-winning radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com. He is also the financier and executive producer of the forthcoming movie “Alongside Night” (trailer posted at http://www.youtube.com/watch?v=sTZ8vn45Cds).