Gold News

Engines of inflation

Central banks only exist to inflate the money supply...

WHETHER it be the US Fed or Bank of England, the sole purpose of central banks is to inflate. They are the engines of inflation.

   At the same time, central banks also understate the ongoing inflation problem and manage the public's fears. Therefore, in order to protect your wealth in this era of constant inflation, it is essential that you fully define and understand inflation.

   You need to distinguish, in other words, between "cause" and "effect".

   Most people today have been conditioned to believe that inflation is an increase in prices. This increase, they think, is captured by the official "Consumer Price Index". However, the truth is that inflation is an increase in the quantity of money and credit. And as the supply of money and credit are inflated (the cause), prices of goods, services and assets also rise within an economy (the effect).

   How does this work? Any over-supply of an item will cause its value to diminish due to over-abundance. For example, a bumper crop of wheat will cause wheat's market value to decline. On the other hand, a poor harvest of wheat will cause its market value to rise.

   Similarly, a constantly increasing quantity of money and credit available within an economy means that its value will diminish. In other words, the purchasing power of each unit of money will dilute, requiring more and more quantities of money to purchase the same amount of goods, services and assets.

   This "confiscation" of purchasing power is the No.1 consequence of inflation. But monetary inflation has another dire consequence – it does not affect everybody in a uniform manner.

   Thus inflation causes a great and widening wealth-divide. Those who get access to this newly available money first, and most importantly BEFORE the remaining population, gain the most. Their incomes rise prior to any increase in the price of the items they buy.

   In contrast, impoverished people in the remote reaches of the economy – yet to receive the new money – get robbed. They find that prices have already risen before the new money has a positive impact on their incomes.

   Furthermore, inflation also causes grave economic distortions. As this ever-expanding supply of money spreads through the economy, it causes gigantic "asset bubbles". The inevitable busts result in much hardship and wealth destruction for the majority of people. The most recent example is the sharp 10% intra-day decline in Chinese stocks.

   So, if inflation is such a menace for society, why do the central banks continue with their inflationary program? And why do they claim that they are fighting inflation?

   Banks are in the business of lending money in exchange for interest. The more credit they create, the greater their income through the collection of interest. Under "normal" circumstances – and for as long as the public is not worried about inflation – banks continue to inflate. However, for this immoral system to work and be accepted, the public must remain oblivious. Hence the constant official propaganda of fighting inflation.

   Occasionally, a situation arises whereby the public panics about their loss of purchasing power. This causes people to start exchanging their paper-money savings for tangible assets. Under these circumstances, banks momentarily stop their inflationary program and raise interest-rates to show they are indeed "fighting" inflation; a monster which they themselves created in the first place!

   This scenario occurred in the late 1970s, when Americans started dumping their US Dollars in exchange for gold and the Federal Reserve had to intervene by substantially raising interest-rates.

   If you still have any doubts about the constant inflation agenda, you may want to note that despite the highly advertised recent monetary "tightening", US bank credit has continued to surge and currently stands at a record $8.4 trillion. In fact, US bank credit rose 9.4% over the past year which is close to the record-high annual growth rate of 11.2% recorded in December 2005.

   Furthermore, our planet is still awash in a sea of inflated "paper money". Non-gold international reserves held by non-US central banks are also at a record-high ($4.92 trillion). Emerging nations hold a record-high $3.52 trillion and the industrial nations hold $1.4 trillion. It is interesting to note that China's reserves alone have soared to over $1 trillion, whereas Japan's reserves are now around $880 billion with no signs of a slowdown in sight. Finally, Asian central banks (excluding China and Japan) own another mind-boggling $1.17 trillion of paper money.

   This ever-expanding quantity of money and credit may eventually contract. However, in the meantime, central banks have plenty of methods they could use (if required) to flood the world with additional supplies of Dollars, Euros, Pounds or Yen.

   In a world of inflated asset-prices, precious metals, energy and agricultural commodities are still inexpensive in real terms – and especially inexpensive relative to the price of financial assets today.

   Furthermore, given the massive Chinese demand for natural resources and tight supplies, I believe that this sector will continue to be the biggest beneficiary of monetary inflation over the coming years.

Puru Saxena is the editor and publisher of Money Matters, an economic and financial publication run from Hong Kong. He is a regular guest on CNN, Bloomberg, CNBC, RTHK, NDTV and TVB Pearl, as well as featured writer for the Hong Kong Economic Times, South China Morning Post, Benchmark Magazine, and The Daily Reckoning.

See the full archive of Puru Saxena articles.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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