Author: min S
If you ask the average working American, “How does the government transfer money from your pocket to its own?” I’d bet that at least nine out of ten would answer, “Taxes.” This is understandable since almost no attempt is made to hide taxes. We see taxes taken out of paychecks and added to our receipts at the store. In addition, we can’t possibly miss the fact that we must file tax returns every year.
But there is a second, much more insidious way that the government takes our wealth – inflation. Through inflation the government secretly confiscates vast amounts of wealth from its citizens. The amazing fact is, most of the victims never become aware of it.
Technically speaking, inflation occurs when the supply of money grows more quickly than production in an economy. If an economy produces ten percent more items this year than last, then the money supply could have also grown by ten percent and prices would have remained stable. But what would happen if instead the money supply doubled? To answer this question, we must recognize that the value of anything depends on its scarcity. Diamonds are valuable in part because they are very rare. Grains of sand are not rare at all and are, unsurprisingly, not very expensive. In the same way, the scarcity of money affects its value. When money grows scarce it becomes more valuable. In this case it takes less money to buy goods and services and prices drop. In contrast, when money becomes more plentiful its value decreases and it takes more money to buy things. We see this in the form of higher prices - the direct result of inflation of the money supply.
Most Americans are aware that prices tend to increase year after year. The trend of increasing prices has been going on for so long in the US that many conclude that rising prices are natural and inevitable, like the law of gravity. You must realize that this is not the case! The truth is, prices have been rising for decades simply because the government has been inflating the money supply for decades.
There are many factors that affect the money supply and the government has control over most of them. The most important of these is the creation of new money. Simply put the government, in cooperation with the Federal Reserve Bank, can effectively print new money at no cost to themselves and use it to buy goods and services. It may appear as if they have created wealth out of thin air. However, as we have already learned this new money inflates the money supply, resulting in higher prices in the future for everyone else. It is often said that, “there ain’t no such thing as a free lunch.” What the government “buys” using its newly printed dollars must be paid for by the rest of us with the reduced purchasing power of our pre-existing dollars.
The key fact to remember is: When the government prints a new dollar, that dollar’s value is stolen from all the other dollars already in existence. Wealth is stolen from everyone holding dollars and transferred to the government. This is the ultimate hidden tax.
If you don’t believe that printing new dollars is theft, just imagine what would happen to you if the treasury caught you printing dollars at home. You would go to jail as a counterfeit. Why? Because counterfeiting – creating new, unearned dollars – is theft!
It is obvious that one of the keys to a successful counterfeiting operation is the ability to produce fakes for less cost than what the fake represents. For instance, if a criminal found that it took $1 in paper, ink, and electricity to produce a counterfeit $1 bill he probably wouldn’t waste much time on his scheme. If he is determined to steal through counterfeiting, he must find a way to drastically reduce his production costs.
Similarly, in the early 1960’s the US government could not cheaply produce new money. Coins were made of silver and dollars were redeemable in gold – both very precious metals. So the production of a new dollar was not free at all – each dollar required one dollar’s worth of raw materials. The government clearly could not get something for nothing sticking with this old plan. It’s solution? Sever the link between the currency and anything of value. It stopped making coins out of silver, and stopped backing dollars with gold.
With no tie to anything of value, there was no restraint on the creation of new money. After changing the rules of the game so that it cost them only pennies to create new a new dollar the government shifted its money creation into overdrive.
The predictable result was inflation and the corresponding increase in price of most everything.
Perhaps you feel that the few percent per year lost to inflation is “small potatoes” compared to the much greater percentage you initially pay in income taxes. The story of US silver coins will change your mind – it vividly illustrates the devastating, wealth eroding power of inflation.
Through 1964 US dimes, quarters, and half dollars were 90% silver. Silver is useful, rare and therefore valuable. But in 1965 the US mint started to produce dimes and quarters out of predominantly copper rather than silver. Admittedly copper is valuable, but not nearly as valuable as silver. While a 1965 dime appears nearly identical to a 1964 dime there is a tremendous difference between the two – the 1964 coin has value because it is silver, whereas the 1965 coin has value ONLY because the government insists that it does.
Let’s imagine that we are back in 1965. There are still plenty of the earlier silver coins in circulation, being used interchangeably with the new copper coins. We take both a 1964 dime and a 1965 dime, put them in a time capsule, and bury it in the backyard - remember, in 1965 these coins have equal purchasing power. Now we patiently wait 46 years and open the time capsule. In 2011 the 1965 dime worth precisely ten cents. Yet in comparison, the 1964 dime is worth more than two dollars! Only a fool would insert his now precious 1964 dime in a pop machine or parking meter as it is now worth twenty “regular” dimes.
So how do explain the disparity in value between our 1964 and 1965 dimes? Most people assume that the silver coin was a good investment and it has gained purchasing power over time. This is not the case. The price of most everything has risen greatly in price since 1965. The silver dime can be used to buy roughly the same goods and services today as it could in 1965. So the silver dime was an effective store of wealth, but it did not increase wealth.
If the silver coin hasn’t gained purchasing power the only other explanation is that the copper dime has lost purchasing power. This is the correct understanding. The value of the 1965 dime has been decimated by inflation. The copper coin has lost 95% of its purchasing power between 1965 and 2011 – an effective rate of return of -6.3% for 46 straight years. The rate of inflation in any given year may have appeared low, but by compounding year after year it has grown large. Where did the wealth represented by that 1965 dime go? It was transferred to the government the instant they made a copper token and passed it off as a silver coin.
Today, with the exception of the nickel, no US coin has value justified by its metal content. The situation is even worse when we consider paper money. How much intrinsic value does a little green piece of paper have? Almost none. Today the government can produce both coins and bills effectively for free. It has and is continuing to produce them en masse.
By now it should be obvious that the amount of money something costs and its true value are two very different things. A gallon of gas increases in cost every year, but its value – the energy it contains, the number of miles it will push your car down the road – remains the same. In a world in which the value of money is constantly falling, you must train yourself to think in terms of value rather than cost.
As has been mentioned several times, the creation of new money from nothing is theft. It is a moral crime, and like all crimes there is evidence left behind. The evidence of inflation crime is increased prices. But successful criminals try to hide the evidence of their crimes, and our government is no different. It tries desperately to hide the fact that prices are climbing in response to their money creation.
Say you were given the job to measure the rate of inflation between this year and next year. The obvious thing to do is put together a list of goods and services. You’d put together a nice mix of things you commonly need – a tank of gas, a cart full of groceries, a portion of your gas and electric bill, etc. You’d figure how much it cost to buy everything on your list this year. Next year you’d buy everything on your list a second time. You’d report the price difference as an honest measure of inflation.
Now think, “Who measures price inflation in the US?” Why the US government does – the same government who causes inflation! It’s as if a policeman committed a murder, successfully escaped, and then through some twist of fate was assigned to investigate his own crime scene. How honest and thorough would you expect this murderous police officer’s report to be?
The government has been tracking inflation for a long time. Believe it or not, in the distant past they measured inflation in the honest way – they tracked the price of a standard basket of goods, just as you or I would do. This was fine since at the time the government was not stealing through inflation. But as they accelerated their money printing they needed to hide the price increases that inevitably resulted. They drastically changed the way they calculate inflation so that the number always turns out tremendously lower than if they had continued with the honest calculation. (link to "crashcourse" for details)
For instance, right now the government reports that the consumer price index (their measure of inflation) is an almost insignificant 1%. There are however, universities and other groups who continue to track inflation in the old, honest way. The inflation number they calculate is 6-8%. Which figure is more in line with your experience? As you likely realize, the 1% CPI reported by the government is bogus – it is the intentional cover-up of their inflation crime.
So the government is creating vast amounts of money out of thin air and lying about the resulting price increases. The value of dollars is steadily falling. How does this affect you?
Reduced Purchasing Power – As was just mentioned, an honest assessment of price inflation last year was 7%. That means that that in order to simply maintain your current purchasing power you needed a 7% increase in your salary. Did you manage to get a 7% or greater raise last year? It is unlikely. Because of the recession many companies froze salaries, cut salaries, or cut employees. But this isn’t just an anomaly due to the recession. Even in good times the rate of wage increases do not keep up with real inflation figures. When price inflation outpaces the growth in your salary, you have reduced buying power. Whether this reduced buying power means you can’t buy the new flat screen TV you wanted or it makes it more difficult to pay the mortgage and put food on the table, you will feel its effect.
Two generations ago in the US, most often the husband worked and the wife stayed home. The household had one income but the standard of living in America did not suffer for it – it was the highest in the world. One salary had more than enough purchasing power to provide for a family. Today it is far more common that both the husband and wife have full time jobs, yet they often struggle to make ends meet. This is the direct result of the wage growth lagging inflation for 50 years.
Saving and Investing Punished – There are many reasons why you may want to set money aside for the future – the purchase of a new car, a down payment on a house, your children’s college education, and retirement are examples. Saving for the future means storing wealth today. For most of us that means either a bank deposit or the stock market. Both of these options offer the possibility of investment income. The bank will offer interest. A stock may offer dividends and hopefully an increase in share price. By now the question you should be asking yourself is, “Does either investment offer a rate of return greater than the honest rate of inflation?” If the answer is no, then despite the fact that the dollar amount of your investment is growing, the true wealth it represents is dwindling. (Kelly adds: do the math folks, if your 401K gained 7% in 2010 then you broke-even, anything less & you lost money. But read on)
The interest rate on bank accounts – currently less than 2% – falls far short of the real rate of inflation. And while your stockbroker (who’s advice is hardly unbiased) will claim that an average return in the stock market is 10%, he will have a hard time explaining why the market has been flat for more than a decade. The bottom line is, both the bank and the stock market offer returns less than the rate of inflation. Investments in either will constantly lose true value because of this fact.
If the savings picture already appears dismal, brace yourself for another setback. To maintain the value of your investment, its return must not only match the rate of inflation, it must match it after the government has taxed it! Remember that investment gains are taxable both by the federal and state governments. If your combined tax rate is 35%, taxes will transform a 10% initial return to a 6.5% effective return. This is barely keeping pace with inflation. And remember, the 10% initial return is exceptional and unlikely.
Recall that value and price, while commonly used to mean the same thing, are actually very different. Value is the inherent worth of something. Price is the number of dollars you must trade to obtain it. The increase in price of any item may be due to an increase in its value, the decrease in value of dollars that must be traded for it, or both.
If our tax system were just, only the increase in price attributable to increase in value would be taxed. But in our system the increase in cost due to the declining value of dollars is taxed as well. Usually this is the greater of the two effects. The combined effect of taxing inflationary gains is devastating to savers.
For example, say that you buy a share of stock in a mediocre company. The company always just breaks even and never issues a dividend. Over the years, it manages to stay the same size, maintain the same assets, same sales, and so on. Every factor that affects the value of this company remains constant, and so the true value of your share remains constant. Your ownership of the stock produces absolutely no increase in wealth for you at all.
However, over the period of your investment inflation has not been idle. Every year the value of the dollar decreases. This means that, despite the fact your stock is not gaining in actual value, the number of dollars having an equal value to your share of stock grows larger and larger. When you finally sell your stock the government requires that you pay taxes on the price increase of your investment despite the fact it did not gain actual value. Inflation of the money supply has produced an illusionary, paper gain for you, which generates real tax income for the government. So not only is inflation theft – stealing the value of existing dollars – but also it distorts the real value of investments, producing imaginary income subject to tax.
At this point hopefully you have come to realize that “the system” is rigged against you. It is purposefully designed to take your wealth – the fruit of your labor – and transfer it to the government. This is not an accident. It is by design. What can you do about it?
Understanding the real nature of the game is the essential first step. This short paper can’t completely explain the nature of inflation and its effects on you, but hopefully it has opened your eyes. There are plenty of books and web resources that describe every aspect of inflation in much more detail. Please investigate further for yourself. The current system can continue only so long as most of the population remains ignorant of it.
Next, realize if the game is rigged, the only way to avoid losing is not to play. If you truly understand inflation you will realize that a dollar you earn today will never have as much purchasing power as it does right now. Keeping your wealth in dollar form only exposes it to the ravages of inflation. Therefore you should exchange your wealth from dollars into tangible goods that you know you will need in the future.
An example from an excellent book (The Alpha Strategy by John Pugsley – available in PDF form online) is razor blades. Razors are a necessity to a large fraction of the population, value dense, and consumable. They take little room to store, keep indefinitely, and never become obsolete or go out of style. A young man with extra money to invest would be wise to spend it on a lifetime supply of razor blades rather than put it in the stock market where it will be consumed by inflation and taxes. Razors are one, seemingly whimsical example but there are many more if you think about it. Items that you will truly need in the future and have no risk of spoiling or becoming obsolete are best bought immediately. Remember that your dollars will never buy more than they will right now.
FYI - following is a link to a site with more info than we can post here, and it's updated regularly to keep a close watch on this subject. http://inflation.us/