Wednesday, September 07, 2011

The Incredible Shrinking Dollar

Dollar in hand

From time to time I like to write about the continuing economic crisis. I’m particularly interested in the massive monetary inflation that lies just around the corner for all major Western nations.

“Aw heck, Baron!” you say, “I hate it when you talk about this stuff! What’s inflation got to do with the Great Jihad, anyway?”

Well, nothing, really. At least not directly.

However, over the course of the next decade or so the world’s major currencies will lose a significant portion of their value. This will not only affect whether Joe Consumer can afford to vacation in Ibiza every year, or buy a new hybrid. It will also:

  • Inhibit the ability of the United States to project its military power overseas.
  • Force a reduction in domestic welfare spending.
  • Restrain the U.S. government’s ability to hand out goodies as inducements for cooperation, both domestically and internationally.
  • Cut the amount of money spent by governments and private charities to stave off famine in Third World nations. Those countries that lack oil and have to subsist on the margin — Egypt and Bangladesh come to mind — are likely to face starvation and further political unrest.

So the coming inflation will have an effect both on the Jihad and those who would resist it. The process, however, will be complex and hard to predict.

For the rest of this post I’ll concentrate on the United States, where the crisis is the most advanced, and which I understand more fully. But we may assume that Canada, the UK, the Eurozone, and Japan will eventually enter their own inflationary spirals of varying intensities.

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Back in the fall of 2008, after the real estate bubble burst and the recession began, it became obvious that we would have to face a bout of major inflation sooner or later. The response to the crisis — repeated fiscal stimuli and the borrowing of more money — only guaranteed that the inflation would be even more severe.

The amount of sovereign debt owed by the United States is much more than can ever be paid back under any realistic circumstances. Improved productivity will not be enough to rescue us. No tax increase, no matter how large, can ever supply the necessary revenue.

Since the dollar is still the world’s reserve currency, there is no need for the USA ever to default on its debt, even partially. Instead we will monetize it. This process used to be known as “printing money”, but in this all-electronic age, we call it “quantitative easing”, which means in effect that the Federal Reserve creates more imaginary money to buy more newly-issued Treasury bonds.

Depending on whose estimate you read, the dollar will have to lose 75%-95% of its current value before the debt can be paid down to a manageable level. This means that price inflation will eventually become obvious. We can already see its effects at the gas pump and the supermarket.

Inflation will act as a hidden tax on the wealth of the American people. The federal government is paying for its past profligacy by sucking the purchasing power out of the assets held by ordinary citizens and handing it out to its creditors. By using this method, the president never has to propose any cuts in public spending, and Congress never has to raise taxes. Four fifths of your wealth will just evaporate — unless you were savvy enough to acquire precious metals in good time — while the federal debt overhang disappears. It’s a nice, simple solution for the Powers That Be.

The only sticking point in the scheme is the mandatory cost of living adjustments (COLAs) in federal pensions and certain categories of entitlement spending. COLAs are tied to the official rate of inflation, so this year’s Social Security payment is supposed to have the same purchasing power as last year’s, no matter what amount is actually printed on the check.

If COLAs have to mirror an increasing inflation rate, it’s an obvious recipe for hyperinflation. The system will enter a vicious circle of increasing payments to make up for the decreasing value of the currency. It’s a positive feedback loop that can only spiral out of control.

Since it would be politically impossible to repeal the COLA regime, from the earliest stages of the crisis it has been obvious that the government would have to game the official inflation rate. How else could it hope to cut the real value of Social Security checks and pensions and thus avoid hyperinflation?

The only question was how the official inflation rate could be scammed in a manner that would fool the general public.

Last fall I knew the feds had succeeded when President Obama declared that the previous year’s inflation rate had been very low, only 1.57%. The president proudly proclaimed that it was the lowest rate of inflation in a decade.

This was obviously bogus — anybody who had to fill up his gas tank, heat his house, or buy food at the supermarket knew that inflation was much higher than 1.57%. However, a look at the fine print of the CBO’s statistical methods told you all you needed to know: the rate was calculated to exclude “food and fuel”.

That’s a nice system they’ve got there. Two major categories of expenditure which count as absolute necessities, and whose prices are increasing very rapidly, are not to be considered when calculating the official rate of inflation.

OK, so it cost forty bucks to fill your tank last year, and it costs fifty this year. But you can console yourself with the thought that the inflation rate is only 1.57%! Doesn’t that warm your patriotic heart?

Silver Certificate

When the official annual inflation rate is gamed by the U.S. government, it makes the real inflation rate very difficult to determine, at least for a layman. The federal accounting gimmick made me wonder how much those pensioners and Social Security recipients might be losing every year. If the official rate is 1.57%, but the real rate is 6% or 8%, those pension checks will lose a big chunk of their value in just a few years’ time.

Prices increase exponentially at a constant rate of inflation. If annual inflation were 10% — as it was in the last days of the reign of Jimmuh from the Ummah — something that costs a dollar this year would cost $1.10 next year, $1.21 the following year, $1.33 the year after that, and so on. In a little over seven years, prices would have doubled.

At an annual rate of 1.57%, however, in seven years prices would only have increased 12%, and it would take them 44 years to double.

Or, to look at it a different way, let’s say that inflation is 10% p.a., and your pension is now $50,000. In seven years’ time you’ll need $100,000 just to keep your standard of living the same. The Social Security Administration, however, has pegged the rate at 1.57%, so after seven years your pension is $56,000. In effect, you now have a 44% shortfall.

That’s bound to erode your lifestyle. A few more years of that, and you’ll have to sell the condo just to buy the dog food you’ll be eating while you sleep under the railroad bridge.

Morgan Dollar

So what is the real rate of inflation, and what effect will it have on us if the federal government keeps lying about it?

I decided to construct a simple model of the current situation. The complexity of economic reality means that my model is not at all accurate, but it may provide some insights to help us make guesses about the truth.

The Federal Trade Commission reported [pdf] that the price of gasoline increased 240% over the space of seven years, from 2004 to 2011. That corresponds to annual increase of 19% over those seven years.

According to the Department of Agriculture [pdf], the price of food increased 80% in slightly less than four years, between 2004 and 2008. When annualized, that’s an inflation rate of a little over 16%.

Those are the two categories which the federal government omits from its inflation calculations. That tells you how screwy the official rate must be.

However, the prices of some fuels are not increasing as quickly as the prices of oil and gasoline. Natural gas, for example, lags behind. And aggregate food prices are complex and volatile, making it difficult to guess at a rate of increase over a sustained period of time. Settling on figures to use in our model will be tough.

After we have picked an inflation rate for each of these categories, we have to determine the proportion for each of them in an average family’s expenditures. This is not a simple matter, since people don’t budget for “fuel” as such — heating oil may come under “housing”, gasoline under “transportation”, and propane for camping under “recreation”.

But, just for the heck of it, we’ll make some educated (and not-so-educated) guesses, and take a wild stab at the numbers for our model.

According to this handy graphic covering the year 2010, the average American family spends 15.6% of its income on transportation, 13% on food, 34.4% on housing, and 37% on everything else.

We’ll give that family an initial $1,000 in 2010 to spend in those proportions: $156 for transportation, $130 for food, $344 for housing, and $377 for “other”.

Now we have to guess at annual inflation rates for these categories. “Transportation” includes buying a car, fixing a car, buying gasoline and oil, taking the bus, flying in an airplane, and riding a bicycle. So we can’t just use the price of gas to judge our rate of increase; there are many other factors. However, since gas is a large part of transportation costs for most people, we’ll set the inflation rate at 15%.

We’ll assume that food prices will not always increase as quickly as they are now, and set the food inflation rate at 12%.

Housing is where it gets interesting. The price of real estate has fallen drastically over the past three years, by some estimates as much as a third. However, house prices are not the only factor we look at — people are paying mortgages or rent on places that cost much more than they would now, and that cost is still being amortized. If you pay rent with utilities included, that may include heating oil, which is rising steeply. Then there are repairs, painting, etc. for homeowners.

So let’s assume a modest rate of deflation for housing — I think this may well be a component of that low 1.57% touted by Obama — and say that housing costs are dropping by 2% a year (a –2% rate of inflation).

And now the hardest category: “other”. This includes shoes, TVs, iPads, skis, Cross pens, Rolex watches, paper clips, and annual subscriptions to Playboy. All consumer products are affected by the price of oil, since their manufacture uses energy and they have to be transported to the point of sale. Many are made from petroleum derivatives, which makes their pricing even more susceptible to changes in the cost of oil.

Throwing up our hands in despair, we pick a figure out of thin air for “other”: an annual increase of 4%.

Now we can get down to business and run our model, using the same rates to plot price increases each year for ten years. Here’s a table of the results:

Year Transp. Food Housing Other
2010 $156.00 $130.00 $344.00 $370.00
2011 $179.40 $145.60 $337.12 $384.80
2012 $206.31 $163.07 $330.38 $400.19
2013 $237.26 $182.64 $323.77 $416.20
2014 $272.85 $204.56 $317.29 $432.85
2015 $313.77 $229.10 $310.95 $450.16
2016 $360.84 $256.60 $304.73 $468.17
2017 $414.96 $287.39 $298.64 $486.89
2018 $477.21 $321.88 $292.66 $506.37
2019 $548.79 $360.50 $286.81 $526.63
2020 $631.11 $403.76 $281.07 $547.69

As you would expect, the cost of transportation experienced the steepest rise, from $150 to $631, an increase of over 300%. The price of food more than tripled, from $130 to $404. Housing decreased modestly, from $344 to $281, a drop of 18%. And everything else went from $377 to $548, a 45% increase.

The net result is that it took $1,863.63 in 2020 to buy what cost $1,000 in 2010. That’s an increase of 86%, or 6.4% per year.

However, for those ten years the federal government has been beavering away, calculating the inflation rate based only on the last two categories, housing and “other”. Costs in those categories went from $714.00 to $828.76 in ten years, an increase of only 16%, which gives an annual rate of 1.5% (and which, perhaps coincidentally, is tantalizingly close to the rate that Mr. Obama was so proud of last fall).

If that original $1,000 came from a federal pension, the COLAs compounded each year would have brought it to $1161 in 2020. But our needs actually demand $1864, which means that we have experienced a 38% shortfall in our income, and will have to adjust our lifestyle accordingly. Looking at it another way, we would have to increase our income by 60% to regain our former standard of living.

Bear in mind that the federal government stayed within the letter of the law while all this happened. Congress never had to vote to cut Social Security, or reduce federal pensions, or change the rules for cost of living adjustments. All that was needed was for the bean-counters in the Congressional Budget Office to leave food and fuel out of their inflation calculations.

That’s some catch, that Catch-22.

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Suppose we were too optimistic in our guesses. What would happen if the rate of inflation were a little bit higher for transportation and food?

Let’s boost the annual rate for each of them by an additional 1%, to 16% and 13% respectively. Running the model again for ten years gives the following results:

Year Transp. Food Housing Other
2010 $156.00 $130.00 $344.00 $370.00
2011 $180.96 $146.90 $337.12 $384.80
2012 $209.91 $166.00 $330.38 $400.19
2013 $243.50 $187.58 $323.77 $416.20
2014 $282.46 $211.96 $317.29 $432.85
2015 $327.65 $239.52 $310.95 $450.16
2016 $380.08 $270.65 $304.73 $468.17
2017 $440.89 $305.84 $298.64 $486.89
2018 $511.43 $345.60 $292.66 $506.37
2019 $593.26 $390.53 $286.81 $526.63
2020 $688.18 $441.29 $281.07 $547.69

Since the rates for housing and “other” didn’t change, their increases remained the same, and our pitiful pension remains at $1,161 for 2020. However, the inflation in transportation and food costs has driven our expenses from $1,000 to $1,958 in ten years, the result of an actual annual inflation rate of 7%. That leaves us with a shortfall of 41% compared to what we were used to, and we would need to raise our income by 69% to regain our former lifestyle.

A further ironic twist to all this may be found in the progressive rates used in different tax brackets. The tax code indexes the bracket ceilings to inflation, to prevent “bracket creep”. However, the IRS uses the same official inflation rate as the rest of the government, so that anyone whose wages have increased at more than the official inflation rate — in other words, whose pay has risen at something closer to the real inflation rate — will have jumped a bracket or two during the past ten years, and his taxes will be that much higher.

Once again, this happened without Congress voting any tax increases. This really is taxation without representation.

As you can see, this is a good deal for the federal government in all possible ways. It gets to extract wealth from its citizens without the tiresome necessity of consulting their elected representatives. By making everybody significantly poorer — except for the very rich, whose financial consultants know exactly how to hedge against inflation — it acquires the means to get rid of the debt without having to shut down the federal behemoth. And the size of the federal behemoth is what the game is all about.

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So how does all this affect the Great Jihad, and our resistance to it?

The situation is so complex that prediction is difficult. When the populace becomes that much poorer, it will consume less oil. However, given that we have already passed Peak Oil, the price may keep rising anyway, keeping the sheikhs awash in petrodollars and the jihad well-funded.

At the same time, poorer Muslim countries like Egypt and Pakistan will see mass starvation and political chaos. Anybody who acquires a nuke may decide it’s time to extort a payoff at that point.

Taking a different point of view, if Europe’s road is similar to the one America is on, state welfare will have been drastically reduced or eliminated for many of the “New Europeans”, who will then be surrounded by natives who are much poorer and far angrier than they were before the inflation. I won’t make any predictions about what happens at that point, but the likely outcome may not include much multicultural peace, love, and understanding.

When regional powers like India and Iran realize that they no longer have much to fear from a suddenly impoverished United States, what will they do? The calculus that informs prudent statecraft will change drastically. Once again, the situation will become inherently unpredictable, especially when nuclear weapons are involved.

Three years ago many economic analysts predicted that hyperinflation would be upon us by now. Obviously, no one really knows what will happen in any detail, nor the time frame in which it will occur. The current crisis is unprecedented, so its future course cannot be envisioned with any reliability.

All we can say for certain is that massive inflation is a systemic inevitability. It cannot be avoided. It will probably occur within the next ten years or so, twenty at the outside.

For the past decade our leaders have been making short-sighted, self-serving, and corrupt decisions. Many of them will still be alive when the full consequences of their foolishness arrive. Assuming that they can be found and identified by the masses of people they have hoodwinked and impoverished, they will be lucky to escape with their skins intact.

This tells us that they are not very smart. They don’t really know what they’re doing.

Oh, yes, they know how to work the system effectively in the short run. They are shrewd enough to feather their own nests, leave their children a fat legacy, and enrich their cronies.

But insight into the long-term consequences of their actions escapes them. They are simply unable to comprehend the inevitable ruin that they are bringing down upon all of us.


Errbe said...


History is full of unexpected turns.

Our not so smart politicians keep trying very hard to avoid bank and sovreign failures. But they may be overestimating the trust the voters have in them.

Finland is requiring collateral for any loans to Greece, whilst everything that could be used as such is being sold out.

Angela Merkel is loosing local elections.

Soon large amounts of treasuries have to be rolled over. Then it may turn out that required interest makes it impossible. Why should anybody spend money on a Greece, that obviously never will be able to pay back ?

The banks holding today's treasuries will loose giant amounts. Some of them, in Germany and France, will go bankrupt. This will spread to other banks and we have a situation much worse than the freeze of finances in 2008.

If I have money in a bank, that is at risk, and the government, who is guaranteeing deposits, has no money, can I do anything else but request the deposit in cash, i.e. starting a bank run ?

Cash will be king. At best hard cash in silver or gold.

US dollars will be revalued.

This scenario depends on the fact that most of the "money" is not treasuries or banknotes, but loans. When these cannot be payed, the amount of money in circulation suddenly drops. And it may drop so drastically and so fast that governments cannot keep pace by printing notes or creating "easing".

When cash is king, all prices will drop.

That's called "deflation".

But thereafter the inflation will come galloping.

Anonymous said...


This is a very interesting analysis on possible future inflation or hyperinflation.

However, the scenario is not necessarily all bad.

For example, once real inflation becomes obvious, it will not be as easy for governments to engage in foreign adventures such as Iraq, Afghanistan, and Libya, not to mention Serbia and Bosnia. These foreign peccadilloes not only drain the national treasury, but they are a source in real instability in the Middle East. Saddam Hussein was not pretty, but he provided an effective counter to Iran.

Domestically, in Europe, Germany and Holland might give up the ghost of the European Union, and pull their resources out of the pockets of the EU bureaucracy. Countries will then have to get off the fix of German support, and will be free to protect their own borders without asking the permission of Brussels or the Hague.

The US might find it necessary to pull its military completely out of Saudi Arabia, leaving the Saudis to arrange for their own protection. Instability in Saudi Arabia might mean that their pipelines get blown up, meaning less oil for the world, and less dollars for the jihad. I think it's a fair trade.

All in all, the future looks to a bit of excitement and hope, as governments lose their ability to paper over the effects of policies based on fantasy and short-term political advantage.

LS said...


Alternate Inflation Charts

Alternate Unemployment Charts

volkgeist said...

A falling dollar also increases exports and can drive economic growth that way. Plus if we look at what the markets themselves are actually telling us, it is that inflation fears are not what is driving investors. Were inflation a primary concern, interest rates on US government debt would be driven higher (ie, Treasuries would fall, due to this inverse relationship), and stocks would climb, so as to price in inflation expectations.

That is emphatically not what has happened. Instead, Treasuries are at their lowest levels in HISTORY, and the market has dropped.

Trust the market--the market tells the truth.

Sol Ta Triane said...

Hi Volkgeist,

"A falling dollar also increases exports and can drive economic growth that way."

Yeah, it's going to "drive" the economy into the ground is what it's going to do. I don't understand how anyone can believe that becoming poorer helps the economy.

Sagunto said...

From this excellent article:

"Aw heck, Baron!” you say, “I hate it when you talk about this stuff! What’s inflation got to do with the Great Jihad, anyway?"

There's the structural and systemic debasement of our currencies through monetary inflation; the debasement of our culture going hand in hand with the ongoing state-sponsored islamization of the West. This triple debasement is accompanied by the non-stop rhetoric that screams "diversity", while real life shows this Orwellian discourse to be a diversion that belies the process of ever more "Gleichschaltung".

Common factor enabling all of this: the modern, progressivist (i.e. both "left" and "right") welfare state.

There's your connection: the enablers of Islam belong to the very same nomenclatura whose core business turns out to be the debasement - and ultimately destruction - of our currencies.

Many thnx again for a great instalment in the "FreedomWatch" series. We lack freedom of speech and expression when Islam is concerned. The fundamental lack of economic freedom is just the other side of the coin (i.m.o.).

Kind regs from Amsterdam,
Sag. said...

Treasuries are all-time low because the Fed. is buying them directly or indirectly. The same is true for Italy, Greece, and likes with the ECB doing the same.
The real market rate would force a default in few days in Europe and US.

Iran have bought a few more time for itself with a large investment last year in gold. But they must bribe their people in submission or pay armed thugs to do so.

Egypt, with no money from tourism, under the MB, with no money for importing food, will disintegrate. The same is true, with a little year or two of delay for Iran.
Without enough money for food it is very difficult to motivate the people to obey.

Spengler have noted that Iran fertility is at 1.5 children for women. This will spell the end of Iran in a decade or two. If you are a poor there is no way you can keep up raising a family and caring for two parents alone.

The price of oil will never grow, in real term, higher than now. It was stable for more than ten years.
Less handout will have very interesting effects. Egypt will lose much as Pakistan (US Congress just need an excuse to cut the aid) and both government will collapse.

Very, very, interesting times.

Ex-Dissident said...

Thank you for another fine analysis and I wish to add a point and contest another.

One: Muslim immigrants will benefit from these economic woes in one specific way and it has to do with regional tradition. They come from places where people have avoided holding their wealth in banks. As per tradition, they store their wealth in gold and silver, and in order to take a bride, a man has to pay the family a certain amount of gold. This gold stays in the family and grows with time. Also, today this amount of gold buys much more than 10 years ago and families who have been storing their savings in precious metals, today can move into nicer neighborhoods, send kids to better schools, and have greater influence over local politics.

Two: I disagree with your assessment over deflation related to housing costs. The average rent in NYC has not decreased and has only modestly increased. Utility costs have skyrocketed. So most folks in NY, have seen an increase in their housing costs. Maybe this is different in other parts of the country but I can only witness the reality that surrounds me. As far as house prices decreasing, that is true but this doesn't make the payments for those who bought houses earlier any better. Unless they default on their loans and renegotiate with the bank, they won't benefit from decreasing house values. I am also unaware of anyone's property taxes becoming lower. In all, I disagree with your assignment of negative inflation rate to this part of the equation.

Otherwise, excellent article.

Baron Bodissey said...

Ex-Dissident --

Actually, I agree with you about housing. Remember, this is a somewhat cautious scenario, designed to show how things will be even if various conditions aren't as bad as they have been or might be. This is not worst-case.

I tried to cobble something together that would approximate the government's official inflation rate "excluding food and fuel". I couldn't see "other" going much below 4%, so I let housing deflate to bring the rate down. But I don't think it really is deflating, except in the terms of the price of real estate.

babs said...

I am glad you concede the point about housing. In 1998 my property tax was $8,000. In 2011 it is $15,750. In 98 our electric bill was $90 (with 2 children living with us.) In 2011 the electric bill is $200/mo with 1 1/2 people living in the home as my husband travels 5 months of the year.
While it is true that we could dump the house out and move to more modest housing, isn't that exactly the argument you are trying to make? We must adjust our lifestyles to the new, poorer reality and, if our local and state gov't chooses to price us out of our homes we have very little recourse.cablearm