``Inflation, in brief, essentially involves a redistribution of real incomes. Those who benefit by it do so, and must do so, at the expense of others. The total losses through inflation offset the total gains. This creates class or group divisions, in which the victims resent the profiteers from inflation, and in which even the moderate gainers from inflation envy the bigger gainers. There is general recognition that the new distribution of income and wealth that goes on during an inflation is not the result of merit, effort, or productiveness, but of luck, speculation, or political favoritism. It was in the tremendous German inflation of 1923 that the seeds of Nazism were sown.”-Henry Hazlitt, What You Should Know About Inflation p.130
Despite signs of recovery in the US stockmarket which most have imputed as “green shoots” of economic recovery, the immense inflationary policies, the unwinding of huge short positions, adjustments in accounting standards to accommodate financial statements of the banking sector, huge oversold levels, the PTSD effects and ‘positive’ earnings from the financial sector have all been significant factors which may have contributed to the recent rally.
Nonetheless here’s the message we’d like to repeat: inflation is a political and not a market process. When governments chooses the winners over the rest, through subsidies, loans, guarantees, bailouts, transfers, market maker or buyer of last resort or through fiscal spending-these are actions decided not by the marketplace but by the political authority. Price inflation as manifested in the markets or in consumer prices signifies as symptoms or the consequences emanating from the accrued policies of the past.
Today’s inflationary process has been driven by the promulgated desire by the global political authorities to cushion or jumpstart markets or economies from the recent crisis based on the economic ideology that governments can substitute for markets during “market failures”. In their ideology, it is assumed that markets always needs to go forward and should never falter- a misplaced perception of capitalism which is actually a profit and loss system.
The political process to inflate the market is seen as the only antidote against the market process, which had been recoiling based on natural economic laws against systemic over indebtedness or overleverage, overvaluation and a system built on excess capacity which produced supply surpluses against an artificially constructed debt inflated demand.
The most recent global collapse in the markets and economies simply reflected the natural state of markets which overwhelmed the untenable imbalances accreted in the system.
Yet by government’s opting to duke it out with market forces works to only delay and worsen the impact on the day of reckoning. Even more so are the policies which have been aimed to perpetuate the same unsustainable paradigm which had been at the root of the crisis.
We never seem to learn that the more imbalances built into the system, the bigger the impact of the next crisis.
And while inflationary policies appear to be gaining traction, which has managed to juice up the activities in marketplace or parts of the US and global economy over the interim, the ongoing market driven deflationary forces will most likely result to outsized volatility, especially in areas plagued by the recent bubble bust.
So those aspiring for “market timing” won’t likely get the same expected conventional patterns because the operational structure of the marketplace has been unprecedented in terms of the scale of government intervention and unparalleled in the scope of massive inflationary measures applied.
The same global inflationary process has apparently been manifesting its presence in the equity and commodity markets.
And that’s why most of the mainstream analysts have apparently been perplexed by the present developments, as economic figures and market signals have been in a deep disconnect. For the bulls, present market actions seem reflexive, they read today’s signals as signs of recovery, for the bears, market actions signify as overreaction and rightly the effects of manipulation. For us, today’s market action has been anticipated and represents as principally a function of inflationary dynamics.
Diminishing Federalism And The Emergence Of Centralized Government
Nonetheless, we expect that global governments to continue to use their “limitless” power to churn money from their printing presses to counter the adverse reactions from market forces.
The financing of US states could be an example why inflationary policies will persist. Presently, revenues in 45 out 47 states in the US have been sharply falling as shown in Figure 2.
And falling revenues against present level of expenditures implies of huge state budget deficits, this also translates to rising risks of state bankruptcies, if not the loss of the autonomous “federalist powers” from a deepening trend of dependency on Washington.
According to the USA Today, ``In a historic first, Uncle Sam has supplanted sales, property and income taxes as the biggest source of revenue for state and local governments.
``The shift shows how deeply the recession is cutting. Federal stimulus money aimed at reviving the economy and a sharp drop in tax collections have altered, at least temporarily, the traditional balance of how states, cities, counties and schools pay for their operations…
``Federal grants — early stimulus money plus conventional federal aid — soared 15% in the first quarter to a seasonally adjusted annual rate of $437 billion, eclipsing sales taxes, which fell 2%.”
Incidentally, California will hold a “special election” or plebiscite aimed at addressing the largest ever state budget gap next week (May 19th). The electorate will vote on several proposed measures as raising taxes, paring down several social service programs, selling state landmarks and laying off some state workers. However, polls suggest that Californians will likely to vote down on the proposed measures which could translate to a credit rating downgrade or higher costs of financing.
Given the high chances of voter’s disapproval, the state of California will possibly have a harder time borrowing, which means that the odds for a bailout from the Federal Government loom larger, otherwise a state bankruptcy .
California could be a precedent for other states. And state bailouts by the US Federal government should translate to expanded deficits which will likely be met with more money printing, especially if the borrowing window shrinks (Financial Times). Yet if we look for signs from the recent actions in the auction market of US Treasury bonds, then government borrowing does not seem like a promising option.
So aside from inflationary costs, the other costs from state dependency on Washington, according to Conn Connell of the Heritage Foundation (bold emphasis mine) are, ``The costs of the loss of federalism to the American people are real. As Reagan outlined above federal aid to states blurs the lines of government accountability, making it easy for politicians to sneak in government-growing legislation and hard for voters to hold those politicians accountable. Moreover, as states become more dependent on federal funding, they begin to lose their ability to set priorities and make policy decisions that are best-suited to their specific needs. Finally, sending money to Washington, only so that it can later come back to the states, creates a fiscal detour of inefficiency and inequity.”
The point is: The Federalist structure of the US government appears to be evolving into a centralized platform gravitating around Washington, which has been using deficit financing as the primary instrument to shore up or consolidate power.
Entitlement Imbalances + Deficits From Present Crisis = Risk Of New Crisis
We may further add that recent developments have point to the imminence of the possible entitlement crisis encompassing the welfare programs of the US Social Security and Medicare as discussed in US Presidential Elections: The Realisms of Proposed “Changes”, see figure 3.
Figure 3: Heritage Foundation: Entitlement Crisis Dwarfs Current Spending
According to a report from Bloomberg (emphasis added), ``Spending on Medicare, the health insurance plan for the elderly, will reach a legal limit by 2014, the same year predicted in 2008, the trustees’ report said. It’s the third year in a row that Medicare’s trustees have pulled the so-called trigger, a law mandating that the president introduce legislation the following year to protect the program’s financing.
``The trustees’ annual report also estimated that Medicare’s hospital fund will be exhausted by 2017, two years earlier than predicted a year ago. The trust fund will need an additional $13.4 trillion to meet all its obligations over the next 75 years…
``Spending on Social Security is expected to exceed revenues in 2016, one year earlier than last year’s forecast, the report said. The trust fund will need an additional $5.3 trillion over the next 75 years to meet all scheduled benefits, the trustees said. The retirement-assistance program can continue to pay full benefits for about 30 years, the report said.”
In short, growing payments to beneficiaries are likely to be unmatched by revenue collections which should lead to expanded deficits. Again according to the same Bloomberg article,`` The government retirement system faces a cash shortfall because the number of retirees eligible for benefits will almost double to 79.5 million in 2045 from 40.5 million this year. By 2045, there will be 2.1 workers paying into the system for every retiree, compared with 3.2 workers this year.”
This implies another major source of pressure to raise financing.
Author and former Treasury Department economist Bruce Barlett in Forbes recently posited that the US may require taxes to rise by some 81% just to meet these coming budgetary shortfalls.
And considering the degree of deficit financing arising from today’s crisis, which if present programs don’t succeed to rekindle an immediate return to growth “normalcy” for the US economy, and combined with the growing risks of the entitlement crisis, all these could translate to a jarring future for Americans-the risks may not be one of deflation but one of bankruptcy or at worst hyperinflation.
On the same plane, the former comptroller general of the US David Walker recently warned at the Financial Times of a prospective downgrade of America’s AAA credit rating should current trends persist.
Hence it seems to be much ignored by the mainstream or by policymakers how the structure of the US political economy has been evolving to apparently increase dependence on the US government’s inflationary mechanism to support the status quo, as currently depicted by evidences of the diminishing Federalism and from the huge intractable welfare programs which looks increasingly like a Ponzi financing model.
As famed economist Herb Stein once said ``If something cannot go on forever, it will stop.”
