I have just discovered a way for everybody to get rich.
First, a quick review of how to make money from securities. The key is to sell at a higher price than at what you buy. Buy low sell high. If you buy a security and it rises in price, you can profit when you sell. If you think the security will fall, you just reverse the order of your trades, selling first and then buying. You can do this by borrowing the security, selling it, then buying it back and returning the borrowed security, in what the financial industry calls selling short.
This gives us our first clue to limitless wealth. All you need is to design and issue a security that only goes down.
Then you get everybody to borrow the security, have it go down, and everybody gets rich. Nobody needs to work. No need to till the soil, grow food, build homes and cars, provide medical care, or educate the young. As long as you have a security that always goes down, endless prosperity is guaranteed. The holy grail of the free lunch.
What could go wrong?
If it sounds too good to be true … hmmm … maybe it is? Something must be wrong, because if nobody grows the food, we all starve. If no one builds the homes, we have no shelter. This isn’t exactly our idea of prosperity is it? Rich on paper but homeless and starving? Pretend prosperity that could only work for a time … before too many people went too short, generating a monster short squeeze in which the security ingeniously managed to always lose value instead did the opposite and soared, leaving everyone desperate to cover.
There would be a crash.
So it must be flawed. The system would careen from boom to bust. The energy and ingenuity absorbed by financial gaming would sap the productive vitality of the economy more with each cycle. An insider elite would grow ever richer while the living standards of the many decay. Alas, I must withdraw my suggestion.
The trouble is, this isn’t just some crackpot fantasy. This is how the United States of America actually tries to run its economy.
The Federal Reserve says it wants to make the security it issues – the US dollar – go down at a nice, orderly 2% per year, and that if it does, our economy will grow. Everybody will borrow it – homeowners, students, corporations, governments – and all will prosper. When it all doesn’t go according to plan, it’s only because not enough people borrowed and went short enough, and the cure is to double down and get more people to borrow even more dollars.
Folks, if this is the kind of thinking that having a PhD in Economics gets you, let’s please try and get less educated people on the Fed.
Monetary policy is straightforward if you don’t try to encroach into other turf. Buy and sell Treasuries and gold as needed to manage the money supply to keep the value of the dollar roughly constant over time. Remember that nothing can deflate without having first been inflated. Don’t engage in price fixing in the credit markets; don’t target interest rates. Don’t try to target arbitrary inflation levels or inflate the volume of credit and debt. Don’t mess with mortgage securities, corporate bonds, try to kite stock prices or “stimulate” the economy. Above all, don’t try any crackpot make everybody rich schemes.
I would like to understand the true motivation for te FED wishing for inflation. What is the end profit they see coming from it, and what group do they see as profiting?
To my way of thinking it keeps the hamster wheel rolling, and keeps the hamsters (workers) running, while the wheel owner (asset holders) siphons off energy. It encourages borrowing to buy assets, and drives the prices of those assets based on expectations of asset appreciation. It drives a desperation to purchase, before one is “priced out.” It drives bubbles. It cruelly traps young families into debt servitude by having them reach to provide security, and overpay for a house before thay forever miss the opportuniy. It is one of the components of many modern societies and is uncivilized. It steals from the young and uncapitaled to support the capitaled. It gives a substantial leg up to the well born, and penalizes the disadvantaged even beyond their current impoverished condition. It is like conducting a race uphill, where the weakest participants are burdened with a backpack full of rocks, while the strongest participants are given a shot of oxygen to start the race. It drives inequality and is ruinous to a moral and virtuous society. It turns people into wagesalves, or less.
Is it as evil as the picture I paint, or is their some hidden virtue that the all knowing FED has provided? Is it a necessary component of keeping society working? What am I missing?
Start by bearing firmly in mind that inflation is dollar depreciation. Who would benefit from dollar depreciation? Anybody who’s short. That is, anybody who’s in debt. That would most conspicuously include the US government and corporations. So it’s basically a scheme to empower and enrich politicians and corporate insiders at the expense of everybody else.
In this post I highlight a side effect: It only works as long as everyone doesn’t try it. Once too many people start to jump on the bandwagon and run up debt – go short dollars – the scheme breaks down and you get a crash. 2008 for example was in essence a massive short squeeze on the dollar.
So it’s ironic that even as it talks about how it’s working to stabilize our economy, the Fed is actually destabilizing it and causing it to careen from boom to bust. Meanwhile the Fed’s real constituency, the financial elite, feasts on a free lunch.
What exactly is a short squeeze?
A “short squeeze” is financial vernacular for when too many people try to profit by going short at the same time. See e.g. the Investopedia definition at https://www.investopedia.com/terms/s/shortsqueeze.asp
In the context of this post, it refers to the problem of profiting by going short dollars, i.e. going into debt. Corporations do it by leveraging their balance sheets, homeowners via mortgages, and governments by running deficits. In each case the borrower attempts to profit from the decline in the value of the dollar (inflation), by repaying dollars of lesser value than those originally borrowed.
The notion that an economy can collectively benefit is a central flaw in the Federal Reserve’s policy of pursuing and targeting inflation. The idea that an economy as a whole can profitably do this is the economic equivalent of perpetual motion. It can’t work. Once too many people get on the bandwagon it backfires, resulting in a surge in the value of the dollar (deflation) as speculators rush to cover their shorts (scramble for dollars to reduce debt as they begin to rise in value). A practically perfect example was 2008.
Bottom line … the Fed’s fantasy of a nice steady 2% inflation is just that – fantasy – and doomed to result in a boom and bust economy careening between inflation and deflation. Any inflation rate other than zero is intrinsically inconsistent with price stability.