Inflation, Deflation and Wealth Redistribution

The Federal Reserve has two mandates:
1. Price Stability (often read as low monetary inflation)
2. Maximum Employment (usually accomplished by a moderately growing economy)

Basically, the Fed would like to target a 1%-2% price inflation rate annually. This rate is (theoretically) where maximum sustainable economic growth occurs. More inflation than this can result in runaway asset price inflation (breaking Mandate #1) or an overheated economy that meets with a bust later on (breaking Mandate #2).

Throw all of the above in the recycle bin. This is worthless PR drivel meant for the consumption of the masses. I will give you a key to understanding politics and politicians:

Ignore what they say. Watch what they do.

In that regard, what is the true mandate of the Federal Reserve?

Protect the interests of the wealthy.

Does this occur because the wealthy run the government, or because the government creates wealthy people? Probably some of both. But I digress.

Why do I say that the Federal Reserve mandate is to protect the wealthy? Because of one simple thing: The Fed will always, in all ways and everywhere defer to the side of economic and monetary inflation over deflation.

Deflation strikes fear in the heart of all wealthy people. Why? Wealthy people have a majority of their wealth in assets. Assets produce income or store wealth in proportion to their price. If asset prices fall, their store of wealth, income produced, and relative standing all go down in large measure. Conversely, deflation (as long as it does not crush the economy) favors the working poor, who generally live off of a fixed income as they trade their time and labor for money. The “poor” generally don’t have assets to deflate, and their expenses form a greater percentage of their overall wealth, so the reduction in prices directly impacts their lifestyle. Basically, deflation has the net effect of transferring wealth from the rich to the poor.

Inflation strikes fear in the heart of all working “poor” people. Why? “Poor” people have a majority of their wealth in fixed income streams or cash. This income (job, pensions, etc) is relatively fixed in relation to prices. If asset prices rise, their store of wealth, income produced, and relative standing all go down in large measure. Conversely, inflation (as long as it does not crush the currency) favors the wealthy, who generally live off of income and assets that gain a greater value as prices rise. The wealthy generally don’t have problems with fixed income streams that are penalized by inflation, and their expenses form a smaller percentage of their overall wealth, so the rise in prices is offset in large measure by the rise in the value of their assets. Basically, inflation has the net effect of transferring wealth from the poor to the rich.

Back to the Federal Reserve–Ignore the rhetoric. Have the policies of the recent past, from Greenspan’s free money, to Bernanke’s rate slashing campaign, to the alphabet soup of toxic investment relief vehicles, buying Treasurys, increasing money supply in the face of global credit deflation–have they been using every tool in their arsenal to combat inflation or deflation? They always err on the side of inflation. ALWAYS. It’s simple to see why. Follow the money.

By my read, about half of the S&P’s ~40% gain since the March lows has been made up of inflationary pressures, leaving only ~20% in actual equity appreciation. Bears, shorts and other doomsayers have been annihilated in this latest wave, even though they may have been accurate in their prognostications for the economy. This is part of the reason why. Half green shoots, half green paper.

Of course, hyper-inflation is as damaging as mega-depression. I’m not arguing the extremes. Just pointing out that if you can’t dance the 1%-2% dance precisely, which side of the line do you think the Fed and other monetary and fiscal authorities will fall towards? The Fed will always choose inflation over deflation. The margin of safety will always be on the inflationary side of the line. Count on it, position for it, expect it.

Just know that the revolutionary socialists aren’t the only ones that pursue a policy of wealth redistribution.

Tags: deflation, inflation