January 25, 2010 - In just a few days, President Obama will give his second State of the Union speech to a joint session of Congress. While it is widely expected that he will shift the focus to his speech to job creation and the economy, it is highly unlikely that he will paint a true picture of the financial position the country is in. Real unemployment rates are higher than they have been since the Great Depression and Congress and the White House have been printing and spending money so fast that it is almost impossible to keep track of. The end result is that the country is broke and that the only way to dig out of our financial mess is to inflate our way out of it. If you think that sounds farfetched, it is exactly what the government did to pay for all of the big government programs of the 1930's; forcing taxpayers to foot the bill for the government's spending splurges.
Most economists will tell you that inflation is a bad thing because it reduces the spending power of your money. And most economists that have looked at the recent spending habits of the United States Government will tell you that so much money has been spent that it can't be paid back without inflation. Essentially the government needs to reduce the value of the dollar so that the dollars it spends today can be repaid with dollars that will be worth a lot less money.
This kind of behavior has historical precedent. In the early 1930's the United States was on the "gold standard". That means that the value of the US Dollar was based on the price of gold.
There is only a limited supply of gold. The government can't simply make more of it when Congress wants to spend up a storm. That simple fact presented a huge obstacle to President Roosevelt. He wanted money to pay for projects that ranged from the Hoover Dam to Social Security. So the administration came up with an ingenious plan. It removed gold coins and certificates from circulation, took US citizens off the gold standard and made it illegal for Americans to own gold bullion with some very limited exceptions. It may have been the biggest robbery in history and with the cooperation of Congress, it was all perfectly legal.
Up until FDR's order, 1 ounce of gold was worth a little over $20. Immediately after the order, the US set the foreign exchange rate for 1 ounce of gold to $35. The change essentially reduced the purchasing power of every single US dollar by 42 cents. Put another way, it amounted to overnight inflation of 75%.
Even though US citizens were not able to use gold any more, governments - including the US - did continue the practice. And the international transaction rate of $35 for gold remained in place until 1971. Still, the US continued to print currency and by 1971 the global market lost confidence that the US had enough gold to cover its outstanding dollar supply. They were right and their fears led to a financial crisis. First, Switzerland demanded that the US pay them $50 Million in gold. Then the French demanded $191 Million in gold. That is when then President Nixon made a surprise announcement that the US would no longer back international transactions with gold.
The effect of that announcement ended international currency trading as it had been done for decades and the hard currencies of the world began to float - meaning go up and down in value. From that point on, there was absolutely nothing of value at risk - at least to the government - when making purchases in dollars.
Then as now, the government relied on Treasury Bonds to finance its massive debt. Creating money out of thin air… which creates inflation… was then and is now the only way to pay the entire debt back. That leads to inflation.
Unfortunately, as convenient as this is for the government, it is equally detrimental to the average person. In this scenario, inflation is actually being used as a tax. And the people that pay that tax are anyone - individuals and businesses - who receive payment in US Dollars.
In his State of the Union speech, Obama is expected to make the announcement that he is reeling in government spending while at the same time expanding programs that will help the average taxpayer. An expansion of the child tax credit is just one of the things that are expected to be included. This is likely to be popular with millions of families and perhaps it will even benefit you personally. Just keep in mind that this is simply one more program that the government will have to pay for, and which is likely to be paid for partially through inflation. So what you get from the government today, you will have to repay tomorrow through lower purchasing power.
Inflation also saps the private sector of growth capital. This holds down the number of new jobs that can be created. It makes borrowing money more expensive, so everything from credit card payments to mortgages and company loans go up in price. Most experts agree that with the amount of money printed by the government over the past 18 months, it is only a matter of time - likely sometime this summer - before it starts to take a large toll on the economy.
The bottom line here is that the government has repeatedly found ways to create inflation and avoid paying for it with the tax dollars it collects. Instead, and in addition to those collected tax dollars, it has shifted the burden of repayment to taxpayers through inflation. And although politicians will tell you that "inflation is bad" until they are blue in the face, the truth of the matter is that they couldn't afford to pay for most of the programs they spend money on without it. And they certainly couldn't afford the Trillions of dollars they have spent over the past year without it. But it is taxpayers that will ultimately be responsible for the bill.
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