Obama's Inflation

Posted by Arkady K. On 12/01/2008

America is heading towards the path of inflation and under Obama's economic plan it may very well be one of the worst inflationary periods ever experienced.

The cornerstone of Obama's economic plan rests on the following, from a CNN story:

On Monday, President-elect Barack Obama said the measures would be "creating and saving 2.5 million jobs - jobs rebuilding our crumbling roads and bridges, modernizing our schools, and creating the clean energy infrastructure of the twenty-first century."

In order to understand why this is far more dangerous than meets the eye, one needs only to look at the root cause of inflation. Despite what you may know or not know about inflation, the primary cause is the increase in monetary supply, or simply put - money. When money is created out of thin air and not matched by a corresponding output (GDP), the value of this money drops. There is only force that can create money, it is our government and it is doing so at a very rapid rate and more will follow. Observe chart:

Virtually none of what is proposed will actually increase production; a road, a bridge, even a modern school will not increase our country's output. Instead it will provide jobs under the employment of the government. However, the government needs money to pay for these jobs and it will be forced to create this money by printing or purchasing bonds - much like we have been doing currently in order to bail out failed companies.

This will be Obama's inflation and will become his responsibility. While America can be convinced that increasing money is justifiable for the sake of Homeland Security or that withdrawing from Iraq is too dangerous - how can we justify that we must install computers into schools or create unprofitable green energy sources? There simply is no justification for this type of money increase in this kind of economy.

At first blush, everything would appear to be quite rosy. People will be happily employed, new infrastructure will be appearing and everyone will be dancing in the streets. But guess who will be implicitly paying for all this? Answer - anyone holding money (you), because the value of your money will drop. As additional currency enters the market place your buying power will diminish. It will be an implicit tax on all citizens, but unfortunately it gets worse.

In conjunction with Obama's tax cut for the middle class, there will be a substantial increase in money - because once again these tax cuts must be paid for somehow, but virtually no appreciable increase in production/output.

Inflation will begin to erode our savings, reduce our purchasing power and weaken our currency. While the US has experienced double digit inflation before, during the 1970s for example, out of control inflation has power to destroy countries. A well known example is the Weimar Republic in Germany during the 1930s. Money became so inflated, German citizens were burning German marks to keep warm because the paper was worth more than the actual money!

Yet while no government wants hyper-inflation, the general approach toward moderate inflation is a bit more receptive. Reason being is that the government can continue frivolous spending at the expense of it's citizens. Wages will generally increase to compensate for the increase in prices, but salaries now move up the tax bracket scale. Why would the government object to that, right? Furthermore and probably even more important, it is a convenient way to reduce the national debt. As our dollar drops in value, holders of our debt will get less back from the United States - while we sheepishly 'pay back' our obligations. Possibly the trickiest aspect to recognize and most important for you, is that the inflation lag can be quite long. The effects of newly printed money entering the economy can take anywhere from 4-12 months to materialize. So while we are in a deflationary period now the landscape can change dramatically and very quickly.

What should be done instead?

First of all, this obsession with employment is unhealthy and nothing more than a gimmick to create an illusion of improvement. FDR did the same thing during the New Deal by employing thousands of Americans on public works projects. Yet not surprisingly unemployment and people on relief were just as high in 1939 as they were in 1932 (if not more). Japan tried to spend their way out of their real estate crisis with massive construction projects and remnants of failed projects still line the roadsides.

Creating jobs out of thin air and paying for them with money the government does not have, is dangerous.

Instead jobs must be created in sectors that will boost the nation's GDP. The best way to achieve this result would be stimulate employers. Cutting the corporate tax and decreasing government regulation could be a tremendous boost to both employment and total output. Anything from deregulating the FDA to the ICC would be a welcomed change.

Second of all, Bush has been rightfully criticized for his spending habits, yet Obama is headed down the same path. Spending must be drastically cut. The tax cut to 95% of Americans should be buried, Obama became president based on that promise, but now it's time to disappoint people. Those hundreds of billions should instead go towards paying back our national debt.
Low-income families might experience a tingling sensation after receiving a $1,000 check, but it will be of little use to them when gas goes back to $4 a gallon and crude oil back to $100/barrel. With inflation, this will most likely happen, because oil is traded in dollars.

Spending money on ineffective programs like the civilian national force, massive construction projects and battling global poverty are all examples of programs that should be abandoned. All these programs result in monetary supply increase and have no benefit to our production capabilities. Only in booming economic times should these types of programs be considered and even then - sparingly.

If Obama continues down the path of attempting to spend his way out of this recession using money we do not have, we will face an inflation of staggering proportions. As an educated consumer, you can protect yourself by sheltering your money in traditional inflation safe havens; real estate, physical gold, shorting the dollar (UDN) or shorting bonds. I recommend the ETF - TLT (ultra long) and TBT (ultra short - thanks to one of the readers for providing this).

Be patient though as this will take a long time to play out, but once it does - you can not only protect yourself, but benefit from a potentially devastating scenario.

27 Response to 'Obama's Inflation'

  1. Arkady Said,

    Pretty scary stuff, good article.

  2. Arkady Said,

    Bush has been spending like crazy and there is no inflation. Why will it be any different under Obama?

  3. Arkady Said,

    Why would you assume that the GDP under Obama will be nearly as high as it was under Bush? Bush was enjoying high revenues and was borrowing in a growing economy.

    Second of all, according to the bond market there appears to be a heavy increase in borrowing. Any additional borrowing in this economy is suicidal.

  4. Arkady Said,

    I believe you meant to recommend TBT not TLT if you intend to short long bonds expecting to gain from higher interest rates.

  5. Arkady Said,

    I actually did not know there was an ultra short ETF, in that case TBT is even better.

    Is TLT not shortable?

  6. Arkady Said,

    I have said many times that once a democracy figures out that the people can get "gifts" of help from the government, democracy is dead. We are so close to this now that it is really really scary. And your post, with all the great information in it, is equally as scary. We voted this man into office, and now we will all suffer for it.


  7. Arkady Said,

    This is probably the only thing I agree with you on. The creation of fiat money on this scale will only hurt us and the world in the long run. I tend to lean toward the Austrian school of thought on economics.

  8. Arkady Said,

    That is probably the most important thing then.

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