What about deflation?

Inflation is not much bother to high income people; it is a definite bother to middle income people; it is a blood-sucker and poverty-perpetuator to poor people. And, only the government benefits because it gets more money to spend on more things. And history shows that whenever the government gets more money, it just spends more money.

Inflation saps the will of an economy. It causes and maintains poverty and is rightly known as the most evil of all taxes to mankind because it disproportionately hurts poor people.

History shows us, time after time, that when a country’s economy weakens, especially through inflation, the economy eventually collapses. It has always meant the loss of freedom . . . the loss of rights. It usually means dictatorial powers come into play supported by some kind of police or army. People have no choice, they have no rights; they are told what to do, they are told what not to do . . . penalties are supreme. Those who do not learn from history are condemned to repeat the mistakes of history.

Well if inflation is so bad, why do some people say that deflation is worse? Let’s take a look. . .

Let us recap the example from last time on inflation:

Our government currently has $1,600,000 in circulation. The budget is $400,000 short on funds for promised programs. Taxes are already high and politicians are afraid to raise taxes or they could lose future elections. The government is in charge of printing all currency, so they just print $400,000 more to pay for the programs.

Prior to printing the extra money we had 100,000 things available for sale in the country, called goods and services. When we had $1,600,000 in total money divided by 100,000 things, the average price for a ‘thing’ was $16. Now that we $2,000,000 in total money divided by 100,000 things, the average price for that same item is $20. What used to cost $16 now costs $20 all because the government printed extra money.

            $1,600,000 ÷ 100,000 = $16 average cost for a thing before inflation
            $2,000,000 ÷ 100,000 = $20 average cost for a thing after inflation

Things that used to cost $4 now cost 5 $. Remember, the Gross Domestic Product went from $1,600,000  up to $2,000,000 in money, but the actual goods and services stayed the same.

           $20 – $16 = 4
            4 ÷ 16 = 1/4 = 25% inflation

A loaf of bread that used to cost $1 now costs $1.25. Bus fairs go up because union workers demand more money because their bread costs more now too. The tailor charges $50 instead of $40. The doctors charge more because their expenses go up. And the politicians and government workers pay more too, so they vote themselves pay raises. Then the $400,000 that was printed to cover programs has already been spent on increases in government pay and expenses, and the programs are still not funded.

Let’s look at borrowing. Under the inflation model, our friend Joe borrows $10,000. The interest rate is 5 percent over 10 years. Joe will pay $106.07 each month for 10 years, a total of $2,727 in interest. Inflation decreases the real value of money so demand is high because people and businesses are behind on their bills because of the inflation. Joe might even default on his loan because he has less money to live on and now the added expense of the loan. So the bank increases their rates to 10% for the next customer and they now make $5,858 in interest.

Well now let’s look at how deflation would work:

Our government currently has $1,600,000 in circulation. Instead of printing money, production rises by 25,000 things, or $400,000. Now we have $2,000,000 as the Gross Domestic Product because the actual goods and services increased. But we still have only $1,600,000 to spend.

            $1,600,000 ÷ 100,000 = $16 average cost for a thing before production increased
            $1,600,000 ÷ 125,000 = $12.8 average cost for a thing after production increased

            $12.8 – $16 = -3.2
            -3.2 ÷ $16 = -20% deflation

A loaf of bread that used to cost $1 now only costs 80 cents. Bus fairs don’t go up. People don’t have to demand more money just to make ends meet. They even have a bit extra to spend.

Let’s look at borrowing now. Under the deflation model, our friend Joe doesn’t really need to borrow money, but he’s doing okay and the bank offers him a low interest rate loan to buy that new sports car he’s been eyeing.  The interest rate is 3 percent, but Joe only wants to pay over 4 years. Joe will pay $217 each month for 4 years, a total of $624 in interest. That’s over $2,000 less than the same loan in inflationary times. Deflation increases the real value of money so demand is low because people and businesses are ahead on their bills because of the deflation. So the bank decreases their rates to 1% for the next customer and they now make only $205 in interest.

It looks like citizens win and banks lose in times of deflation.

Now, what if the banks received a bailout from the government? They would win once because they would be given taxpayer money in exchange for nothing. Then the would win again by the inflation caused by the government spending, because inflation means citizens get less for their money and need loans, and banks get more business and higher interest rates.

My question for you is: If inflation hurts citizens and helps banks, and deflation helps citizens and hurts banks, why does the government say deflation is worse than inflation?

How to Understand Economics in 1 Hour

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Who benefits from inflation?

Inflation is measured by differences in the Consumer Price Index (CPI) from one month to another. Who calculates the CPI? Our old friend the Bureau of Labor Statistics (BLS). The BLS sends people called economic assistants to various providers of goods and services across the US to gather a sampling of prices on about eighty thousand items. Of course, just like unemployment, they are only sampling part of the population. If you live in a rural area, are in the Armed Forces, or are in an institution such as a prison, you are not included in the sampling. Two specific groups are included: 

  • all urban consumers, and
  • urban wage earners and clerical workers.

The types of goods and services included in the sample are food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and a miscellaneous category that includes such items as haircuts and cigarettes.

So is inflation good or bad? Let’s take a look at monthly inflation rates over the past few years and then apply them to the money in our pockets. 

Monthly Inflation Rates (percentage change) 1999 – 2012

 From the chart it looks like prices are on the rise most of the time. The BLS started collecting this data in 1913. The chart below shows the difference relative to that first date. 

 

Inflation is calculated by the difference in what items cost from one year to the next. That means back in 1914 if you bought groceries for $20 went to the store, today you would need $458.21 to purchase those same groceries. That is an inflation rate of 2191.0%! So how about a decade? If we bought $100 in groceries in 2002, those same groceries would cost $127.35 today.

While we all feel the cost of higher prices, people that make more money can still afford to pay them. It’s the people who are living exactly within their means that inflation hurts the most.

So what causes inflation? Let’s say that our government currently has $1,600,000 in circulation. The budget is $400,000 short on funds for promised programs. Taxes are already high and politicians are afraid to raise taxes or they could lose future elections. The government is in charge of printing all currency, so they just print $400,000 more to pay for the programs. Problem solved, right?

Well, let’s take a look at the impact of that on us. Remember when we discussed the Gross Domestic product and Standard of Living? Let’s say that prior to printing the extra money we had 100,000 things available for sale in the country, called goods and services. When we had $1,600,000 in total money divided by 100,000 things, the average price for a ‘thing’ was $16. Now that we $2,000,000 in total money divided by 100,000 things, the average price for that same item is $20. What used to cost $16 now costs $20 all because the government printed extra money. Inflation is the lessening of the buying power of money caused by the government pumping money into the economy in order to feed its ever-increasing appetite for programs, which require more and more money.

If you or I printed money we’d go to jail, but when the government does it, there is no one to say ‘You can’t do that.’ The government is the only winner because as incomes go up because of inflation, the government taxes a bigger share of your income because you’re in a higher income bracket even though your income buys you less. Unions must demand higher wages to cover inflation, and business owners must raise the prices of goods and services to cover higher salaries and costs of production. The government is the only winner.

The current high levels of national debt, which we now discuss in terms of only being able to pay interest, as well as unsustainable programs where overpromising has occurred for generations, are among issues that cause the government to print money. There are other minor factors in inflation. Increases in federal taxes exacerbate the situation because businesses pass off the higher tax rates in the cost of products and services.

Inflation is of little consequence to the wealthy, and a bother to middle income earners. But where inflation hits the hardest, is for those who are already at or near the poverty level. People that cannot demand a raise in pay, but can no longer afford the new price of a loaf of bread or their rent increase. So why does the government print more money for programs to help the lowest income people if those low income people are the ones who are hurt the most from inflation?

How to Understand Economics in 1 Hour

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How do they calculate unemployment?

The Bureau of Labor Statistics (BLS) releases monthly United States unemployment numbers. Where do these statistics come from? Many people think that these numbers come from unemployment insurance claims. This wouldn’t really give the true figure since not everyone that is unemployed is eligible for unemployment. Some have dropped off at the end of their benefit allotment and wouldn’t be included if this is how the numbers were calculated. Other people think that the BLS counts every single unemployed person. While we don’t often hear the government use high cost as a preclusion, that’s what they say about counting each person. It simply would cost too much money to do this each month.

So what do they do? Well the Bureau of Census for the BLS has conducted a monthly survey of households called the Current Population Survey (CPS) every month since 1940. Monthly, wow! They’ve never called me. How about you? There are about 60,000 households included in the sample for each survey (about 110,000 people). For selection, counties and county equivalent cities are grouped into 2025 geographic areas. The Bureau of Census then designs and selects a sample of 824 of these representing different types of industrial and farming areas, and the major geographic divisions of each state. Every month, one quarter of the households in the sample are changed so that any single household is not included in the sample for more than four consecutive months. Once a household leaves the survey they are out for eight months then resurveyed for four months again before leaving the sample for good.

The definitions of employment and unemployment play a large role in the statistics, especially in poor economic times. Here are the Bureau of Census definitions:

• People with jobs are employed.
• People who are jobless, have actively sought jobs in the past four weeks, and are available for work are unemployed.
• People who are neither employed nor unemployed are not in the labor force.

We’ve all heard people debating the unemployment numbers, especially now when unemployment is so high. The focus of many of these debates is around the definition of unemployment. Since some people ‘give up’ on actively looking for jobs, they are deducted from the unemployment figures. These could be people who are receiving unemployment benefits, people who work multiple jobs to make ends meet but are currently working only one. They could be people who economically need employment, or who desire employment but are waiting for something to change before they start actively seeking work again, or a job for which they qualify just hasn’t come up in the last four weeks.

Confused yet? This won’t help . . . After all the data is collected from the survey, the Bureau of Census applies “seasonal adjustments”. They claim this is necessary to account for things like weather and holidays. Don’t we have weather and holidays every year? Yes, and that is why the annual statistics are calculated without the seasonal adjustments.

Monthly Unemployment Numbers

Annual Unemployment Numbers

 

It looks like the rates have been a little high the past couple of years. Now we understand a bit more about the Gross Domestic Product and unemployment and have taken a look at the figures. Next time we’ll tie it all together.

How to Understand Economics in 1 Hour

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Why should we care about the GDP?

The Gross Domestic Product (GDP) for the United States represents the collective results of our labor. If you add up all the products that are made and services that are rendered, that amount represents the GDP. The consumption of those goods and services is called the Standard of Living. The Bureau of Economic Analysis (BEA), which is the research arm of the Department of Commerce, provides quarterly statistics about the GDP.

The growth rate, or change from one time period to the next, helps us to determine economic health. Generally, the best growth rate is considered to be between 2% and 3%. This indicates enough growth to provide ample new jobs for job seekers, but not so much growth as to create scarcity of goods and services that might quickly increase prices. At times when unemployment is high, the GDP growth rate needs to rise significantly in order to not only create the standard amount of new jobs, but to get unemployed people back to work.

Seems pretty straight forward, right? Well like so much that touches government hands, it gets much more complicated. The BEA reports are distributed in three releases. The advanced report is released about one month after the quarter ends. The second report is released two months after the quarter. And finally, the third report is released at the end of the quarter. These reports can differ significantly since there is limited data available for the advanced report and all statistics are in by the final report. Sounds like a politicians dream. If the data is not favorable to a politician, the statistics can be explained away at first by lack of data and beaten to death before the true statics are released. On the other hand, if the data looks favorable to a politician, they can plaster the version they like everywhere.

So how do we sort through the politics to get to the true economics? One way is to study the trends over several years. Let’s take a look at the quarterly and annual GDP for the last several years.

 GDP by Quarter

 GDP by Year

A rate of 2% to 3% is supposed to be good, right? Uh oh. Looks like we’re pretty low, and. . . right now we are experiencing unusually high rates of unemployment. Perhaps we should take what we’ve learned today and add our current employment numbers to the equation. I know what you’re thinking. Aren’t unemployment figures another area where we don’t really understand how the figures are calculated? You bet! Next time we’ll discuss unemployment figures. Then we’ll tie it all together.

How to Understand Economics in 1 Hour

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