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ECONOMIC CATASTROPHES

So far we have seen that printing money is a criminal enterprise who shifts wealth from the poorest people to the richest, therefore ensuring lower standards of living for everybody except the government and the Power Elite. But what about the economy? Does the economy suffer due to the actions of Central Banks? Is there any other side effect? There most certainly is.

Boom

As Central Banks pump money into an economy while ensuring that this information is not known nor distributed, such money entering the market will indeed have the purchasing power of pre-printing money. As such, a person selling a good or service will have no idea why sales are up. He will only know that sales are up. And what does every good entrepreneur when sales are up? Prepares for more demand. Seizes the opportunity. Buys more goods and services to sell. Expands the store. Creates new products. Hires more people.

In summary, a good entrepreneur extrapolates current economic conditions into the future. And why not? Who is to say that current economic conditions are not real? Sales are real. Sales are the ultimate source of economic information. As there is an up-surge in sales, the entrepreneur would wisely increase prices, since there is a larger demand.

And so, this person moves money and resources around to prepare for a growing economy. Loans are probably taken. Contractors contracted. Precautions thrown to the wind. This is only common sense. A good entrepreneur cannot escape this conclusion and must use this opportunity to the maximum.

In Austrian Economic terms we would say that such an entrepreneur is re-allocating resources on a different time-structure than it existed before. All this means that old plans have been replaced by new and more expensive plans based on future forecasts.

Bust

Unfortunately, the money that created a surge in purchases was newly printed money. Once this injection of printed money is over, sales begin to drop to previous levels and worse.

It so happens that by this time, the entire economy has realized that there is more money around but the same amount of goods and services and it adjusted its prices up accordingly. Which means that most people (those on fixed salaries), now have less purchasing power because their salaries have not been increased. Remember that salaries are expenses from a company’s point of view. If all raw materials a company uses just went up in price and sales are flat or down, they won’t increase salaries. It would be suicidal to do so because it would eat up whatever profits are left and the company would probably go bankrupt.

But it gets better (actually worse). Remember all those new-and-improved expensive plans that the companies placed in motion during the Boom phase? Well, the key word here is expensive. They created plans and spent and borrowed money based on the assumption that the economy was growing. This was a key assumption. Unfortunately, the economy was not growing; not only that. As we have seen above, they are now facing rising costs and falling sales, while at the same time (due to those new-and-improved plans and financial commitments) they are in a much worse financial shape. Actually, they are in dire circumstances!

What do companies do in such circumstances? They shrink. They stop all plans and revert to emergency downsizing plans. They freeze all salaries and hirings. They lay off people. They sell assets. Cancel purchases. Stop expansion projects. The works. They go into full panic mode fighting for survival. Result? Lower purchasing power, unemployment and rising prices.

How do we call this result? Economic Bust.

Central Banks to the rescue

What happens next? Political pressure is applied to politicians so that they instruct the Central Bank to print some more so that companies may get “relief” from such dire economic conditions and “bring back” the booming economy. The Power Elite happily agree, since they are the first to get paid with newly printed money. Politicians agree, since booming economies buy votes.

And so Central Banks print some more. The only problem is that as with any other drug addict, in order to get the same “hit” the dose needs to be increased. This is simple to see. The effects of newly printed money are proportional and not absolute to the total amount of money. Let’s say that a Central Bank estimated that in order to get the same economic effect, it is necessary to print 10% of the current amount of money. Let’s do the math assuming the original amount of money was 1000 Bolivars.

Originally: 1000 Bolivars

First print (10% of 1000 Bolivars) = 100 Bolivars

Total amount of money after first print = 1100 Bolivars

Second print (10% of 1100 Bolivars) = 110 Bolivars

This means that in order to get the same “benefits”, more money than the last time needs to be printed. And again, this produces a Boom followed by a Bust. And new political claims for “relief”. The cycle begins anew.

The Boom and Bust cycle becomes permanent

As new money is spent and a new Bust horizon approaches, politicians and the Power Elite shift into high gear and order Central Banks to keep printing for the foreseeable future. The problem is that, as we explained before, in order to get the same results more money needs to be printed each time. We go into what mathematicians call a “geometric” growth. This means that money printing accelerates all the time. The graph below shows money printing in a geometric fashion:

Printed Money Needed To Achieve The Same Economic Effect

The red line represents the amount of new money Central Banks print in every cycle. The blue line represents the normal amount of growth in a Free Market.

As you can see, for every cycle of Boom and Bust, Central Banks need to print more and more money.

Inflation is simply more money chasing the same amounts of goods and services. Let’s say that in a Free Market goods and services grow at approximately 2% per year. If we increase the amount of money by about the same percentage (2%), prices remain stable since although we have more money, we also have roughly the same amount of new goods and services. Of course, if we would to do this, we would lose all deflation benefits, but let’s stick with it for a second.

If we increase the amount of printed money beyond what the economy can grow naturally, then we do indeed have more money chasing far less goods and services and therefore prices increase and we get inflation.

The impact of rising prices

As we have shown above, the problem with having new money injected surreptitiously into a market is that salaries are the last thing to adjust. As such, salaries are stuck on the blue line of the above graph, while prices rise as the red line. The difference between blue and red is the Price Gap so produced, also called Inflation.

This graph demonstrates quite graphically how Central Banks continuously destroy your purchasing power. Sometimes the destruction is mild, as when countries declare that Central Bank’s target is to keep Inflation between 2 to 3% per year (this is print between 2 to 3% per year above the natural growth of the economy). This means that you are “only” losing 2 to 3% of your purchasing power per year.

Sometimes Central Banks are ordered to print endlessly to cover for budget shortfalls, in which case this printing quickly gets out of control and slides from inflation into hyperinflation, where your purchasing power decreases by 20 to 30% per month or worse!

This impact of rising prices is so devastating because your salary is absolute to you, while printing is relative to Central Banks. Consider this:

When Central Banks print let’s say by 10%, prices go up by 10% while your salary hasn’t changed. The situation is as follows:

Before printing

  • Salary = 1000 Pesos
  • Apartment rental = 300 Pesos

After printing

  • Salary = 1000 Pesos
  • Apartment rental = 330 Pesos

Do you care that printing has produced an increase of your rent of “only” 10%? Of course not. What you care about is that your rent is now costing you 30 more Pesos. For any intent and purpose, you don’t care if printing was 10% or 50%. All you care about is the 30 extra Pesos you will now have to come up with. Your money is absolute, you only have a certain amount of Pesos available. For a Central Bank, they don’t care since their supply of Pesos is infinite and therefore they deal in relative percentages.

This is just the tip of the iceberg. As printing accelerates, the absolute amount of money you have available becomes geometrically less and less capable of purchasing what you need. This can be seen in the graph below. As the Price Gap or Inflation grows geometrically, your Purchasing Power also decreases geometrically.

Purchase Power Loss Due to Central Bank Money Printing

PM: Printed Money

PPLwSI: Purchasing Power Loss with Salary Increases

As you can see, even if we account for salary increases, if printing is sufficiently fast it overwhelms any such increases you may have had. Printing money truly is a weapon of mass destruction.

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Central Banks must go - Part 4

 

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