George Orwell’s dystopian book “1984” introduced the world to the concept of Newspeak. Newspeak is the process of redefining words for political purposes. Examples in the book include, “War is peace. Freedom is slavery. Ignorance is strength.” There are plenty of examples of Newspeak today in the United States and doubtless throughout the world. The United States Federal Reserve is a terrible offender when it comes to the use of Newspeak. Below are several examples.
Federal Reserve Newspeak: Price Stability
Part two of the Federal Reserve’s “Dual Mandate” is “Price Stability.” However, the Federal Reserve actively undermines price stability. Here is a quote from the St. Louis Federal Reserve website:
Price stability: If prices for goods and services are stable, that preserves the purchasing power of money. The Federal Open Market Committee, or FOMC, has equated price stability with a low, measured rate of inflation. (Inflation is a general, sustained upward movement of prices for goods and services in an economy.) To achieve this part of the mandate, the FOMC targets an inflation rate of 2 percent over the longer run.
Why is this newspeak? Two percent inflation is not stable. If a ship is losing 2% of its buoyancy every year it will eventually sink. Take a worker who makes $15 an hour. After 20 years, at a 2% inflation rate, that money is now worth $10.09. That “stable” price stability cut a workers wage by a third.
Price stability actually means prices neither rising nor falling.
Of course the real rate of price increases is well above 2%–more on that later.
So when the Federal Reserve use the term “Price Stability” what they really mean is rising prices and a steady erosion of the purchasing power of the dollar.
Federal Reserve Newspeak: Balance Sheet Normalization
The US Federal Reserve makes available their “recent balance sheet trends.” The Federal Reserve narrative of their balance sheet trends is as follows:
The Federal Reserve’s balance sheet has expanded and contracted over time. During the 2007-08 financial crisis and subsequent recession, total assets increased significantly from $870 billion in August 2007 to $4.5 trillion in early 2015. Then, reflecting the FOMC’s balance sheet normalization program that took place between October 2017 and August 2019, total assets declined to under $3.8 trillion. Beginning in September 2019, total assets started to increase.
There is lots of Newspeak in that paragraph. I will give the Federal Reserve some credit, as one sentence doesn’t need too much translation “During the 2007-08 financial crisis and subsequent recession, total assets increased significantly from $870 billion in August 2007 to $4.5 trillion in early 2015.” Here is the translation:
The Federal Reserve’s balance sheet has significantly expanded over time. During the 2007-08 financial crisis and subsequent recession, total assets more than quadrupled from $870 billion in August 2007 to $4.5 trillion in early 2015. Then, the FOMC’s balance sheet normalization program that took place between October 2017 and August 2019 failed and the balance sheet was only able to be reduced back to about $3.8 trillion which is still 3.3 times higher than it was prior to the 2007-2008 financial crisis. Starting in September of 2019 the balance sheet started to grow again. In the year long period between March 2020 to March 2021 the balance sheet increase by over 80% and is currently almost 8x higher than it was back in July of 2007
Balance Sheet normalization in actual english would mean reducing the balance sheet from $4.5 trillion back to under $1 trillion. But in Federal Reserve Newspeak it means reducing the balance sheet 17% from the highest it had been up to that point, going from $4.5 trillion down to $3.8 trillion and then proceeding to more than double it up to $7.7 trillion.
Federal Reserve Newspeak: Tools to Fight Inflation
Fed Chair Jerome Powell has talked about how he has the tools to fight inflation. This is arguably just a lie and not Newspeak, but since Newspeak is a way of lying this distinction doesn’t matter. The translation of this statement is that the tools the Federal Reserve will use to fight inflation will be to ignore and downplay that inflation exists and claim it is transitory.
The Federal Reserve was previously targeting a 2% reduction in the value of the dollar per year. Now that the CPI is officially over 2%, the Federal Reserve is saying this is transitory and that because there were periods of time in which inflation was under 2%, it is okay to be above 2% now.
So the Federal Reserve starts by using a number that is already too low (2.6% instead of 6%) then redefines price stability to mean 2%. So we’re really only seeing a 0.6% increase in prices and that is transitory.
Meanwhile, the only real tools the Federal Reserve has to fight inflation would be to shrink its balance sheet and raise rates. But this would tank the stock market and make it too expensive for the US government to borrow money.
In US Federal Reserve Newspeak, “Price Stability” is rising prices. “Balance Sheet Normalization” is doubling. “Fighting inflation” is ignoring it.
I remember hearing about inflation as a kid and I remember asking “Why are my savings worth less each year?” What I was really asking was “What causes inflation?”
I might have gotten an answer about rising prices or more dollars in circulation but I didn’t understand. When I got older I did my own research and now understand the mechanics and causes of inflation.
Today I Explain What Causes Inflation
But before I do I want to make sure we’re on the same page regarding what Inflation is.
Inflation and Price Inflation are often used interchangeably, but it makes more sense to separate them out because one is the cause and the other is the effect.
Let’s define some terms:
Inflation: An increase in the money supply. An increase in the money supply is a fancy way of saying there are more dollars in existence than before.
Price Inflation: Rising prices as result of an increase in the money supply.
Inflating the money supply causes rising prices
An Example of the Effects of Inflation
Imagine everyone woke up one morning to find their bank account balances had doubled. The money supply had been inflated by a factor of 2!
Some people would choose to buy goods and services with their new-found “wealth”. But there aren’t more goods and services in the economy. Thus, consumers will bid up prices.
Basic laws of economics tell us that when demand increases and supply does not, prices rise.
Prices would then be higher as a result of the increase in the money supply in what is properly called Price Inflation.
What Causes Inflation?
Inflation is caused by creating new dollars. But who is creating these new dollars and how do they do it?
New dollars are created by banks.
The main bank responsible for inflation is the US Federal Reserve. But virtually all other banks also cause inflation via Fractional Reserve Banking.
The Federal Reserve Inflates the Money Supply
The US government spends much more than it brings in via taxes. To make up the difference the US treasury borrows money by issuing debt in the form of bonds.
This debt, these bonds, are then bought by investors, foreign governments, pension funds, and the central bank of the United States called the Federal Reserve.
If the debt was purchased with existing money this would not be inflationary. However, the US Federal Reserve conjures money out of thin air to buy US bonds. How do they conjure money?
They simply create deposits in the Federal Reserve accounts. Imagine if you could go into your bank account and type in that you now had 1 million more dollars. You’d be creating money out of thin air! That is what the Federal Reserve does.
The Fed has inflated the money supply. The Fed caused inflation by creating new dollars.
Using this this freshly minted money the Fed buys US government bonds. The US government then takes the dollars it got from the bonds it sold and spends it on tanks, government employee salaries, national parks, welfare, social security payments, you name it.
This new money that was created out of thin air by the Fed flows through the government into the economy and bids up the prices of goods and services for everyone else.
This resultant rise in prices is one of the effects of inflation.
A Second Cause of Inflation: Fractional Reserve Banking
Another cause of inflation is fraction reserve banking.
Fractional reserve banking means that banks do not have to keep all of their depositor’s funds available for withdrawal. Banks only have to keep a fraction (or portion) of their clients funds in reserve.
When you despot $100 into your checking account it doesn’t go into a vault and sit there. The bank loans that money out to other people or uses it to buy stocks, or bonds, or other investments.
Now banks aren’t allowed to loan out and invest all of their depositors money. After all, if you were to go to an ATM, you need to be able to withdraw cash, or when you write a check to pay your mortgage, the bank needs to send that money to your landlady.
Banks estimate how much money people will spend and withdraw over a given time and they keep that amount in reserve.
There are also regulations in place that dictate the amount of liquid dollars a bank must have in reserve. This is known as the reserve requirement. The reserve requirement is set by the Fed.
If the reserve requirement is 10%, that means that for every $100 in deposits, a bank can loan out $90. So, if you deposit a $100 bill into your checking account, the bank will loan out $90.
The person who received that $90 might spend it on a new pair of shoes. So they give $90 to the cobbler (shoemaker). The cobbler then deposits the $90 back into the bank, which can then be loaned out again. So the bank could make an additional $81 loan. This process repeats itself again and again and that $100 deposit, with a 10% reserve requirement, could become nearly $900 floating around the economy with only $100 in reserves in the bank.
So by not holding 100% of deposits in reserve, banks increase the money supply and cause inflation.
Do you have a better understanding of Inflation now?
The actions of the Federal Reserve and Banks cause inflation. I personally don’t like that my dollars are worth less each year because banks only hold fractional reserves and because the Fed prints money out of thin air.
This knowledge has led me to hold some money in gold. Unlike dollars banks can’t create gold by typing in numbers into a computer.
It also goes to show that if everyone were to try to withdraw their money from the bank at once the system would collapse. Don’t count on the FDIC, which is supposed to back up the banks, because it is undercapitalized. This knowledge leads me to hold some money in physical cash.
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