Three types of inflation

on Wednesday, August 24, 2011

We hear a lot about inflation, and mostly hear about the Fed or government being responsible for the dollar's decline in value over the years. This is a bit strange, and muddles a lot of conversations about the economy and the Fed. In my view there are three distinct, separate causes for inflation; good, bad, and "natural," inflation.

1. "Bad" inflation occurs when bankers "cheat" and print up new notes out of thin air. This is the only cause of inflation recognized by most conservative or libertarian economists, like Milton Friedman or Thomas Sowell. They consider inflation to be always and only a "monetary phenomenon," where the cause of inflation is always an excess supply of currency, relative to existing goods and services. In their view, the only way to inflate a currency is to use the printing press excessively, of which governments have historically been very fond.

This type of inflation is certainly possible, but is unlikely with the system that we have in the United States.  New dollars, created by the Fed, are used to purchase assets that are held by the Fed. At some point in the future, they will be resold on the open market. In order for those new dollars to be permanently inflationary, the currency must be deemed worthless.  A central bank that buys a brick of gold with new money harms no one if it sells the brick for the same money at a later date. It only temporarily lowers the value of existing dollars until it sells the gold. The only way to truly steal by printing money is by issuing a brand new currency, or by never selling the gold back to the market. As long as the Fed's assets are resold to the open market, no harm is done. The only effect is a temporary change in the value of currency.

Think of it this way. Imagine the Fed prints up endless amounts of money and purchases literally every asset on earth. It would hold all assets on earth, and the people would hold paper money. Now imagine it sells all of the assets back to the people, on the open market, and burns the dollars it receives. Are we not right back where we started? Has anyone been harmed? No, the only way they can hurt anyone is in buying up all the assets and then declaring the money held by citizens to be worthless.

2. "Good" inflation is a bit more complex. To understand this it is helpful to imagine that we are using a commodity as money, as was done in the past.  Imagine that we are still today using pigs as our medium of exchange, store of value, and unit of account. Everyone prices goods in "pounds" of pig flesh. Further imagine that many people are holding huge amounts of preserved pig-meat in their mattresses and basements for a rainy day. What would happen if suddenly, all of the hoarded meat were offered in trade on the open market?

The value of pig-meat would fall as its supply rises (relative to other goods). This would be an inflation of the pig-meat commodity-money, but has this inflation harmed anyone? No, the inflation of pig-money only makes it easier to acquire pig-meat, which most people enjoy consuming! The world becomes wealthier as the meat flies out of basements and onto the open market. Suddenly, it is ridiculously easy to eat bacon. The only people who do not benefit from the explosion of meat-money are those who do not consume pig-flesh. To them, the only use for pig-meat is as money (exchange, storage, accounting). They are pretty pissed off when everyone begins liquidating their pig-meat on the open market, because the value of the meat in their basement falls in value.

So this type of inflation is good for everyone except those who don't consume pig-meat. In the modern world, the only people that "consume" US dollars are those who use them to pay down bank loans, denominated in US dollars. When a bank accepts dollars in payment on a bank loan, the dollars are destroyed; removed from circulation in the same way that a slab of bacon is removed by a hungry citizen. Today, when people are encouraged to spend what they have saved, everyone with a bank loan finds that it is easier to repay his loan, just as people would find it easier to eat pork. This idea won't sit well with anyone who does not consider modern money to hold real value to people who are obligated to "consume" it by repaying bank loans.

(If this is you, you may want to take a quick three-part journey, beginning with The Curious Nature of Ownership. Next, you'll want to read What is Wealth? And finally you may end with Banking: A Picture Book. I don't expect a full realization from these essays, but it may be enough for you to at least consider a new viewpoint regarding the reason modern "fiat" currencies hold value.)

The reality is that most people don't hold very much wealth as paper money. Most people hold it in some type of investment, which is a bit like loaning out slabs of bacon to your neighbor, who uses them as furniture. If suddenly, because of some act of the Fed, congress or God, you are moved to liquidate your bacon holdings (spend money), you would remove the furniture from your neighbor's house, and move it somewhere else that looked better. Perhaps you'd trade it for a new car. This act would help the man with cars and hurt the neighbor with whom you had previously invested that pig-money. The net result is likely a lot of movement and very little productive action.

This is the type of intervention that is praised by some, because it creates a lot of economic activity, and bemoaned by others, because it encourages people to move assets from productive use (neighbor's furniture) to another, perhaps questionable use as a new car. It creates what they view as "malinvestements," that will later cause bigger bubbles, and bigger crashes, than would normally occur.

3. "Natural" inflation occurs when everyone is so rich they demand more in trade to do work. It’s easier to hire a poor man to clean your bathroom; Bill Gates might want $50 million per hour to do it, if he agrees at all. When everyone in the market is becoming richer and richer, labor prices naturally rise, and assets that involve a lot of local labor rise in price. As everyone accumulates more and more wealth through productive action and trade, they become less and less willing to do boring or difficult or dangerous tasks in exchange for money. The only way to avoid the price of unskilled labor rising is to introduce new workers, either through immigration or young adults entering the workforce, but even the children entering the workforce will be less willing to work because they will have been raised by richer families, and over time immigrants will require more and more in trade as they too become wealthier.

So in this way, whatever component of an asset that requires a human being to labor to produce it will become more and more expensive over time. Today, it requires an entire bedroom full of electronic equipment to motivate a minimum-wage earning teenager to work a summer job. Fifty years ago, the same labor would have produced a lot less.

In my view it is quite silly to talk about inflation as if there is always an immediately identifiable cause, or to assume that a change in the value of dollars is always a bad thing for our quality of life. As I briefly outlined above, inflation is almost never harmful unless a new currency is issued, or unless the Fed never sells its assets back to the open market. Higher inflation might be annoying, and might make it harder to do business because the future is uncertain, but it certainly doesn't always "steal" from anyone, per se, and it certainly is not "always and only" a monetary phenomenon.

Dive With Hammerheads (Galápagos Islands, Ecuador)

on Sunday, August 14, 2011

If it weren’t for Darwin, the Galápagos Islands might have remained in obscurity with their wealth of odd, indigenous, and fearless wildlife. His evolutionary theories helped land the archipelago on the tourist map, but the great scientist missed out on one of the most stunning landscapes of the Galápagos: its underwater realms. The islands, 600 miles (966 kilometers) from the coast of Ecuador, receive both warm and cold currents, with the Antarctic upswelling, sending a smorgasbord of marine nutrients, attracting a gold mine of marine life.

Here divers see penguins next to tropical reef fish, families of sea lions, and the rare red-lipped batfish in the hundreds. Most divers come, however, to see the preponderance of megafauna. During prime viewing season (July to October), divers swim with hundreds of scalloped hammerhead sharks and spot dozens of bus-size whale sharks. (And yes, they're both harmless.) Live-aboard boats are the best mode of transportation, and the Galápagos Aggressor is one of the few that offers both dives and land-based stops. In the morning, passengers spot blue-footed boobies and prehistoric-looking tortoises on these remote islands; by afternoon, they Zen out amid a panoply of sharks, their jagged bodies silhouetted against the glowing blue of the sea beyond.

The Galápagos Aggressor offers seven-night live-aboard boat trips that stop for land visits on three islands and dives off five islands (from $4,495 per person;

Surf the North Shore (Hawaii, United States)


Hawaiians know that riding the ocean requires the rare combination of calm, confidence, and utter respect for the power of the sea. That's how the best surfers in the world ride down the face of waves that, every now and then, reach 40 feet (12 meters) at the mother of big-wave breaks: Waimea Bay (pictured) on the North Shore of Oahu. It's warmer and more predictable than other breaks of its size, which makes it a favorite among pro surfers. But it also forms a perfect stadium for aspirants looking for a glimpse of some of the world's biggest rides.

Surfing was born on these shores, and many of its biggest competitions, like the Triple Crown, still feature here, which is why Oahu is perhaps the one place where surfers of all levels pilgrimage. It has breaks of every shape and size and offshore winds that create perfectly shaped and unusually long rides. Local surfer Bryan Suratt, whose family has ridden these swells for four generations, coaches such greats as Andy Irons but also offers lessons for all levels. Suratt's laid-back aloha vibe helps even first timers feel the high that every surfer, at one point, feels: a humble gratitude for the timeless power of the ocean.

Sunset Suratt Surf School offers surf lessons on many of Oahu's North Shore breaks ($100 for two hours, including equipment;

Complete the Explore Sweden Adventure Race (Sweden)

on Wednesday, August 10, 2011

Sweden makes an ideal adventure-racing venue for many reasons, chief of which is its preponderance of summer daylight. For racers tackling Explore Sweden in July, that translates to nearly 24 hours of nonstop action that can stretch as long as 670 miles (1,078 kilometers) and take between four and seven days. Though Sweden's terrain is mellower than that of other locales, the race attracts a flock of strong international teams, who, in the last six years, have transformed it into something rare: a world-class competition open to anyone.
What levels the playing field is that racers never know what to expect. Each year, the race organizers get creative, coming up with a new route and a new set of activities. In 2010, racers traveled 520 miles (837 kilometers) from Norway's high peaks, down through Sweden's river valleys, and to the Baltic coast, trekking,mountaineering, kayaking, mountain biking, and rappelling along the way. Past races have taken participants canoeing, sailing, and what the Swedes call "coasteering," or traveling sections of dramatic coastline by any human-powered means, such as swimming, paddling, and climbing. The diversity ensures that those who complete all disciplines and limp across the finish line after days of nonstop movement will have some serious bragging rights.
Explore Sweden is open to any four-person team willing to pony up the $3,500 entry fee (

Inspiring Adventure


Adventure travel encourages you to stretch your mind or your body--and often both--while having a wonderful time. It doesn't matter whether you are hiking up a 14,000-foot-high mountain in Colorado, swimming with dolphins in the Caribbean or floating over an African veld in a hot air balloon. What counts is the new ways you are seeing the world, making friends in foreign places and how you are pursuing your own definition of adventure travel.

Adventure Photos:

The debt of the United States is nothing to worry about

on Wednesday, August 3, 2011

The debt of the United States government is not a problem. Compare the following graphs, one of the assets of the United States, and the other of its liabilities. As you can see, both are growing in tandem, and the nation owes about half of what it owns. This is equivalent to a man with a net worth of $50,000 having a mortgage on a $25,000 house. His payments would be $120.36 per month. (Currently, Uncle Sam must pay 4.07% on his long-term debt.) Hardly an irresponsible situation.

The total assets of the Unites States currently total about $185 trillion. The US government currently "earns" about $3 trillion per year (tax receipts), and owes about $14 trillion. Imagine a wealthy man, who owns $185 million in real estate, stocks, bonds, gold and cash, who earns an additional $3 million per year from his businesses, and owes $14 million in outstanding real estate debt. Further, imagine that he has a tremendously low interest rate on that debt (4.07%) and that he is easily able to get a loan from any bank in the world because his credit rating is so high, and he has never been late on a payment in his entire life. This is the financial situation of the US government.

But even this is not the whole picture, because the government owes a large amount of the $14 trillion debt to itself, and to quasi-governmental agencies like the Federal Reserve, and the Social Security Trust Fund.

So, not only does this very wealthy man owe a small amount when compared to his assets, it turns out that he owes a good amount to himself ($6 trillion to the Fed and other government agencies). It's as if one of his companies issued bonds that were purchased by another of his own companies.

If we continue to think about the situation, we should realize that a man owing money to himself is somewhat of a non-issue. Further, around half of the money the United States government owes is to its own citizens, which is a bit like a father owing money to his own young children. The father always has the power to confiscate 100% of the income and assets "owned" by his children, which is also the case with the US government. If push comes to shove, Sam can simply take what he needs to pay his debts, but as we have seen above, there should be little doubt in anyone's mind that he'll be able to keep his promises without resorting to extreme confiscatory policy.

Ownership of U.S Treasury Securities

Additionally, there is much talk about social security "running out of money" soon, and being unable to pay its debts. If you take a look at its history, there is little reason to think this might be the case. If anything, the danger is that the trust fund will accumulate too much excess funding. It currently holds $2.6 trillion in assets that it will use to pay its debts, and has very rarely paid out more than it received over its entire history. The basis of this nonsensical fear is precisely that the US government owes money to itself, and most of those contemplating the situation fail to consider its true nature. It is as if one company owned by the wealthy man has issued bonds, and another owns them, and sells them on the open market in order to fund its liabilities. They forget that those bonds hold real value, as demonstrated by the willingness of the public to purchase them when one of the companies offers them for sale.

It is a mistake to think of the bonds held by the Social Security Administration simply as "debts of the United States." Those bonds are salable assets, and the total quantity of their issue is a known and widely published fact. When the bonds are offered for sale by the SSA, it isn't as if the market reacts to the offering as though the bonds have materialized from thin air. On the contrary, when the SSA trades the bonds for dollars, and subsequently hands those dollars to retired citizens of the United States, the market doesn't (and shouldn't) react in any way that is different than a hedge fund offering the same assets for sale. Those bonds have been issued, and are now distinct pieces of wealth. They happen to be debts of the US government, but there is little difference between the SSA holding $2.6 trillion in government bonds, $2.6 trillion in corporate bonds, or 1.6 billion ounces of pure gold. They are all assets, and all of them can be converted via the open market to cash.