Monday, August 04, 2008

There's Your Answer. But....

When an economy contracts, people stop spending money. Goods and services that people normally consume then go unused and prices eventually go down to a level at which people are enticed to continue consumption. As prices come down, the value of money is effectively increased. This is deflation.

If the government decides to fight a contracting economy by adding to the amount of money in circulation, that is called inflation. Governments do this by spending more on government services than they take in on tax and other revenues. Loaning out money at interest rates that are less than the lowest estimates of current inflation also is a way that the government can add large amounts of new money to the economy. More money circulating means people have more money to spend on goods and services and prices go up. They hope that the increase in monetary supply will stimulate the economy and it will expand by more than can be explained simply by the addition of more money into the economy.

There is no mystery as to what is happening in the economy today or for the last fifty years. There has been continuing, substantial, inflation. The government would like to say that this is not true, especially now that the American economy has reached a crisis point on so many fronts, mortgage defaults, bank failures, energy availability, budget deficits, disintegration of the manufacturing sector, international trade imbalances, rising unemployment and decreasing real income to name a few.

You only have to ask yourself, "Is my dollar worth more or less?"

There's your answer.

Remember, inflation is not always a totally bad thing. If the government adds enough money to the economy so that people can easily pay off their mortgages, banks will stop failing and the prices of houses will start to appreciate. Likewise, if they continue to add money to the economy, the debt that the American government owes becomes immaterial. If this happens though, several other systemic problems will arise. These problems may be worse than the original ones.

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