In a prior episode, John Flaherty and CEO Keith Weiner discussed the intricacies of inflation, its definition, and the monetary and nonmonetary forces at play. This time, they go a little deeper.
- The simplest definition of inflation
- How to properly measure inflation
- One universal belief that is absolutely wrong
- Two pending consequences of the Fed’s current activities
John Flaherty: Hello again and welcome to the Gold Exchange podcast. I’m John Flaherty. I’m here with Keith Weiner, founder and CEO of Monetary Metals. Today, we’re going to continue our discussion on the topic of inflation. Last week, we laid some groundwork with some definitions, and I’d like to start by reinforcing those. So, Keith, last time we talked a little bit about the flaws in the mainstream definitions of inflation, I’d like to hear crystal-clearly, how do you define inflation?
Keith Weiner: It’s the counterfeiting of credit. It’s when you call it borrowing, but you have neither the means nor intent to repay. And often the lender doesn’t even know he’s lending. So when people hold dollars today, they don’t think they’re lenders, they don’t think they’re creditors, because the system has trained them – from grammar school on – to think of the dollar as money.
And they have definitional logic for that as well. “Money is the medium of exchange. It’s true, the dollar is the medium of exchange, therefore the dollar is money. Therefore, if you have a dollar, you have money. And you can lend it if you choose to, but you can hold money if you don’t.”
But actually, the dollar is itself a credit. So the lender doesn’t know, the lender doesn’t agree to lend. I’ve had many discussions with many different people over the years who think that interest rates have to go higher because of the risk of default with the Treasury and so on. And I say, if you don’t like lending to Treasury, what are you going to do? He said, “Sell the Treasury bond.” But you’re still holding a credit slip. That’s the credit slip of the Fed, which finances the Treasury.
There’s there’s no way out. They’ve closed all the…in 1933 by making the dollar irredeemable to Americans, it’s like we’re all animals penned in a pen and they’ve slid shut the last gate. There isn’t any way to get out of it. And that’s not well understood, obviously.
John: So just to restate, inflation is an increase in the amount of borrowing by the Fed. Is that accurate?
Keith: Well, no. I mean, there’s a lot of different kinds of counterfeit credit and not just the Fed and also the Treasury, major corporations as well. It’s a counterfeiting operation. You can say an increasing quantity, but I don’t really prefer to put the focus on quantity, per se. I prefer to put the focus on the fact that there’s something not only morally corrupt about it, but economically wrongful and obviously unsustainable as well.
There are consequences to creating fraudulent paper that occur in the system, and it’s doing all kinds of damage.
John: All right. Well, if we’re focused on the principle and not quantity, then then how do we answer the question of how do we properly measure it? How do we properly measure inflation?
Keith: I mean, I guess short a short answer would be…and you wouldn’t be that far off… just look at the increase in the combination of the the Treasury’s debt, which is virtually all counterfeit at this point. So it’s a little bit of it is not the Treasury borrows from the bond market and then it lends to various third parties, including students. And some of that student debt is actually good, although much of it isn’t. If you’re getting a student loan to become an engineer and make a lot of money and solve problems, the world needs solved, then I’d say that isn’t really counterfeit. The lender still doesn’t really realize it.
So if you look at how much the Treasury debt is increasing, that would be a good first pass. And then if you look at how much the Fed debt is increasing, taking out how much of it is financing the Treasury, you don’t want to double count it, the Fed is financing other things, including bad mortgages, bad business loans and all kinds of other rubbish now on their balance sheet, that would be a good thing to add into it.
John: OK, so if I understand this, and we talked about this a little bit last time, inflation as a concept really has very little to do with rising prices or prices of goods in general, period. Is that right?
Keith: Yeah, that’s right. Most people assume that there’s a nice, simple relationship between…if you increase the quantity of what they call money, they either call that increase inflation or they believe that there’s a direct effect and that prices will rise if you increase the quantity of what they call money.
And so the word inflation either refers to the increase in the quantity itself or the inevitable and marginal increase in the prices that occurs. And so you get confused statements like Milton Friedman saying “Inflation is everywhere and always a monetary phenomenon” by which at that moment I believe he means prices rising as a monetary phenomenon, although often he’s using inflation to mean increasing the quantity of dollars.
John: So the Fed has a target of two percent inflation. Now, again, we’re dealing with two different definitions here. What is the Fed definition of two percent inflation? Is it just CPI? How do we reconcile this?
Keith: Yeah, the Fed is looking at the consumer price index and of course, it’s making another fallacy in that assuming that purchasing power is intrinsic to the currency. That how much groceries you can buy with your dollar bill is inherent in the dollar bill itself. So they’re saying that they want the dollar bill to go down in value as measured by the inverse of consumer prices. They want consumer prices to rise at two percent per year, and that’s what they mean by, two percent inflation.
John: OK, so they’re after two percent. First of all, why do they think inflation is a good thing? I’ve heard someone say what’s wrong with everyday low prices. Right? And then, why is two percent the magic number?
Keith: Right. So what’s wrong with everyday low prices? You know, they have their stated reason. For an article for Forbes that I wrote some years back when Obama had appointed Janet Yellen to be the new Fed chair. I think I wrote that right before she actually became Fed chair. But she’d been ratified by the Senate. So, to write this article about her…she’s considered to be, at least on the left, an expert in the economics of labor and how labor intersects with monetary policy and monetary theory.
So I dug up her seminal paper that she coauthored with George Akerlof, another PhD economist who also happens to be her husband, and I went through it. And when you strip away all the gobbledygook and the abracadabra presto change-o, incantations and all that, you come down to a very prosaic little core of what she’s saying. And I think this kind of captures the essence of…at least this is the rationalization…this is how they sell what they’re doing. And then I’ll tell you what the real thought is.
And so, again, this is kind of a labor oriented theory, but you can see how this probably applies to other things as well. She says that if workers feel that they’re underpaid, they will slack off, be passive aggressive, and they may even sabotage the tools that they’re given by their employer, if they’re really pissed off enough at how low their wage is. So employers have to give them a raise.
But since there’s only a finite budget for payroll, then the more you pay each worker, the fewer workers you can employ. And therefore we have structural unemployment. So what’s the solution to this? As you can imagine, from a monetary crank, the solution is the Fed is going to print more. And this is going to somehow enable employers to pay more and therefore all the workers can get the wage they want and you can hire all the workers because now you have as much budget as you need because the Fed has printed it.
Now, she does concede..I was going to say grudgingly, but I don’t think she was grudging. I think she was more brazen, absolutely owning up to, “Yeah, that’s going to cause prices to go up and that’s fine. And the workers are going to figure that out and the workers, the unions, and everybody is going to demand raises and all that. But,” she says with a sly wink and a nudge, “We can get inside their decision loop. We’re creating inflation, it takes them some time to realize the game and demand a raise. And it’s that delay in which we can live with our monetary policy. And by the time they demand raise because of the inflation, we’ll print more in order to accommodate that raise. And we’ll keep the game going.”
This is literally the core of her seminal paper that I’ve just outlined. So in my Forbes article, I debated whether I should call this evil and mendacious and all that. I think I settled on calling it frivolous. But that’s sort of the essence of it.
Now, that’s the stated reason. The real reason is they’re trying to ease the burden on the debtors. If you owe money, at whatever amount that you owe, and then they devalue the money…and if it were true that everything was a nice linear, OK, well, now the money is worth less because instead of being able to buy 10 loaves of bread with your paycheck, you can only buy nine loaves of bread, then that means that money is worth less and therefore you’re making more of it.
So there’s a bunch of assumptions in there that don’t necessarily hold true. Then by debasing the money, you make it easier on the debtors, including the federal government, to service their debt. Everything that the Fed…forget CPI and forget unemployment…everything is really about enabling the government to borrow more than it otherwise could, so they can spend more than tax revenues and buy votes. And then the overarching prime directive that the Fed has is to make sure that all the debtors, including the marginal debtor, can get enough dollars to service their debt.
So they figure, well, by debasing it, then that’ll make it easier.
John: So is the two percent kind of what they figured back to your Janet Yellen example that they can get away with?
Keith: Well, so Janet Yellen in that paper, as I recall, never actually gave the magic number. And I used the term magic number and magical thinking to describe this whole thing. If two percent is good, why not three percent?
Now, Milton Friedman, and his so-called K percent rule did propose three as the right number, back then.
John: But where did he get that?
Keith: It’s all magic, it’s all, you know, astrology and tarot cards and eye of newt and burning incense and sheep entrails under a Midsummer’s Eve moon. It’s magic. I mean, it’s the same thing with the minimum wage. If fifteen dollars is good, why not fifty? Why not 500? Why not 50,000 dollars an hour?
John: Right. But, still trying to anchor this to what the point you were trying to make or what Yellen was trying to make. And that is, if you can stay ahead of the riots, then you’re going to try to introduce a rate that will keep the riots at bay. Do I have that right or is there more to it?
Keith: Leaving aside my mockery of the magical thinking of it, yeah, internal to those discussions is going to be ultimately what I call a cynical calculus of, “How much can we get away with?”
If you dispense with all principles and you say “I’m against principles on principle, I just want to do whatever works” then what’s the standard for what works? I mean, without principles, how would you even define working versus not working? And ultimately it comes down to getting away with it, right?
So if the peasants revolt and they bring the torches and pitchforks and then they put you head up on a pike, then you didn’t get away with it, so it didn’t work. If you can keep the game going another year, then it worked.
And that’s the only standard that…I was going to say that these people have. But it’s the only standard that could be had. There could be no other standard for committing a…for running a counterfeiting operation. Other than, “Well, let’s not get too greedy. Let’s not kill the goose that lays the golden egg. Let’s just steal the ax.”
Keith: Right. It’s whatever you’re getting away with.
John: All right. So, Keith, I think the most important question that I was hoping we could get to on this episode was…we’re all familiar with the stats. Since 2008, all these dollars have been created. All this counterfeit credit has been injected into the system. Right.
And for all this time, the prophets of doom have been sounding the alarm that hyperinflation is right around the corner. We haven’t seen anything close to that. Why can’t the Fed achieve its stated goal of two percent inflation as they define it? And now that we’re in kind of a hyperdrive stage of this with the pandemic response and another two trillion coming down the pipe here, won’t this cause inflation?
If it didn’t in ’08 and hasn’t since then? We’re starting to see real estate explode in different places again and in different commodities. Wood, gas…your thoughts on this topic?
Keith: This is one of those perverse things that everybody from the hard left to the hard right, the socialists, the supply siders and the libertarians, everybody agrees that if you increase, roughly, if you double the quantity of dollars, then maybe with delays and maybe unevenly, some parts of the economy, you know, respond a little bit differently than others. But roughly, you should double the general price level. That’s universally believed. And it is absolutely wrong.
It just isn’t true. So the Fed can’t achieve their goal of two percent rising prices by increasing the quantity of dollars by either two percent or 20 percent, so in the wake of Covid, the Fed increased the quantity of dollars by an obscene amount, as they did in the wake of the previous crisis. And since the theory is wrong, then it doesn’t work out in practice the way the theory predicts. It’s that simple. You’re just wrong. So when counterfeit credit is created and issued, you have to say, well, what is it going into and what is the consequence of going into that?
So, it’s going into the bond market. It’s going into lowering interest rates. So if the Fed is buying more bonds, this is oversimplifying my theory of interest and prices, but…if the Fed is buying bonds, then all else being equal, the price of the bond is going up, which means interest rates are going down.
What that’s doing is that’s enabling everybody from hamburger stands to pencil manufacturers to farmers, to you name it…. it’s enabling everybody to borrow more to increase production. So if you’re if a hamburger restaurant and you’re staring at your spreadsheet that says, OK, we open up a new store, we’re going to get three percent return on capital for that store, and the interest rate is three and a half percent. Obviously, you’re not going to do it. And then the Fed lowers the cost of the interest rate and your cost of borrowing goes down to two and a half percent.
They’ve made your business case for you. Now you’re going to go and get that loan and open up a new hamburger store. So what happens to the price of hamburgers if you and all the other hamburger chains are borrowing money to open new stores? The theory says prices are going to rise. Supply and demand says there’s now just whatever, double the supply of hamburgers within the town. Supply and demand says what’s going to happen to the price of hamburgers? Not rise, obviously.
So people neglect that, that the interest rate, the interest expense is a major component, and whether anybody makes their business case or whether they fail to make their business case. So you push interest rates down and you get all these perverse things.
I want to talk about lumber a little bit. In a supply chain…and I’ve written a lot about how this happens in gold. Gold in the global bullion market isn’t necessarily scarce. However, the machinery that can precision mill a coin blank is highly inflexible. And so you can end up with a shortage of coins when there’s no shortage of gold in the bullion market, in either kilo bars, 100 ounce bars, 400 ounce bars…there’s no shortage there, but there’s a shortage of one ounce coins. Or in silver, even more extreme.
So in the case of the lumber market, it turns out that years and years and years of falling interest rates has incentivized lots of different investment groups. And there’s actually investment funds out there that buy up land and plant trees.
The amount of trees that are available for harvesting is off the charts. Enormous quantities of trees are available. However, because there’s a boom and bust to this whole thing, sawmill capacity is not necessarily high. And so the sawmills are able to buy dirt cheap logs from the landowners that are growing them.
But in the wake of the pandemic, the interest rates dropped so much, you can get a 15 year mortgage for well under two percent. And a 30 year fixed mortgage, it looks like current rates are about two and a half percent. So it’s so cheap, and of course, there’s also people fleeing the cities. You actually do have a change in supply and demand for real. It’s so cheap that everybody is building new houses. Probably half of them are investment properties. Everybody’s moving out of the city and buying a home in the suburbs and everybody’s remodeling, all of which drives demand for lumber.
So you have a real change in demand, which is skyrocketing. You have inelastic, at least temporarily, sawmill capacity. And then on the other on the other side of the sawmills, you have way more forest land ready to sell logs than you have sawmills that can actually cut it. And so the sawmills are making a mint right now, and if you combine high profit margin and low interest rate environment, what would we predict is going to happen in sawmill business? With a suitable lag for environmental permitting and all of that? Rising margins to run a saw mill, falling cost of interest to finance building a new sawmill, we’re going to get the building of new sawmills.
Keith: And probably just in time for the building boom to end. And so the return on capital in the sawmill business is going to plummet to be no better or maybe even worse than the return on capital everywhere else. Classic.
John: So then what are the conditions that would lead to hyperinflation? Can it be avoided? And what role, if any, is gold likely to play in the solution?
Keith: Everyone just is focused on the quantity of dollars, and I’ve debunked that idea.
I have a different theory. So I’m going to tie together two different ideas. But they all integrate together in the currency ultimately.
The first is that our system today, in fact, this is socialism’s goal. This is what socialism always does. And it’s not a bug, it’s a feature. Socialism seeks out capital to consume and to destroy.
Look at the latest socialist proposal from Elizabeth Warren, a wealth tax they literally want to take away…I think it’s two percent in her case…of whatever wealth you and your family have managed to accumulate over whatever number of years, decades or centuries that you’ve been accumulating it. They literally want to take it away so that they can dole it out for consumption. Give it out as welfare, spend it as pork, or whatever it is they want to do with it. And so that’s what socialism does.
Our monetary system incentivizes capital consumption by driving asset prices up and so people then sell assets to make a gain. I’m way oversimplifying my yield purchasing power theory, but as asset prices are going up, it’s a process of conversion of one party’s wealth into another party’s income to be consumed. Nobody wants to be the prodigal son and consume your own capital.
So a lot of people might balk at the idea if you a house and the value went up to borrow against that house in order to go on a consumer binge. A lot of people would feel uneasy about that. A lot of people wouldn’t – they do that happily. But I think normal people wouldn’t want to do that. But, if they sell the house, then essentially the borrower is doing the same thing for them. The borrower, or the buyer, is borrowing in order to give them that increased amount. And then whatever the increase is…let’s say they bought the house for one hundred thousand. They sold for four hundred thousand. There’s a 300 thousand dollar profit.
And they could take that some of that 300,000 and consume it. And so our monetary system, in a myriad of ways, is making an incentive to consume capital. And the problem with consuming capital…and Mises, as well as Ayn Rand, used the term “eating the seed corn.”
So picture you’re a farmer on the frontier, every year you have to plant your crop. And so you set aside a certain amount of grains of whatever crop you’re growing in a bin. And that’s for seed. You dare not eat that. No matter how bad the winter gets. You don’t eat that ever. Because if you do, you won’t plant a crop next year. And if you can’t plant a crop next year, then the following winter you’re going to starve for sure. What capital consumption is, a good analogy is eating the seed corn. So they’re incentivizing eating the seed corn. Well, there’s a finite end to that, and that’s when you run out.
And so we’re going to run out. And in fact, the rate of eating the seed corn is growing exponentially. When we run out, then there’s a real problem because the paper currency, which is…you can sort of think of it in a way, as being backed by all the future production. When you’ve finished off the capital, consumed it down to the last bit of consumable, you’ve destroyed it’s…there’s no longer any ability to produce the goods in the future.
The goods will become genuinely scarce. It’s not a matter of rapidly rising quantity of dollars chasing fewer, you know, the same goods. The goods actually goes down. Obviously, demand for food is inelastic. And so when food becomes genuinely scarce, as you see in places like Venezuela, the prices skyrocket. It’s not entirely monetary, although the monetary system caused it.
The other half of this, the other side of the coin is that the Fed is in a way playing a game. And that the Fed issues its liabilities. The Fed borrows off the public and off the banks and off of everybody in order to finance its purchase of, we’ll say treasury bonds, but there’s other junky assets in there as well.
So the Fed has a balance sheet. It owes X amount and it owns X amount worth of somebody else’s debt. When the Fed is buying good assets, let’s say Treasury bonds, so long as the government’s paying the interest on those Treasury bonds, then the Treasury bond holds its value, at least in dollar terms. Maybe not in gold terms, but in dollar terms.
And Fed meets two conditions for solvency. One is its assets are greater than its liabilities…so it’s fine. And then, two, the interest income that it receives from its assets is greater than the interest expense it has to pay for its liabilities, or its borrowings. So that’s solvent. And as long as the Fed is solvent, you don’t see the hyperinflation. And so everybody has been predicting hyperinflation over the last 12 years now has missed that point. But what happens if the Fed suddenly has assets less than liabilities and interest generated from its assets is less than the interest expense that it pays on liabilities?
Well, then it started to print money not to buy assets, but to finance a negative cash flow. That’s a spiral that will get out of control and then ultimately destroy the currency. So those are two things that are inevitably coming as a consequence of what the Fed is doing and what’s already set in motion. It’s already baked into the cake. It’s a matter of time.
John: So can it be avoided and can gold help?
Keith: Yes. So I’ve written a paper called Using Gold Bonds to Avert Financial Armageddon. And I’m saying that the problem with the dollar is that there’s no way to extinguish a debt. We pay a debt using dollars. The dollar is itself a debt. So all we’re doing is shifting the debt around while the total debt accumulated in the system is growing exponentially. And there’s no way out. If you set up a gold bond market and then all the dollar debtors issue gold bonds in a certain way, as I proposed in that paper, then you can essentially substitute gold bonds for paper bonds and get out of debt because gold debt can actually be repaid and extinguished.
So if the powers that be are willing to transition to a gold standard using this mechanism, then there is a way out. And that’s that’s what my hope is. And that’s obviously part of Monetary Metals’ goal is to bring about that day. In the meantime and on the current trajectory, no, there’s there’s no way out.
John: All right, Keith, well, as usual, we appreciate your insights on this complicated topic. That’s all we have time for today. Thank you for joining us on The Gold Exchange.