Reading a sovereign budget

Reading a sovereign budget

by tonytran2015 (Melbourne, Australia).

Click here for a full, up to date ORIGINAL ARTICLE and to help fighting the stealing of readers’ traffic.

(Blog No.20x).

#fiat money, #deficit, #sovereign debt, #inflation, #gold, #immigration, #carrying capacity, #environment, #war reparation,

1. Meaning of Fiat Money.

Fiat money is just “Coupons for paying taxes and receive government’s goods and service”. Calling it money is just an attempt by issuers to confuse it with real moneys (like gold or food). Fiat money should not be viewed as any kind of exchangeable natural valuables but as only coupons (with various half-lives) issued by each nation to its citizens to pay to that nation its taxes, services, and state supplied goods.

Once a nation (the taxing authority) ceases to exist, so do its coupons and its fiat money!

Former USSR, Eastern European Communist Countries were with systems of fiat money not unlike current USA is.

With enough reckless printing, “easy to print coupons” may become not appreciated by its citizens and that is when we say hyper-inflation occurs to that fiat money.

There is NO MAGIC in wealth creation with printing fiat money.

2. National Yearly Budget.

Every year a sovereign government collects its taxes and pays its contractors and employees with its own “fiat money” (coupons). This is specified in its budgets. The yearly budget specifies:

Total expense (total coupons handed out during the year) which is the sum of

e1/- yearly expenses on contractors and employees,

e2/- dispense of coupons on “treasury bonds” maturing in the year.

Total income (total coupons collected in the year) which is the sum of

i1/- yearly income from tax collection (total coupons collected during the year from taxes),

i2/- collection of coupons from the issuance (sale) of “treasury bonds” which are redeemable after various specific dates in the future, and

d/- yearly addition of coupons (newly printed coupons issued during the year).

The total payment often exceeds the total income by a wide proportion and is called the deficit for the year. The deficit is equal to the amount of total expense minus the amount of total income.

Total Expense = Total Income + Yearly Deficit.

The deficit may cause uneasiness among citizens. However the deficit is of no real concern as long as the nation can continue to operate.

3. Dealing with deficits.

The sovereign may deal with yearly fluctuation of the deficit by issuing “treasury bonds” (i2) having redeeming dates on years with anticipated surplus (e2).

On the other hand, pertinent deficit is dealt with by one or a combination of the following methods:

d1/- Print new coupons to quitely devalue the existing coupons at some target rate such as 2% per year. In principle, printing an additional 2% of existing amount of coupons per year plus issuing an additional 2% of existing amount of “treasury notes” per year should cause only a loss of 2% per year of values of existing coupons. A nation with high amount of coupons in circulation and large amount of issued “treasury notes” can print large amount of coupons as well as issue large amount of additional “treasury notes”.

For USA, as of June 10, 2020, there was $1.91 trillion worth of Federal Reserve notes in circulation ( https://www.federalreserve.gov/faqs/currency_12773.htm ) and 25.986 trillion in Public Debt (https://treasurydirect.gov/govt/reports/pd/pd_debttothepenny.htm), this 2% inflation target allows the printing of 38 billion worth of additional Federal Reserve notes for that year and the issuance of 520 billion worth of additional Government Debt.

The costs are to be born by holders of Federal Reserve notes and of US Government Debts (including Treasury Bonds, Treasury Notes and Treasury Bills). These holders include other sovereign governments holding US dollars just for international trading and investments. This is called the “exorbitant priviledge” of the issuer of US dollars (https://en.m.wikipedia.org/wiki/Exorbitant_privilege). Foreign sovereign governments would be better off using gold for international trading, and there is now some movement for that.

d2/- Use gold from national treasury to buy (import) most common goods to sell to citizens to stabilize their prices in order to give the feeling that the coupons still hold their own validity. This solution to a pertinent deficit will finally exhaust the gold holding of the nation. This is also known as using gold to support currency.

d3/- Use part of national output to buy (import) most common goods to sell to citizens to stabilize their prices in order to give the feeling that the coupons still hold their own validity.This solution to a pertinent deficit requires the nation to have an ever growing output. Greenies may object against this method of having ever growing outputs.

d4/- Allow massive immigration in the hope that new migrants will contribute to future income from taxation (https://www.cbo.gov/publication/55967).

Immigration increases total economic output, though not necessarily
output per capita. It also affects the federal budget through the taxes
that foreign-born people pay and the government programs in which they
participate. https://www.cbo.gov/publication/55967

This method may backfire badly if the new migrants don’t want to pay taxes (https://www.theglobeandmail.com/opinion/swedens-ugly-immigration-problem/article26338254/).

Questioning the consensus is regarded as xenophobic and hateful. Now all of Europe is being urged to be as generous as Sweden.

So how are things working out in the most immigration-friendly country on the planet?

Not so well, says Tino Sanandaji. Mr. Sanandaji is himself an immigrant, a
Kurdish-Swedish economist who was born in Iran and moved to Sweden when
he was 10. He has a doctorate in economics from the University of Chicago and specializes in immigration issues. This week I spoke with him by Skype.

“There has been a lack
of integration among non-European refugees,” he told me. Forty-eight per cent of immigrants of working age don’t work, he said. Even after 15 years in Sweden, their employment rates reach only about 60 per cent.
Sweden has the biggest employment gap in Europe between natives and
non-natives.

https://www.theglobeandmail.com/opinion/swedens-ugly-immigration-problem/article26338254/

Even if the new immigrants are willing to work and to pay taxes, this solution to a pertinent deficit may brings to the nation a population replacement or may make the nation exceed its own carrying capacity and ruin its own environment.

d5/- Provoke wars against weaker countries to win over them and force outrageous war reparation on them (https://en.m.wikipedia.org/wiki/War_reparations).

References:

[1]. Your fiat money (Part 2), https://survivaltricks.wordpress.com/2017/01/12/your-fiat-money-part-2/.

[2]. https://www.federalreserve.gov/faqs/currency_12773.htm

[3]. https://treasurydirect.gov/govt/reports/pd/pd_debttothepenny.htm

[4]. https://en.m.wikipedia.org/wiki/Exorbitant_privilege

[4b]. https://outofthecave.io/articles/you-want-to-talk-privilege-ok-lets-talk-privilege/

[5]. https://www.cbo.gov/publication/55967

[6]. https://www.theglobeandmail.com/opinion/swedens-ugly-immigration-problem/article26338254/

[7]. https://en.m.wikipedia.org/wiki/War_reparations

Added after 2020 July 11th.

[8]. https://larspsyll.wordpress.com/2020/07/12/the-deficit-myth-a-review/

New? Cranks? Reading one of the founders of neoclassical economics, Knut Wicksell, and what he writes in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise) soon makes the delusion go away:

… It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank …
A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system …
We intend therefore, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers.

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The “Mean Realizable Present Value” of a future income

The “Mean Realizable Present Value” of a future income

by tonytran2015 (Melbourne, Australia).

Click here for a full, up to date ORIGINAL ARTICLE and to help fighting the stealing of readers’ traffic.

(Blog No. 3xx).

#inflation, #present value, #inflation discount, #probability,

Many investors have run into losses due to their blind application of inappropriate valuations. They just blindly buy a bond if it is sold at less than its “present value” and thought that they have bought such a thing at a discount only to find out later on that they have paid too much.

Here I propose that they should use a more appropriate “mean realizable present value”
instead of “present value” for stream of incomes such as bonds.

1. The “present value” commonly used by investors.

The “present value” of some future income is an amount of money needed at present to buy and store a wealth to match that income when it arrives.

The present value of an uncertain future income is therefore also uncertain like that income.

Common application of “present value” to a stream of future incomes has simply equated it to the “inflation discounted value” of that stream of income.

For example, when a bond issuer commits to pay the bond holder 3 yearly installments of 1000 dollars each, the “present value” of that bond is often valued by only compensating for inflation to be

1000×(1-Inf) + 1000×(1-Inf)×(1-Inf) + 1000×(1-Inf)×(1-Inf)×(1-Inf)

At a rate of inflation of 3% per year, it will be

1000×(0.97) + 1000×(0.97)×(0.97) + 1000×(0.97)×(0.97)×(0.97) = 2911 dollars.

Many investors have run into losses due to their blind adoption of such inappropriate “present value” for their bond. They just blindly buy the bond if it is sold at less than 2911 dollars and thought that they have bought a “debt at a discount”.

If and when the bond issuer goes bankrupt, they lose all uncollected payments and the reality is they receive much less than the 2911 dollars of inflation discounted value in their formula.

Therefore such definition of “(inflation-discounted) present value” is inappropriate for investors. It is proposed here that investors should use instead the “mean realizable present value” defined as in the following.

2. The “mean realizable present value” of a future income.

It is more appropriate for investors to use a “mean realizable present value” of a future income defined to be the “mean of all possible present values” from that income.

Figure 1: The question is “Would you exchange 1 bird in your hand for 3 birds in the bush?”.

For example, when a bond issuer commits to pay the bond holder 3 yearly installments of 1000 dollars each, the “mean realizable present value” of that bond should be valued according to the following.

1000×(1-Inf)×(Pr. of 1st payment) + 1000×(1-Inf)×(1-Inf)×(Pr. of 2nd payment) + 1000×(1-Inf)×(1-Inf)×(1-Inf)×(Pr. of 3rd payment).

At a rate of inflation of 3%, the present value of that bond will be

1000×(0.97)×(Pr. of 1st payment) + 1000×(0.97)×(0.97)×(Pr. of 2nd payment) + 1000×(0.97)×(0.97)×(0.97)×(Pr. of 3rd payment)

It is equal to 2911 dollars only if the Probability of each payment is 1, that is when there is no possibility of any default.

Generally the present value of that bond will be

1000×(0.97)×(Pr. of 1st payment) + 1000×(0.97)×(0.97)×(Pr. of 2nd payment) + 1000×(0.97)×(0.97)×(0.97)×(Pr. of 3rd payment) << 2911 dollars.

Using the past records for the survival of new small companies we can guess the probabilities of survival for any new small company in Australia as:

Prob. of surviving longer than 12 month = 66%,

Prob. of surviving longer than 24 month = 66%×90% = 59%,

Prob. of surviving longer than36 month = 66%×90%×90% = 53%.

Therefore the “mean realizable present value” of a bond issued by a new small Australian company will be

1000×(0.97)×66% + 1000×(0.97)×(0.97)×59% + 1000×(0.97)×(0.97)×(0.97)×53% = 640 + 555 + 484 = 1679 << 2911 dollars.

So the “mean realizable present value” is only 1679 dollars, a much lower value than 2911 dollars of “(inflation-discounted) present value” often advocated in uncritical financial analyses.

3. Dependence on the survivability of the payer.

crystalballc70.jpg

Figure 2: A crystal ball is needed to determine accurately the probability of any given company surviving in the future.

The difficulty in working out the probability of survival of the payer is one essential problem in investment.

The disadvantage of using “mean realizable present value” is that the probabilities in use may NOT be agreed upon between transactional parties whereas the “inflation-discounted present value” has always been mutually accepted as the analysis based on the best case.

However, using this new “mean realizable present value” gives a more appropriate valuation for investors. It presents a combination of the current “present value” and the commercial “rating” of that income. This “realizable present value” reduces to zero when the payer goes bankrupt and the “inflation-discounted present value” is only the upper limit of this “mean realizable present value”. The upper limit is reached when the payer survives past the final payment.

4. Conclusion

This “mean realizable present value” of an income stream can be applied to the income streams of bonds or of commercial loans. If it is used instead of the “present value” in the balance sheet of any economic entity the balance sheet of that entity would give a better estimate of its net worth.

This “mean realizable present value” explains to investors why some certain company issued bond may become worthless when the chance for the company to survive to repay to its bond holders vanishes. The value does increase and decrease with market conditions and can better quantify the market values of “loans” hold by any lender (or bank). It would be easy for investors to then understand the sudden vanishment of “wealth” hold by banks or investment funds.

Using these “mean realizable present values” the balance sheets of central banks may also look vastly different after they bought all bonds on the markets to support all companies on the Stock Exchanges.

References:

[1]. Inflation is vicious to fiat money users posted Mar 29th, 2017.

[2]. Investors-beware-dividend-growth is misleading, posted on September 01, 2017

[4]. Why does the Federal Reserve aim for 2 percent inflation over time?, Board of Governors of the Federal Reserve System,https://www.federalreserve.gov/faqs/economy_14400.htm, updated January 26, 2015, accessed 03 Mar 2017.

[5]. Your fiat money, posted January 9, 2017.

[6]. Your fiat money (Part 2), posted January 12, 2017.

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Real life lessons on national economics.

Real life lessons on national economics.

by tonytran2015 (Melbourne, Australia).

Click here for a full, up to date ORIGINAL ARTICLE and to help fighting the stealing of readers’ traffic.

(Blog No. 167 ).

The current time is quite interesting as it allows the testing of many economic theories. After that, some theories will gain credential while others may get forgotten.

#inflation, #economy, #Venezuela, #Argentina, #Turkey, #dollar,#currency #yuan, #gold based, #oil based

Real life lessons on national economics.

1. Venezuela and its wealth from oil.

Venezuela was a wealthy country living from its sale of oil. The 1998 Venezuelan government by Hugo Chavez then played with the game of commanding the economy and sent its economy crashing and then into hyperinflation.[1]

“Chavez used the abundant income stream to go on a spending spree as he instituted a large number of entitlement programs using the oil revenues. A strike in 2003 interrupted Chavez’s plans and caused the GDP to crash by 27 percent in just four months. Chavez began nationalizing industries and instituting price controls, which was the beginning on Venezuela’s inflationary spiral as Venezuelans developed a reliance on their government for products and services.” [2]

Once hyperinflation has set in, people would avoid using the rapidly depreciating fiat money, and bartering is the only mean for survival.[3, 4]

“If somebody has lots of one thing and too little of another, an arrangement can be made. I’ve exchanged corn meal for rice with friends from high school, eggs for cooking oil with my sister-in-law. Street vendors barter, too, taking, say, a kilo of sugar as payment for one of flour. There are Facebook pages and chat-room groups devoted to the swap-ability of everything from toothpaste to baby formula.” [5]

This should be a lesson to leftists everywhere [6] that even a once rich economy of Venezuela cannot endure the incessant waste of scare resources to FEEL GOOD on everything politicians can dream of.

2. Argentina with its policy of excessive protection for domestic industries.

In its pursue of industrial self-sufficiency the government had given excessive protection to domestic industries turning them into non-competitive. This caused a shortfall in the productivity and tax contribution. Subsequently the government had to rely on debt or inflation or both. These are the root cause of its current inflation:

” Successive governments from the 1930s to the 1970s pursued a strategy of import substitution to achieve industrial self-sufficiency, ”
“The era of import substitution ended in 1976, but at the same time growing government spending, large wage increases and inefficient production created a chronic inflation that rose through the 1980s… also contributed to the huge foreign debt by the late 1980s, which became equivalent to three-fourths of the GNP” [7]

Import substitution and industrial self-sufficiency are quite respectable aims for its economic policy. Argentinian economy could have benefited from them even if locally produced substitutions carried higher prices than available imports. However this approach always carry with it the danger of over-pampering domestic industries. The people in charge of domestic industries may decide to take a free ride to enrich themselves by supplying the domestic industries with obsolete or substandard production methods (for kick backs) rather than with best methods for the nation. [8, 9, 10]

When the cronies are in control, they borrow like mad to build everything so that they can get a cut (kick back) on every project. After that the country will be left with mountain of debts and prestigious but substandard or even useless projects [11, 15]. Cronyism is the cause for the backwardness of socialist countries.

“But just after Argentina settled with the “holdouts” in 2016 on defaulted dollar-bonds dating from its last default, it sold new foreign-currency bonds, in all kinds of issuances, including in June last year $2.75 billion of 100-year bonds at a yield of 7.9% and in January this year $9 billion of bonds, composed of five-year bonds at a yield of 4.625%, 10-year bonds at a yield of 6%, and 30-year bonds at a yield of 7%.”[16]

“ET: This shows that the government’s policy is an abject failure: with a peso that devalued fast; with the interest rate set at a high 40% by the Argentine Republic’s Central Bank; with the $ 8 billion reduction in international reserves that keep declining. And with a debt service that has increased by 100% compared to 2017. Faced with a balance sheet of such a nature, undoubtedly it is a total failure. Macri claimed that a high growth level and a viable debt would be ensured by paying the debt – between end-2015 and early-2016 – and by compensating the vulture funds, in keeping with Judge Thomas Griesa’s verdict. He knelt before the vulture funds (see: [17]). But the facts confirm that this plan did not work. Debt rose at a whirling pace and it’s startling to see how fast it snowballed. As a result, it became impossible to convince the creditors that Argentina could repay its debt in the future.” [18]

“Argentina’s currency is in free fall… The slump threatens to spread havoc through the $640 billion economy, rupturing supply chains for businesses and straining the finances of households.” [19]

Australia and Argentina were economically very similar prior to 1970. They then followed different paths from 1980: Senator Button of Keating’s government dismantled the over-protection for the car industry in Australia. That brought forward a wave of modernization. Currently Australia is in much better shape than Argentina [20, 21].

3. Turkish lira versus the US dollar.

Monetary policy is typically implemented by a central bank, while fiscal policy decisions are set by the national government. However, both monetary and fiscal policy may be used to influence the performance of the economy in the short run.

” It helps quantify the effects of the recent economic chaos in Turkey. Turkey’s economic future remains uncertain, but the reality is that their currency has devalued as a result of large fiscal deficits and heavy borrowing used to make up the revenue shortfall. Inflation is not the cause of the problem; it is a symptom. The cause is the dramatic increase in the supply of lira designed to solve the poor fiscal condition.”[22]

Turkey is an interesting case. The country is a bridge between Western countries and Middle East countries and is not far from Russia. That country relied on its membership in NATO to shoot down a stray Russian fighter jet ! It then mended its bad relation with Russia and went on to antagonize USA with its threat of re-polarizing its foreign policy.

Although Russia now allows Russians to have holidays in Turkey and China is courting it with the OBOR plan (“One Belt One Road” or rather “Once Borrowed Only Regret”? [23]), Turkey’s currency lira is now in trouble partially due to US tariffs imposed on Turkey’s goods.

4. US dollars are being pushed back into their national territory by China, Russia and the Silk Road Alliance.

US dollars are only fiat money [24] after Nixon’s removal of their ex-changeability for gold. They are only useful to people who have to pay tax to and pay for service from the American government. They are absolutely useless to foreigners who don’t have to pay tax to or pay for service from the American government. Having US dollars as a medium for international trade is a privilege to USA: There are more holders of that currency, the pool of dollars in circulation is therefore vast. That allows American government to quietly “tax” all its currency holders, domestic and international, through inflation [25].

American exploitation of this privilege position [26] with its imposition of banking sanctions against many countries has led to the (irreversible ?) push for using gold or oil as exchange medium in international trade [27, 28, 29, 30].

5. Conclusions

This is an interesting time for studying economics. Most theories can be tested and sorted out during this short time. Blind belief in fiat currency is now questioned everywhere.

The leaders of nations have to learn now that there is always a reaction to every of their actions.

References

[1]. http://www.dailymail.co.uk/news/article-6032367/Venezuela-price-chaos-gasoline-costs-just-one-Bolivar-egg-costs-200-000-times-much.html

[2]. https://straightlinelogic.com/2018/09/05/paper-money-eventually-returns-to-its-intrinsic-value-zero-by-alex-deluce/

[3]. https://survivaltricks.wordpress.com/2016/12/05/preparing-for-%e2%80%8bcashless-trading/

[4]. https://survivaltricks.wordpress.com/2017/02/20/cashless-bartering-for-survival/

[5]. https://www.bloomberg.com/news/articles/2018-05-04/in-caracus-venezuela-a-haircut-costs-five-bananas-and-two-eggs

[6]. https://abackwoodsconservative.wordpress.com/2018/09/09/obama-claims-the-current-economy-as-his-and-yet/

[7]. https://en.m.wikipedia.org/wiki/Economic_history_of_Argentina

[8]. http://nomadcapitalist.com/2016/05/30/the-5-worst-countries-for-crony-capitalism/

[9]. https://en.wikipedia.org/wiki/Crony-capitalism_index

[10]. https://www.heritage.org/international-economies/report/cronyism-and-corruption-are-killing-economic-freedom-argentina

[11]. https://www.bbc.com/news/world-latin-america-31639768

[12]. https://www.afr.com/news/world/south-america/china-on-the-march-in-latin-america-with-new-space-station-in-argentina-20180730-h13c95

[13]. https://uk.reuters.com/article/argentina-china-idUKL2N0PT0IK20140718

[14]. https://www.ft.com/content/2d264e78-8cf9-11e5-a549-b89a1dfede9b

[15]. https://www.dw.com/en/chinese-loans-helping-latin-america-amid-oil-price-slump/a-18284605

[16]. https://www.businessinsider.com/the-imf-could-push-argentina-from-a-currency-crisis-into-a-debt-crisis-2018-5/?r=AU&IR=T

[17]. http://www.cadtm.org/Reject-the-Imminent-Agreement-with

[18]. http://www.cadtm.org/The-IMF-is-back-in-Argentina-an-economic-and-social-crisis-even-more-serious

[19]. https://us-issues.com/2018/09/04/argentina-currency-crisis-pain-is-spreading/

[20]. https://en.m.wikipedia.org/wiki/Economy_of_Australia

[21]. https://en.m.wikipedia.org/wiki/Economy_of_Argentina

[22]. https://straightlinelogic.com/2018/09/06/what-turkey-can-teach-us-about-gold-by-michael-lebowitz/

[23]. https://survivaltricks.wordpress.com/2018/06/17/expansion-by-predatory-loans/

[24]. https://survivaltricks.wordpress.com/2017/01/12/your-fiat-money-part-2/

[25]. https://survivaltricks.wordpress.com/2017/03/29/inflation-is-vicious-to-fiat-money-users/

[26]. https://en.wikipedia.org/wiki/Exorbitant_privilege

[27]. https://www.reuters.com/article/us-global-dollar-analysis/dollar-decline-rekindles-reserve-currency-worries-idUSKCN1GJ2XW

[28]. https://www.forbes.com/sites/nathanlewis/2016/05/05/china-is-laying-the-foundation-for-the-next-world-gold-standard-system/#305670a7689e

[29]. https://www.zerohedge.com/news/2018-03-30/yuan-oil-futures-contract-gold

[30]. https://www.rt.com/business/438162-us-dollar-crash-jim-rogers/

Added after 2018 Oct 10:

Dedolarization
[31]. http://www.alt-market.com/articles/3544-the-world-is-quietly-decoupling-from-the-us–and-no-one-is-paying-attention

[32]. https://www.presstv.com/Detail/2018/10/26/578126/Russia-China-Swift-Alternative

[33]. https://www.rt.com/business/442410-gold-demand-up-dollar/

[34]. https://socioecohistory.wordpress.com/2018/10/27/gold-demand-up-42-as-countries-abandon-us-dollar-in-expectation-of-geopolitical-shift/

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, , , , , Cashless bartering for survival, Federal Reserve Bank charges undeserved fees to Americans., A satirical guide to signs of an impending crash for small investors, Your fiat money (Part 2), Your fiat money, Bankers given outrageous incomes by their boards, Signs pointing to an impending crash for small investors,Bankers earn more than interest margin on secured loans, Can most pension funds last?, … all

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Inflation is vicious to fiat money users.

Inflation is vicious to fiat money users

by tonytran2015 (Melbourne, Australia).

Click here for a full, up to date ORIGINAL ARTICLE and to help fighting the stealing of readers’ traffic.

(Blog No.57).

#inflation, #fiat money, #taxation by stealth, #indexation, #cost of living

Figure 1: Fiat money are paid to government employees. All citizens have to pay their taxes with that fiat money.

Inflation is vicious to the citizens who have to accept fiat currency from their ruling government. It is half terrible as having to use money with some use-by dates. Only governments like inflation.

1. Inflation.

It is convenient to begin the discussion with my previous posting entitled Your Fiat Money, part 2 (reference [1]). It is easily seen that the government can choose to pay its employees X units of its fiat currency C1 and require the whole population to pay it all taxes amounting to X units of that currency. The fiat money C1 will find its own value in the population depending on how government employees interact with the whole population of the country.

Alternatively, the government can choose to pay its employees Y units of another fiat currency C2 and require the whole population to pay it all taxes amounting to Y units of currency C2. Again the fiat money will find its own value in the population.

As other things are equal, we must have

X*C1 = Y*C2

and the value of a fiat currency is inversely proportional to the amount issued by the government to its employees.

Consequently, if all other things are unchanged but the government increases both the payment to its employees and the tax to be collected by 3% every year then its currency is worth only 100/(100+3) its former value one year ago. This is called an inflation at a rate of 3% per year.

2. Inflation is a rent on fiat money.

After selling his stock, a trader has cash (which is fiat money), he will have to use his cash to buy new stock. If he holds on with the cash for one year, he can buy only (100-3)% of what he could have bought immediately. This works as if he was renting the cash from the government at a cost of 3% a year.

The long standing wisdom is not renting anything you don’t really need and people should not keep cash longer than it is absolute necessery.

Any government will love inflation. It is its best next thing to issueing money with expiry dates and un-redeemable government bonds, vouchers (Old scams but still can be practiced against illiterate, trusting populations)

3. High inflation may feed on itself.

Remember that the fiat money will find its own value in the population depending on how government employees interact with the whole population of the country.

When high inflation occurs people may try to increases prices in anticipation, causing even more severe inflation.

People may then even try to avoid using any fiat money at all and they may choose their own alternative bartering medium such as food (rice grains or flour) or commodities (gold or silver) instead of the readily available but steadily depreciating fiat money.(see [4,5,6,7] for bartering techniques). Such avoidance of fiat money brings even more loss of its value and deepens the inflation.

When inflation is too high, the ruling government may lose its grips on the economy and chaos may follow (as in Germany prior to 1933).

4. High inflation reduces actual interests on government debentures/treasury bonds.

Inflation is to be subtracted from the interest rate given by any government debenture/treasury bond.

The inflation rate is hard to obtain but it must be taken into account when buying government debentures.

Unless the after tax return from a government debenture/treasury bond is higher than inflation, the bond holders may actually LOSE money on their bonds.

The interest rate given on Government Debenture/Treasury Bond is determined at the time of sale while actual inflation is made after that time. A government can easily wipe out its debts to bond holders by producing very high inflation. (see [10]).

5. Inflation rips off members of pension plans.

The loss caused by inflation on cash based holdings (rents on cash) also applies to long term storage of values such as saving for retirements.

Unless inflation has been taken into account, most perceived benefits of pension plans can be only just mirages given to uninformed plan members. To have any real benefit after tax and INFLATION, plan members usually need cash contributions/injections by the government and if they don’t obtain them there will arise the problem of unfunded liabilities.

In most cases, the contributed funds of any pension plan cannot earn any net income AFTER tax and INFLATION. If there is no cash contribution/injection by government, plan members would be MUCH better off using their contributions to buy gold and save the gold for their own retirements.

Vietnamese standardized gold slabs for trading

Figure: Vietnamese standardized gold slabs for trading.

The imminent run (insolvency) of pension plans are only the tip of the iceberg.(see reference [8]).

6. Inflation produces a stealthy wealth tax.

Inflation actually produces stealthy, disguised taxes on your properties.

When you change your house, as you have to move to a new location for new jobs, the value of that succession of similar houses keep on increasing due to inflation. Governments can classify the increases as “incomes” and impose taxes on them. Some governments have already done that. This type of FALSE incomes may also be extended to include your other possessions such as cars, jewelleries, housegold goods and gold holding.

These taxes on FALSE incomes are actually taxes on your possessions such as your houses and the tax rate depends on inflation. Your legislative representatives will not bother to make yearly oversight of it and the governments easily get away with it.

The federal authority may have encroached on the rights of member states if it makes property taxes! So the federal authority has to do it under the guise of income tax on false incomes produced by inflation.

Note added on 15 May 2017:

Only recently, the US State of Arizona admitted that gain/loss made from gold holding is not subjected to Income Tax of that State.[11]

7. Inflation causes non-synchronized price increases.

Inflation causes uneven, non-synchronized price increases due to different flow on times for different types of goods. This allows the government to put unfair short term weighting factors on individual types of consumer goods. The weighting factors let the government artificially select them to manipulate the yearly statistics on the Cost of living to lessen its obligation to pay pensioners their entitled upkeep.

8. Inflation forces people to borrow.

Inflation forces people to borrow with any purchase plan stretching over many years. A buyer would lose to inflation on his cash accumulation/saving if he wants to remain debt free and save up the whole amount for the purchase. House purchases are typical examples where buyers are forced to borrow.

9. Inflation gives government unfair advantages in charging taxes on citizens.

When you made a huge loss and claimed a carried forward loss to offset against possible future gain in calculating income tax, the loss is NOT indexed by inflation! So a loss of $1000 by a future trader in 2010 can only offset against a gain of $1000 in 2017! (Although $1000 in 2017 is worth much less than in 2010)

10. All governments love inflation.

A government loves inflation for the following reasons:

1. Inflation is a rent on its fiat money.

2. It can define False incomes and tax its citizens on the false incomes.

3. It can muddle statistics on Cost of living and the government can fool the world with its manipulated figures on the growths in GDP, GNI.

4. It allows government to gain unfair advantages over its tax payers when calculating their taxable incomes.

So the claims that Inflation is preferred to deflation by governments should be read with skepticism. Unfortunately, the statement has been told often enough and for long enough so that a number of tax payers have started to believe in it without questioning. (A lie told once remains a lie but a lie told a thousand times becomes the truth, by J. Goebbels [9].)

References:

[1]. Your fiat money (Part 2), posted January 12, 2017.

[2]. Your fiat money, posted January 9, 2017.

[3]. Why does the Federal Reserve aim for 2 percent inflation over time?, Board of Governors of the Federal Reserve System,https://www.federalreserve.gov/faqs/economy_14400.htm, updated January 26, 2015, accessed 03 Mar 2017.
[4]. Neha Sharma and Shalu Yadav, The Indian village that has returned to bartering, BBC News Services,http://www.bbc.com/news/world-asia-india-38180075, 5 December 2016.

[5]. Patrick Bodenham, Will Spain’s coal belt survive through online barter?, BBC News Services,http://www.bbc.com/news/world-europe-38731808, 2 February 2017.

[6]. James Melik, Haggling and bartering gain appeal, BBC News Services,http://news.bbc.co.uk/2/hi/business/7883050.stm, 12 February 2009.

[7]. Mark Lowen, Greece bartering system popular in Volos, BBC News Services,http://www.bbc.com/news/world-europe-17680904, 12 April 2012.

[8]. Dallas police fire pension board ends run, bank stops 154m withdrawals. http://www.dallasnews.com/news/dallas-city-hall/2016/12/08/dallas-police-fire-pension-board-ends-run-bank-stops-154m-withdrawals
[9]. Joseph Goebbels quotes, azquotes.com, http://www.azquotes.com/author/5626-Joseph_Goebbels.
[10]. https://www.moneymetals.com/news/2017/05/04/higher-inflation-consumer-prices-001061, (added on 10 May 2017).
[11]. http://www.zerohedge.com/news/2017-05-13/arizona-passes-bill-end-income-taxation-gold-and-silver
References added after 2017 November:
[12]. http://www.gold-eagle.com/article/deepening-crisis-hyper-inflationary-venezuela-and-zimbabwe
[13]. https://us-issues.com/2017/11/21/social-security-inflation-lag-calendar-partial-indexing/

[14]. http://www.silver-phoenix500.com/article/fed%E2%80%99s-%E2%80%9Cfrankenstein%E2%80%9D-policies-are-about-turn-their-master

[15]. https://mises.org/wire/dollar-dilemma-where-here

[16]. https://straightlinelogic.com/2018/08/04/how-inflation-destroys-civilization-by-nick-giambruno/

Added after 2018 Aug 15th:

[17]. https://www.silver-phoenix500.com/article/anatomy-hyperinflation

[18]. https://us-issues.com/2018/08/19/anatomy-of-hyperinflation/

[19]. https://akahinews.com/2018/07/29/venezuelas-bolivar-currency-worthless-as-inflation-hits-1-million-percent/

[20]. https://dailyarchives.org/index.php/history/1046-ben-bernanke-says-hitler-was-the-guy-who-got-economics-right-in-the-1930s

[21]. https://yapaholic.com/2018/08/19/us-national-debt-heres-what-you-need-to-know/

[22]. https://www.caseyresearch.com/how-inflation-destroys-civilization/

[23]. How Venezuela’s crisis developed and drove out millions of people, https://www.bbc.com/news/world-latin-america-36319877

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