Too Big to Fail?

The argument is familiar. Just like AIG and General Motors, California says it is too big to fail.

And once again, I say: LET IT FAIL. Let’s stop the bullshit, printing fake money so we can try to pump life into zombie banks, insurers, automakers, and states – all at taxpayer expense. Let’s talk about inflation for a moment. Let’s talk about letting the markets correct themselves, painful as that may seem to be.


I’ve watched a few of those Zombie movies. And I know that you cannot stop the Zombies by appeasing them with money. The only way to stop them is to chop off their heads. The fiscal equivalent is to let the big insurers, banks, automakers – and even states, take bankruptcy and reorganize. It’s not the end of the world, and it isn’t the taxpayer’s mandate to shore up institutions who don’t understand basic fiscal responsibility.  Don’t we remember “The Boy Who Cried ‘Wolf’”?

Inflation is seldom defined. Inflation is simply  a decline in the value of money. This simple definition gives us insights into what causes inflation and why we might be concerned about it. It also provides insight into how we attempt to measure inflation.

Milton Friedman was famous for pointing out that inflation is  a monetary phenomenon. If the amount of goods stays the same and the monetary authority increases the amount of money, then it will take more money to buy the same amount of goods, which means that prices will rise. That’s the classic definition; it is as objective as gravity.

This is why we frequently define inflation as  “prices rising”. This  should make it clear that inflation cannot be caused by monopolies, or unions,  or decreasing taxes. It is always caused by the supply of money rising faster than the supply of goods.

If the supply of goods falls but the amount of money in “circulation” remains the same, then we can have the same effect, so it is possible for a restriction in production to cause inflation if the monetary authority does not decrease the money supply to match the reduction in production. Think OPEC, although they haven’t really been very successful.

Inflation, unchecked, can become hyperinflation:


The above is a Zimbabwean 100 Billion Dollar note, along with the number of eggs it can currently purchase. With hyperinflation, the currrency becomes effectively worthless and the population resorts to the use of other currencies or barter.

The Federal Government attempts to measure inflation through the use of various indices. The most popular of these is the Consumer Price Index (CPI). The basic idea is to see how much a basket of goods cost in a base period, currently 1982-84, and compare it to today’s cost of the same market basket.

Right away you can see some problems with this. For example, a 1982 computer will not be the same as a 2009 computer. An iPhone won’t be in the 1982 market basket at all,  whereas it might well be in the typical market basket today.

As prices of some goods rise and the prices of other goods fall the average consumer will gravitate towards the goods with falling prices and away from goods with rising prices. Since some government payments, such as Social Security, are indexed to the CPI, there is some political interest in how this measure is determined as well. For this and other reasons, the Government has been known to “tinker” with these formulas.

Economists recognized some time ago that the Federal Reserve was increasing the amount of money as a mechanism to solve the credit crisis, which was to a certain extent caused by prior Fed policy, and warned that we would be seeing a rise in inflation as a result.

We aren’t seeing “much inflation” – yet. Gold, oil, etc – a little bit.  But it can take years for the effects of the current ENORMOUS monetary expansion to be felt in the general economy. Sooner or later, especially when and if the current slowdown turns into a recovery – you will begin to see the effects. We’ve created more money in the first 100 days of the Obama Administration than was spent to finance the entire Iraq War from 2003 to 2008.


A look at the adjusted monetary base of the US shows that we have created a nearly 40% growth rate in money supply in the last 12 months. Clearly, this meets the definition of future inflation.

Not only that, but we are coming out of the bottom of the lowest solar activity in decades. Once Solar Cycle 24 gets moving and we see more sunspots and solar radio activity, this 11 year cycle tends to exacerbate inflationary pressures. Interest rates go up, commodity prices go up, and “inflation” goes up. The British economist Ralph Hawtrey wrote "It is after depression and unemployment have subsided that inflation becomes dangerous."

Bailout Mania

Taxpayer bailouts are a terrible mistake. They would subsidize the shoddy management practices of the corporate bureaucrats at General Motors, Ford and Chrysler, and would reward the intransigent union bosses who have made the UAW synonymous with inflexible and anti-competitive work rules.

Bailouts of U.S companies, banks, and insurers also would be a mistake, as would bailouts of homeowners, states or any other constituency. If politicians genuinely want to help the economy, they should focus on reducing the burden of government, not increasing it. The reason why California is in such trouble is because it has too much government and not enough income to pay for it. California doesn’t need a bailout. It just needs to learn to balance it’s checkbook  like you and I do.

So, what can you do to protect yourself? Well you can buy oil and gold, and other commodities. Mining stocks may be better than pure gold since they pay great dividends. There are also oil drilling trusts that behave similarly. And, don’t expect the stock market to make any major moves up. Right now, it’s ready for another major decline.

Don’t shoot the Messenger.