Inflationomics

The More Government Does, the More it Takes Away

When a government taxes you, most people would agree that it’s taking away a percentage of your money.  And because time is money, a taxing government is taking away a percentage of your life.  If it takes 50% of your income, it owns 50% of you.

Tax codes distort markets. For example, the U.S. tax code – originally written in the 1920s – goes easy on those who own investments or their own business and makes things more difficult for those who are employees. Landowners can “trade up” for better property without paying taxes on the exchange, business corporations can deduct expenses from their income BEFORE paying taxes on that income, and investors can benefit from a lower (capital gains) tax rate. If you know the tax code and adjust your behavior for the lowest rate, its rules will change and shape your life even more.

The term “inflation” is similarly distorting. While most people think of it as rising prices, most of you who read this site know that inflation is the practice of printing money.  When a government decides to meddle with the supply of its currency by artificially increasing its currency’s supply (its quantity), this may, in turn, raise goods' prices, thus requiring currency holders to hold more units to keep the same purchasing power.

Fortunately for governments, and not so fortunately for their citizens, the first few entities to spend the newly-printed currency (such as the central bank, government agencies, and government contractors) get to spend it before the prices rise. The money printers take a small fraction out of every citizen’s dollar, euro, pound, etc., and use that to their own benefit, taking a little “tax” from everyone else.  To most people, it’s an invisible tax.

Just as parts of the tax code affect different people differently, the inflation “tax code” affects different industries differently. Banking and financial services suffer more because one source of their income, interest, involves lending money out and getting paid back in less valuable dollars—though they also benefit by being first in line to borrow from the Fed. Farmers and some manufacturers suffer less because they sell something valuable to everyone—because their costs will rise, they may have to shrink their products instead of raising prices to keep customers happy. Government contractors, be they in health care or defense, can simply raise their prices to the government which taxes or prints more money.

But, while the tax code is mostly static and gives people time to adjust, inflation is constantly shifting based on where the government chooses to spend its newly-printed money. Because of that, it’s even harder to predict who will benefit and who will lose, or what the appropriate “winning” behavior is.

Still, there are a few predictions that seem pretty certain: the U.S. will be spending a lot on the military this presidential term. Military spending goes toward things like meals for soldiers, ammunition, ships, vehicles, and aircraft, which don’t really add much to civilian prosperity in the American economy.  In fact, depending on your opinion of the wars in the Middle East, you might well argue that we’re throwing our money down the drain. Either way, the spending won’t “stimulate our economy” in a way that helps students pay off their loans or baby boomers survive their retirement.

How much will we lose? If you believe the official inflation rate, then we’ve been averaging 2-3% inflation since the 1980s, which means our currency lost half its value by about 2010, and will lose half its value again by 2040, if we continue at that rate. You can imagine why it might be difficult to retire at 65 if your money is worth a quarter of what it was when you graduated from college!

So, what’s the lesson to take from all this? Don’t trust the government to take care of you OR your currency, and just remember that every time you ask the government to do more, you ask it to take away a bigger percentage of someone’s life.

Roland F. Sennholz

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