Monday, February 27, 2012

When to Pray for Inflation, Currency Devaluation and Global Fear

Why would the Fed (the Federal Reserve Bank of America) want higher inflation?

Think about it. It's so they can make more money.

This is how I see it:

If inflation goes out of their target range on the upside, they use monetary policy to increase the interest rates to bring the inflation back into target range. Debt costs increase and this supposedly forces people to spend less to avoid the increased cost of the debt. Which, in turn forces consumer prices down to encourage more spending - i.e. lower inflation. But, on the flip side, where does the Reserve Bank (South Africa and the USA) make their money? Interest. If they are targeting the inflation rate by increasing interest rates, it has a very simple effect of MAKING THEM MORE MONEY.

What does this mean though? Let's break it down to a very simple calculation. If the South African inflation rate is sitting at around 4.1% and the American inflation rate is sitting at around 2.7%, what does this mean for you if you have money (cash capital) sitting in the bank? If it's sitting in S.A., it's losing value faster than if it were sitting in the USA. (These rates were at the time of writing this article).

But this is a pretty minuscule difference and will only really be felt by the super-rich, so it doesn't warrant any action, especially if we add currency fluctuations and interest earnings into the mix.

So, let's look at the currency quickly. The US Dollar has taken a beating across the board over the last year. Why? Was it on purpose? I think so, but I am no economist. I just try look at all the data with an open mind to see what specific incentives might be driving devaluing of the USD. And my conclusion of many hours of research is this - The U.S.A. is purposefully trying to inflate it's way out of the incredible debt it has. There are a host of reasons for this, but I'll go into that in another article some other time, as there are far too many to list here. What I will mention though, is that the new debt ceiling allows the US government to borrow more money (up to nearly $17 trillion) and they are already talking about QE3 (a third round of quantitative easing - basically printing more money later in 2011). At the same time, the more the currency devalues, the higher the inflation, the more the Federal Reserve Bank can use inflation targeting as an excuse to raise interest rates.

So who wins with this scenario? The U.S.A. inflates away large chunks of it's incredible debt. The Fed can use inflation as an excuse to raise the interest rates so it can effectively make more money. And the average consumer (namely us) is stuck in the middle with no control whatsoever over any of this.

How does this affect South Africa? Well, keep in mind that the USD plays an incredibly important part in the international financial system. It is the reserve currency used as the base measurement for pretty much all international trade. When the US dollar devalues against the Rand, it doesn't necessarily mean that the Rand has become stronger (it just means the USD has become weaker). But it does mean we sit facing very difficult problems due to our heavy reliance on exports for a large portion of our GDP. In fact, haven't you noticed a few articles recently about the S.A. government taking specific measures to devalue the Rand? If you haven't, take a look at these articles and do a bit of research for yourself:

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