Prosperity is Not Inflationary

By: Michael Pento | Mon, Jun 5, 2006
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This morning the Bureau of Labor Statistics reported that there were 75,000 non-farm jobs created, fully 100,000 short of the increase predicted by economists. Astonishingly, traders are already celebrating this number as "the best of all worlds," believing that less employment is actually good for an economy! In a bizarre example of twisted logic, conventional wisdom views this number as being inflation friendly and S&P futures are trading higher as investors become more optimistic that the fed will finally halt its rate hike campaign of 16 consecutive 25 basis point increases.

Why are the fed and the market concentrating so intensely on the number of people employed? Because they still believe that prosperity in the form of low unemployment rates and high G.D.P. rates promote inflation. That myth should be eradicated from the minds of those who are chosen to be stewards of our economy.

In order to prove this point, let's set up a few simple scenarios in a closed system in order to draw some obvious conclusions. First, we will test the idea that higher rates of G.D.P. are inflationary. Under our sample barter system there exist two entrepreneurs, one makes shoes and the other makes bread. In this micro system, there are only one pair of shoes and one loaf of bread and the one loaf of bread is equal in value to one pair of shoes. What happens if through productivity gains, the shoe maker is now able to produce two pairs of shoes?

If the shoes are sold they would be counted as consumption and if they are inventoried, they would be counted as investment. Under either scenario the increased production would raise G.D.P. What then occurs is that the purchasing power of the shoes decreases infinitesimally, as the purchasing power of the bread increases infinitesimally and the exchange value of shoes to bread remain virtually constant. No one would contend, however, that it now takes 2 pairs of shoes to purchase one loaf of bread. The real change in the value of the shoes is miniscule because the shoes maintain their intrinsic value since the product has real worth.

Now, let's change the scenario and say in a fiat currency system there exist $1 and one loaf of bread. Similarly, one loaf of bread can be exchanged for the dollar. If, by fiat, you introduce another dollar into our system, the loaf of bread would cost approximately $2 and the purchasing power of the existing currency decreases by 50% (inflation). The reason why the currency was debased while the shoes held most of their worth is because money has no intrinsic value. The holder of the newly printed $1 bill knows it is not backed by anything and was acquired without any concomitant effort. Therefore, he is willing to part with $2 for a loaf of bread.

Only a tangible good that can be traded and stored will retain its value. Similarly, if growth diffuses equally across all goods in a system there are no changes in values, just more wealth and prosperity. However, if the supply of money outstrips any good, inflation occurs vis-a-vis that good and anyone who is not hedged to protect against inflation would experience a decline in his standard of living.

Much the same as strong economic growth, higher employment allows for the production of more goods with which to absorb liquidity, so it the amount of money in this system remains constant, there can be no inflation. The truth about inflation is that it can exist in an economy regardless of G.D.P., wage or employment growth. When the Federal Reserve says is wants to curtail economic growth, it is euphemism for their desire to slow the rate of monetary growth because the fed knows that real growth is much lower than reported. Problem is, the Fed is rarely serious about curbing money supply.

There is one more fact about inflation that needs to be explained. When the Fed feels it has created too much money and needs to soak it up, it issues new debt instruments. Between March 2005 and March 2006 the national debt rose 6.71% from $7.75 trillion to $8.271 trillion. As of April 2006, the number stood at $8.395 trillion, which is 65% of G.D.P. Once money is invested into U.S. government debt it is no longer counted as part of the money supply. This debt accrues interest, and at some point, the principle must be paid. When that occurs the money is reintroduced into the monetary aggregates, which means the rate of money supply growth is actually understated.

That brings us back to today's economic data. Would it not be better if the fed sought to restrain monetary growth and promote prosperity, instead of striving to put more people on the unemployment line?

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Michael Pento

Author: Michael Pento

Michael Pento
Chief Economist
Delta Global Advisors, Inc.

Michael Pento

With more than 16 years of industry experience, Michael Pento acts as chief economist for Delta Global Advisors and is a contributing writer for He is a well-established specialist in the Austrian School of economic theory and a regular guest on CNBC and other national media outlets. Mr. Pento has worked on the floor of the N.Y.S.E. as well as serving as vice president of investments for GunnAllen Financial immediately prior to joining Delta Global.

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