Thursday, August 12, 2010

Monetary Policy & 2% Inflation: For Whose Benefit?

Monetary policy is controlled by the Federal Reserve Bank. Our central bank, The Fed, has a number of tools in its tool box to either control or influence the growth of the money supply. (Just forget about monetary base, M1, M2 and M3.)

Yesterday on a TV news show, I heard someone say that The Fed fears deflation and would like to see 2% annual INFLATION in the United States. Now, I would like everyone to read that sentence again. The Fed would like to avoid deflation, and at the same time, The Fed would like us to experience 2% inflation in the coming year. Why? Because they fear a slowing in the economic recovery.

My question is: What if you are a wage earner and you don't care to use leverage (borrow money), but would like to live in a country with, say 1/10th of 1% inflation every 5 years. At that low rate of inflation, it would make sense to save your money in a savings account because the purchasing power of the dollar would remain intact. Think about a monetary policy that would be geared to the needs of the savers rather than the needs of the borrowers.

In such a monetary environment, investing in the capital markets, the stock market, would be a choice, not a necessity. As a result, large pension funds would find a level playing field in order to attract their funds for equity investments.

The bankers and corporations would not like this kind of monetary policy. Half of the fun of using leverage is to be able to pay off your debt with inflated dollars.

Now, perhaps, those of you who have been reading MONEYTHOUGHTS over the last few years will understand why I do not like the way our Federal Reserve Bank runs monetary policy. I fully understand that The Fed is charged with helping the growth of our Gross Domestic Product (GDP), but should it be at the expense of all those people that work as wage earners and see their savings erode over the years from inflation?

A 2% annual inflation rate calculated over 50 years means that saving your money for retirement is pointless. You and everyone else in this boat are literally forced by the reality of our monetary policy to invest in the capital markets if you are going to have anything for your retirement.

If investing for ones retirement is the only sane game in town, then should it not follow that the investor, public pension funds and individuals, have a level playing field. Should not the SEC protect the investor against unethical brokers, dealers, underwriters and credit rating agencies?

Stay tuned.

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