How government eats your lunch and leaves you with the bill

This is a follow-up from a post a couple of days ago entitled “The economy becomes the free lunch” wherein it’s explained how the government controls the Rand money supply and in the process exchanges nothing for something, in effect stealing wealth from society.

At first glance it may seem like there are little consequences to the government being able to finance itself through the SARB at a fraction of the cost of capital in the economy, but alas, here we deal with a prime example of “that which is not seen.”

Think of your own personal financial situation. When do you have the ability to increase the amount you can spend on groceries, clothes, entertainment and car repayments on a monthly basis? You’ll likely answer that you can spend more on one category if you spend less on the other. Or you may answer that you can spend more on all items if you have more money at your disposal.

Increased earnings in excess of your annual CPI-adjusted salary will likely come with increased experience and skill, which translates to higher efficiency, aka increased productivity. The other way you can earn more is for you to increase your hours worked in the week, for instance working overtime. In either of these two scenarios, you’re exchanging increased productivity or labour for an increase in remuneration.

Let’s assume your neighbour’s salary remains unchanged, while your salary has doubled in April 2010. You now have the ability to spend twice as much on your monthly shopping while your neighbour doesn’t have room to increase his spending. You, as an individual with a salary that has doubled, now have the ability to pay a price twice as high as before on the same basket of goods. This means you can pay more than your neighbour on goods without sacrificing your standard of living.

Note again that this process is concomitant to an increase in productivity and harder work on your part, which effects to lower the price level as a more efficient and harder working employee lowers the cost of production in an environment of an unchanged money supply.

Now we contrast this with the government and its panacea for all economic ills: the printing press. The government has the ability to increase its own ‘salary’ so-to-speak by issuing government debt which is bought by our big banks (primary dealers) in daily, weekly and monthly auctions, and is then repoed back to the SARB in exchange for freshly printed Rand bills. This is a fact and you can read about it here on the SARB website.

While you are working harder, being innovative, and more efficient to increase your salary, the government prints money to increase its ‘salary’. This increased salary is created through the banking system which is the third leg in the money-printing tri-fecta. The government and banking system are the main benefactors of this new money creation, they are the ones who always see an increase of their ‘salaries’ first, while the rest of the economy sits and waits for the flood of new money to enter the system once the newly-enriched have decided what to spend their increased money on. Government and banks get huge bang-for-their-buck.

The same process now applies as discussed earlier on the level of comparing you and your neighbour. Only you are now the neighbour who is living next to someone who’s increased his salary by printing money in his garage. With its now increased ‘salary,’ government can bid up prices in the economy, while others in the economy cannot do the same. This process which carries on perpetually in the fiat currency monetary system is what drives inflation, as monetarist Milton Friedman once famously said: “Inflation is everywhere and always a monetary phenomenon.”

The government spends newly created money, not by being productive, more efficient and increasing hours worked, but by printing money. This means it is exchanging nothing for something. It doesn’t mean it’s really getting a free lunch, it just means you pay for it through having your wealth erased by inflation (not the CPI kind).

As the government through this process pumps up the money supply and spends on goods and services it deems appropriate to boost economic growth, people who are not connected to this inner circle of money creation unfortunately draw the short-end of the stick as by the time they get to ‘handle’ the newly created money, three, four, five or ten exchanges down the line, they get less bang-for-their-buck, as they also have to deal with prices that have been bid higher by others before them. This is the real reason why inflation impoverishes the poor in society the most. But don’t hold your breath for government to tell you this.