This is trivially true (all civilizations end, the sun burns out, nothing is permanent) but the relevant timeframe is usually one's lifetime, and the stability of the currency over that timeframe is more important.

>> you're paying compound annual interest to the central bank in exchange for nothing

You're paying that "interest" in exchange for a more stable currency, a supply of liquidity that allows for progress/growth . If the central bank is doing its job reasonably well, that is. You may also be paying for the "feature" of money that allows you to transfer value to your future self with relatively little risk.

Not sure it is Trivially, fait can go to zero, gold for example can not as there are other uses for it... Perhaps, like good design, the more timeless option might be the better:-)

You're paying that "interest" in exchange for a more stable currency" who pays for whom might be the better question with who is to benefit.

Where did you think the interest on t-bills comes from?

So "who it benefits" is simple: Whoever buys treasury bills.

The intrinsic value of gold is a lot greater, but probably still only a small fraction of its general market value; its very reputation as synonymous with tangible wealth serves to paradoxically inflate its value.

Gold, on the other hand, has a naturally limited supply and has notable uses. It's reputation as a symbol of wealth is not only because of the cost, but also because there's not enough for everybody. If there was a limited supply of denim, we'd see a big comeback in Storm Riders.

It's like owning a Tesla - it's not just a $100k car, it implies that you're a somebody.

Assuming you count the current economic problems as a fiat/currency crisis, it was a period of 35-40 years - 1933 to 1971 is 38 years, 1971 to 2009 is 38 years.

That is a lot less time than a civilization declining or the sun burning out.

I have always thought that a better model would be to call it 'dilution' instead of inflation since this is the primary mechanism in operation. 'Dilution' would draw a natural comparison with shareholder's equity being diluted by a new share issuance. Inflation makes it sound like something that is either inevitable or is a good anti-dote to the notorious 'Deflation'

In the words of the great George Carlin, "The game is rigged! It's a big club and you ain't in it."

The only conspiracy theory mentioned in the original post that survives this analysis is the idea that the Fed, somehow, is taxing people by inflating. Yet steady inflation is an essential ingredient of monetary policy, since it must be possible to have interest rates below the inflation rate. Almost all important economists, including those of the ardently anti-government Chicago school, agree on this point.

It's only fitting that you quoted George Carlin at the end of the post. He's another person who likes to talk about things while displaying no interest in actually understanding them.

1. Taxation.

2. Going into debt.

3. Printing money.

(And plunder, actually, which is more of an ancient practice.)

The USA finances itself mainly with #1 and #2, with our creditors being sovereign funds, banks, and individuals. Foreign countries are dropping out lately, and individuals and banks are sure to follow. Would you loan the government money for a sweet 0.4 percent yield? It can't be maintained. The yield will rise, and the government either pays more for credit, cuts back expenses, or raises taxes. All painful. But if there's a central bank, well, that third option comes up. All the big wars of the 20th century were paid for in part this way. Inflation is not like a normal tax, but is a wealth levy, and while nobody would approve of the government taking 50 percent of their total possessions, almost everyone is fooled by the printing press...

Some other people suggest that "not holding dollars" is the solution. Doesn't work. In mass inflation, your income typically doesn't index correctly, and you have to sell assets to survive. People were selling pianos for bags of potatoes in the Weimer republic.

(economics neophyte question) Why is that?

That would be bad news in a situation such as, for example, right now, where a massive credit collapse is greatly increasing the demand for money. To keep the economy stable the Fed must print money. They're doing it by buying long-term debt, which is the best they can do but is disruptive to the debt economy.

If you live in zimbabwe, whenever you receive currency, you immediately try to exchange it for something else, either another currency or goods. If you can choose to accept payment in a different currency (ie: by leaving the country), you do.

You can't opt-out of your currency inflating, but you can often choose how much to hold of it. How much currency do you actually have? I bet most of your net-worth is in non-currency. If you own stock and that currency inflates, the amount of dollars you can get for that stock goes up - you don't hold currency. Even savings rates tend to track inflation, if you are a bank and know that the money loaned to you will be worth less in the future, you can offer to pay more interest for the opportunity to use the money now.

It isn't as if the fed can extract interest on all economic value, just all dollars, which is a relatively small fraction of stored economic value.

Interesting as your website is and your forthcoming book sounds to be, I find it hard to reconcile with the rather naive viewpoint expressed in the post above.

To be sure, currencies are only as good as the governments that stand behind them, and many governments have adopted mercantilist monetary policies at different times so as to shield their domestic markets from foreign competition. It is also true that any government administering debts denominated in the country's on currency are tempted to inflate them away, indirectly taxing the citizenry.

On the other hand, ownership of specie (hard currency), although a useful hedge, is no guarantee against economic hardship. In addition to deflation and the resulting economic distortions, at numerous times through history those with large holdings have seen it confiscated by fiat, or quasi-inflation can result from debasement/ seignorage and coin clipping. The Bank of England had a currency crisis back when Isaac Newton was master of the Mint due to disparities between the perceived relative values of gold and silver. I could go on, but my basic point is that you can abuse a hard currency almost as easily as a fiat one.

besides, if central banks issuing fiat currency are so evil as to steal from the pockets of the citizenry via inflation, why do all the largest and most powerful central banks fight against inflation using their control over interest rates? I'm honestly confused by your apparent ideological slant.

Good point that hard currency is not a guarantee against economic hardship - quite true. Nothing can provide that guarantee, but specie is often a better option than most: hard currencies like gold are impossible to counterfeit or produce out of thin air, and the supply is constrained by real-world production, which limits pricing fluctuations or sudden inflation/deflation. Prices have been relatively stable for centuries: an ounce of gold today and an ounce of gold 200 years ago could buy the same amount of physical goods, be it barrels of oil or a fine suit. Fiat currency devalues quickly: a few short decades ago, a nickel would buy a soda or a candy bar, at a similar margin to the manufacturer and retailer. No longer.

Debt is what banks sell. Deflation hurts the most when you're highly leveraged, and it's hard for borrowers to pay back debt if money becomes more valuable than when the debt was originated, which is bad for the bank. Under the guise of "fighting inflation," these banks are altering conditions that will help sell more debt and ensure (as much as possible) those debts will eventually be repaid. Control over interest rates is beneficial to the banks because it allows them to sell more debt, which tends to inflate asset bubbles, as bokonist mentioned.

There's a reason the founders of the US set gold/silver as the official currency and fought strongly against the establishment of a central bank - monetary debasement is a centuries-old issue. It's not a huge surprise it happened eventually, since there's a huge incentive for financial interests to establish this control if they can. It's telling, however, that it was done quickly and in secret, and the inner operations of the Fed are private to this day.

In the end, most countries sell out their currency in exchange for the promise of stability and certainty, which the central banks ultimately can't provide - their interventions create massive second/third/fourth order effects, many of which make the system less stable. The banks don't care, as long as more debt is sold - they benefit from the system until it collapses, at which point they move to a new one.

As to ideological slant, I have the same view of monetary dilution as I do of debasement / seignorage / coin clipping - it's theft, the taking of property without consent. The argument "it's for your own good," which seems to be the rationale behind allowing this to continue, doesn't hold much water when the parties that do it are the major beneficiaries.

Cash has always been a relatively poor investment, useful only because its convenience and liquidity are second to none. Inflation serves both of these purposes. If you don't want to use dollars, you CAN invest in stocks, gold, or just get chickens for bartering.

Seems like the beneficiary of the "interest" is anyone who holds debt against that currency. For instance, if I borrow $1k from a good friend who charges no interest, and pay him back in a year, the $1k he receives at the end of the year will buy him less than it would have previously.

In practice an lender does charge interest but assuming that interest rates, like any other product, is priced not by cost but by what the market will bear, the lender must bear the cost of inflation.

>> there's no way you can opt-out outside of reverting to bartering for goods directly.

Bartering for goods _can_ carry the same risk of inflation if others are able to flood the market with competitive goods. But in a single-currency system we have a central agency that is able to produce money without producing wealth. And producing money without producing wealth is what leads to inflation.

No, you get currency. If you don't want to hold fiat currency then you don't have to. The problem is that barter is really really annoying and inefficient, so we came up with something better. A reasonable rate of inflation (e.g. < 2%) is a small price to pay.

Legal tender laws, prohibitions on issuing alternative money/coinage, and taxes on other forms of money are ways in which government forces its citizens to use its currency. If the currency were really so good, people shouldn't have to be forced to use it.

Regarding currency, government apologists are like commissars who, while preventing their citizens from leaving the country, loudly proclaim that they are better off than their capitalist neighbors.

We need not necessarily be suspicious of the Fed, however, in devaluing fiat currency. It might be easier to think this if you think of interest rates and inflation differently. Interest rates set by the Fed, like the federal funds rate or the discount rate, and inflation are actually negatively correlated. That is, the lower the interest rate, the higher the rate of inflation that will ensue as the monetary supply expands and more goods/services are produced. This is the rationale behind our low interest rate during the recent recession. The interest rate is more of a price on the available credit. A low interest rate makes borrowing more attractive, and thus investing into a new project (rather than borrowing on consumer credit for mere consumption like jewelry or a mortgage for a house that you can't afford) will increase. Instead of thinking of interest and inflation solely as finance charges, think of them as prices of credit/investing and controlling supply/demand of goods in the macroeconomy.

So making the comparison between the Fed and JP Morgan or any private bank in terms of interest rate charging and inflation is misleading. Private, publicly traded banks have the sole goal of high returns to their shareholders. It may help to understand the calculation of the inflation rate as an interest charge, but the intention of the inflation target and the federal funds rates is markedly different than that of private banks. The Federal Reserve is trying to balance inflation with national economic growth and security, and it is a fine line to walk.

And in response to Rothschild, while monetary policy is a powerful tool to regulate the economy, we also have the mechanism of fiscal policy, i.e. government spending in infrastructure and national programs. Fiscal policy is more of a clunker in terms of being slower, since it requires political will of a heterogeneous group of thinkers, but it does present an alternative to pure monetary policy. (When I say monetary policy, I mean anything a central bank does to regulate the amount of currency circulating outside the reserves).

> Think of the Fed... charging you interest on every dollar in your pocket every second of every day, without your permission or consent.

Like I said before: ceteris paribus, the real value of your money remains the same. A dollar may be worth less, but that is compensated with higher interest rates, wages, etc.

> At any time, the central bank has the power to increase the interest rate...

Yes, and that is part of their monetary policy. HOWEVER, interest rates are used as a signal for the macro economy, not a cause. Let's say there is a sudden upward shift of the demand of money (because of a speculative bubble, for our example; a sudden explosion of investing). This shift in demand would therefore change where the supply of money intersects the demand of money. This point is higher. As I've said before, the interest rate (price level) is a response variable. With this situation, the theoretical price level would increase to where this new intersection takes place. The FED can, as a response, increase the supply of money, shifting the supply to the right, hopefully returning the intersection of the (new) demand and (new) supply curve to a level where the interest rate is constant. That way, a constant price level (might) be maintained.

One aspect you've neglected to mention is the breadth of our global economy. The dollar is the global currency (or so I've heard). Let's say that our currency is weakening (becoming less valuable) compared to the euro. The Europeans would then take their money out of the market for dollars, thus decreasing the supply of dollars (a leftward supply shift). This shift would then cause our signal price level (interest rate) to increase. The change in interest rate is not our doing (partially).

There is a way around inflation. If we back our currency with gold/silver/something whose value is stable and makes good commodity money, then the value of money is much more stable. However, the US won't do that.

What are the odds that each and every one of those will change in exactly the right amount?

For example, fixed interest things won't change. My mortgage payment doesn't change with inflation.

You are right. Some interest rates change; others don't. For instance, you can choose between a fixed and variable annuity IRA accounts. I didn't mean to imply that all interest rates change.

Actually, you wrote "I've heard that inflation doesn't actually 'tax' you because all nominal prices adjust so they have similar (previous) real values."

Whenever the adjustment isn't perfect, it's either a tax or benefit. Fixed-rate instruments include an inflation expectation. If reality is different, someone takes a hit.

Thus incomes taxes other than a flat rate income tax, have a "ratchet" effect over time, snaring more and more people with higher tax rates when in real terms they are not earning any more.

BTW I know a few people who are heavily into gold and silver, they are in a way, boycotting the central bank of the country they live in.

Imagine a medieval world where the money supply is fixed. New money is never created, it can only be transferred back and forth. Now imagine somebody invents and rents out a steam engine. The world is now richer by this new technology. Your money's purchasing power just went up, since it can buy something useful that it couldn't before. Since the total amount of money is fixed, other unrelated goods will go down in price. If this becomes a common occurrence people will hoard money rather than buy stuff. This conservatism reduces investment in new ventures, and the overall growth of the economy suffers.

In an ideal world we'd be able to measure just how much the economy grew by and add just that much money into the economy. But we don't know how to do that without avoiding a command economy. And perhaps the question is ill-posed anyway.

Inflation is hard to control, and it can be 'captured' by special interests, leading to tragedy of the commons. We're still looking for a better way to avoid deflation.

1) It can refer to generally falling prices due to increasing productivity. This is entirely beneficial. Video game consoles, transistors, etc, experience deflation and it results in consumers getting better products.

2) A contraction in the money supply, or a shock to the demand for money. The classic example is the bank run that wipes out people's deposits. This type of deflation is terrible because it results in falling aggregate demand, idle factories, and unemployment.

The first type of deflation is beneficial is good, and the second kind is very bad.

The Fed and mainstream economists believe that both kinds of deflation need to be stopped. Economists thus argue for constant inflation to prevent even the slight possibility of slipping into deflation.

To me, this is like arguing that a balloon should be constantly inflated to prevent any chance of it ever deflating. That's not a recipe for preventing deflation, its a recipe for blowing a bubble and then having a disastrous popping. Which is exactly what has happened happened.

Your technology examples have two properties: they're non-essentials, and they're seldom more than a small fraction of most people's assets. If productivity caused more widespread deflation it would cause the same ill-effects and compromise money's major role: as an enabler of investment.

You're right that too much 'margin of safety' leads to bubbles. My favorite test comes from Keynes: http://akkartik.name/blog/2009-09-26-02-40-52-soc

1) In the modern U.S. dilution happens as follows: First banks loan out the same money multiple times. Eventually, years later, they get called on this and there is a bank run ( example, the run on the money markets a few months ago). The Fed then steps in and guarantees all deposits. A guarantee by the Fed to print out money to back a deposit is no different than actually printing money. Thus the whole cycle is equivalent to the government taxing savings and spending that money on subsidized loans to borrowers that have been approved by the nationally recognized rating agencies.

2) From 1995 to 2008, the money supply was diluting at ~9% a year. Just look at MZM ( http://research.stlouisfed.org/fred2/series/MZM ). This is an extraordinary rate of dilution. As a result, Americans trying to save lost a lot of money in real terms. An investor who ten years ago put their money in 50% CD's/50% stocks would have lost money over the past ten years. Even 100% CD's would have lost money. The only investment that can protect against that kind of dilution is gold. But investing in gold is hardly productive.

3) The actual loans the government printed money to fund, went to McMansions, leveraged buyouts, commodities speculation, and credit card debt. These were neither productive nor in either of our interests. They are the classic case of Austrian malinvestment.

4) The rapid dilution forced people to put their money in any place but dollars. However, this did not produce "investment". It produced massive asset bubbles. People were not carefully considering business fundamentals. They engaged in herd behavior, putting their money where everyone else was putting it. They turned everything from stocks to housing into psuedo-money (ie not valuable because of dividends, but because everyone else thinks it is valuable). Sure there were a few gems that came out of this process, like Google. But most of the money was burned up in Vegas real estate and companies like pets.com.

5) Since I define economic growth as "producing more of what people want", taxing people to pay for subsidized loans does not result in economic growth, even if it increases the GDP numbers. Subsidized loans might result in more oil pipelines being built. But if people wanted more oil pipelines, they could have signaled that to the market by buying more oil. Perhaps what people really wanted to was to retire early and spend more time with family and friends. Taxing their savings to fund oil pipelines would thus make it harder to retire and result in less of what they wanted - that's economic decline, not growth. The government does not know what the people want better than the people, so it should not tax their savings to force them to spend money in certain ways.

6) The asset bubbles have made the prices of everything more expensive, from housing and oil to bushels of wheat. Some of these prices are now starting to come down, but a return to dilution will send them right back up again. As a result, for the past 35 years real standard of living has been stagnant. While Moore's law has brought some new technological gadgets, higher housing and commodity prices have forced us to work longer hours just to make ends meet.

7) Investing is not something that just magically works for everyone. Investing takes skill. A stock market investor is an owner of that company. Most people are not smart enough to be owners of companies. They are not even smart enough to pick out a mutual fund that can properly manage a company. Thus the net effect of the mass entry into the stock market from 1980 to 2008 has been to almost completely destroy it. People make crappy investment decisions, then more regulations are put in place to protected them. These regulations then bring the stock market into a state of permanent stagnation. Just look at SarBox.

8) If a fiat currency could be run with a dilution rate of 2-3%, it would be acceptable to me. We came close to this before Bretton Woods ended. I'd prefer 0%, which would be even better than a gold standard. But I am skeptical that we will ever return to that kind of stable fiat currency. The political pressures to dilute are too great. The U.S. has come perilously close to destroying its currency twice in thirty years ( 1979 and early 2008).

My major disagreement is with 8. 0% dilution would be bad for the reasons I mentioned before. Some small rate of dilution would probably be the sweet spot, but better people than me need to figure out whether it's 2-3% or something else.

More tentatively and subjectively, I think you're mischaracterizing regulation in 7. There's been bad regulation, yes, but the response isn't lack of regulation.

If we had a stretch of deflation, the proportion of that debt (which does not deflate) to your now-deflated income would push you into bankruptcy.

If you buy assets, they'll generally keep pace with inflation (with some fluctuation, depending on which assets you've bought.)

If you engage in productive investment of some sort, you'll generally beat inflation and acquire wealth, which is certainly a desired effect.

If you try to sit on your money, investing in nothing, doing nothing, it will dwindle away. And most people in society are pretty happy with that, because it really means "if you're rich, that's fine... but if you want to stay rich you need to continue contributing to society, if only by loaning others your money for a return."

The only "benefit" of inflation to employers is that it makes it easier to implement wage cuts without facing resistance. That said, if you took away inflation as a way to hide wage cuts, nominal wage cuts would be the new normal in a lot of fields.

Most people have wealth held in real estate, stocks, bonds, cars, businesses, retirement accounts, etc... and a comparative few bucks of cash.

So even if you take the view that it's compound annual interest to the central bank, you're only paying it on the amount of money that you float as cash and non-investment accounts. And in return you get a managed, reasonably predictable currency.

Could be taken even further to view it as a regressive tax... Chances are if one can afford to hold your wealth as you described, she is not living paycheck to paycheck.

Especially relevant in an economy where many may have been forced to drain their savings and now indeed are trying to save raw currency to re-establish.

Yeah, when I get older I'll buy stocks, maybe buy a house, etc. But I have a decent amount of wealth, and I'm "paying interest" on all of it.

If interest rates weren't in the toilet right now, I'd look for a savings account paying real interest, a CD, or something of that sort. Luckily the "interest rate" levied on cash is low right now, so it's not worth it to me to bother.