Sam Sez

Date: Wednesday, August 04, 2010

Question: "Inflationary problems?"

Answer: Yes, but in different ways.

At first the attempt to inflate the system out of credit destruction and constricting demand missed its mark. Quantitative easing (QE) is a euphemism for wealth transfer or overpaying for damaged assets. Some analysts suggest that Quantitative Easing is better defined as Qualitative Easing or the reduction or elimination of sound quality standards.

Zero Interest Rate Policy (ZIRP) is a related effort to prop up financial assets but by doing so it impairs the price and risk discovery mechanism for capital markets because it basically says low or no cost money/credit for and project/application particularly for members. In fact, the economy may be on the cusp of the negative outcome event horizon. See related ZIRP articles about regulatory capital impacts et cetera.

Recent talks and papers about another round of Quantitative Easing or QE2 are problematic. The indicated purpose is to raise asset values whether tangible or not and to spur consumption. However, the opposite outcomes are more likely. The greater the inflationary impact, the less disposable income because of the progressive income tax structure. Low real-wage earners would be catapulted into the higher or even highest tax brackets. Therefore if their nominal wages doubled or tripled, the real percentage allotted to taxes would jump and actually less would be available for expenditure. This is dangerous for a consumer/consumption based economy for many reasons. Traditionally this type of movement was somewhat slow and was referred to as “bracket creep.” Dramatic inflation or hyperinflation would trigger bracket jump.

As many government bodies are experiencing revenue decline due to lower income, sales, mortgage and so on taxes and fees, they are mismatching borrowing proceeds for tax revenues. These bodies are raising sales taxes and fees to close their budgetary gaps. However, for the vast majority of people, they spend most of what they make. These actions will curb other consumption expenditures reinforcing further declines in true consumption and productivity.

A Value Added Tax or VAT is being discussed. It is regressive similar to regular sales tax but on a national level. In other words, VAT impacts the poor more than the affluent. Once again, if many people spend most, all, or even more than their incomes (think unemployed, under-employed, financial/medical crisis) then that tax precludes other purchases. Basically, the economy is experiencing a major move towards only inelastic demand goods and services and a movement away from elastic goods and services. The former are necessities whereas the later are the niceties.




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