A very important economic statistic that neither candidate talks about is the quantity (how much money is issued) of money in circulation – the money supply.  This is critical to understanding the economy.

The Central Bank of the United States (the FED) has the sole duty to make money in our economy.  The FED sets both the basic U.S. interest rate and the amount of currency (money) in circulation.  The FED is headed by Dr. Bernanke, who is appointed by the President.

HOW OUR MONEY (DOLLARS) IS MADE:  It’s so simple, someone at the FED enters a number into the FED’s computer – and PRESTO – money is created.  That’s it.

The FED then sends money into the economy by buying debt – bonds, etc. from Wall Street and the U.S. Treasury

Dr. Bernanke is now increasing the money supply (amount of currency in circulation) by 40 BILLION Dollars EACH MONTH by buying bonds from the U.S. Treasury Department (thus increasing the U.S. Debt) and buying mortgaged backed debt from Fannie, Freddie, and Wall Street (a great way for them to unload poor mortgage debt and pass it onto the U.S. Tax Payers).  Dr. Bernanke has announced he will continue this in the future.

WHY DO THIS – GOOD THINGS ANTICIPATED IN THE SHORT RUN.  Keynesian economics says that when you increase the amount of money in the economy, a short run economic boom is created – more money in circulation – therefore people will spend more – therefore an economic jump-start.

BUT KEYNESIAN LONG TERM EFFECTS ARE REALLY BAD.  Dr. Bernanke hopes to withdraw excess currency from the economy BEFORE THE LONG TERM EFFECTS OCCUR.    But this is very difficult and the timing to do this is critical. If he mid-judges, the following bad effects will happen to the economy:

1. INFLATION AND PERHAPS HYPER-INFLATION.  This is what happened to Germany after WWI leading to its economic collapse in 1923.  Starting from World War One Germany radically increased its amount of currency without increasing the wealth of the country.  They printed money with no value behind it in order to produce a short run boom and also to cover up political mistakes.   This created hyper-inflation and in 1923 the German economy finally blew up.  In 1913, One Dollar bought 4 German Marks.  By 1923, One U.S. dollar bought 4,200,000,000,000 German Marks.

The middle class was wiped out.  People were displaced.  Farmers who had food would not sell their food to others using German Marks.  Savers lost all of their savings.  The German economy was only saved by issuing a new, different currency with the promise not to increase the money supply of the new currency.

2.  THE VALUE OF THE CURRENCY IS REDUCED.  THE CURRENCY IS DE-VALUED – IT IS DE-BASED.  Think of each individual dollar representing a claim on America’s wealth.  If many more dollars are in circulation, then America’s wealth must be shared by that many more dollars. This means that the basic (intrinsic) value of each single dollar is reduced.  A dollar remains a dollar but it buys much less.

This clearly is what is happening in the U.S. economy.  That is, a dollar next year will buy less goods and services that can be bought today.  This is a deliberate government policy and helps the government manage the debt at the expense of the people. (Read On)

Another example: Say you buy a ten year treasury bond which pays 1 ½ to 2 percent per year and you get your money back in 10 years.  But, if the value of the dollar is reduced by 15% during those 10 years, you will actually lose money.  Of course, if you let your money sit in a 1% bank account you really lose.

WHAT YOU EARN ON INTEREST.  The FED sets the basic interest rate.  It has deliberately set the interest rate below market  – less than if the free market determined the interest rate.  THE ABSOLUTE FIRST RULE IN INVESTING IS TO EARN AN AFTER TAX RETURN EQUAL TO OR GREATER THAN THE RATE OF INFLATION.  Setting an extra low interest rate prevents people from doing this without taking great risk with their savings such as going into the stock market and thus risk losing their entire investment.

Of course the Government manipulates the Consumer Price Index (CPI) so inflation is understated.  Think of your Social Security, PERS, or STRS COLA contractual increase which is indexed to the CPI.  Your adjustment increase for inflation is way below what true inflation is.  The poor consumer can only guess at the actual inflation rate.  Because of the actions of the FED you earn much less on your savings account than you should.  (This is a hidden tax on your savings account).  A note: the basic interest rate in Australia is 3.5%.

DEBT.  Under Obama, the U.S. Government has increased its debt from 10 TRILLION DOLLARS to 16 TRILLION DOLLARS (a 50% increase).  The rate of increased borrowing is an additional debt of ONE TRILLION DOLLARS PER YEAR, EACH YEAR.  This same rate of increased debt is projected for the next few years.

Debt is a way of spending now and paying later;  You pay out of your future earnings.  The way to think of debt is that it has first claim on future earnings.  The amount of money you can spend next month is what you have left over after you first make your debt payments (mortgage, car payments, etc).  DEBT REDUCES FUTURE INCOME.

Likewise, the U.S. must first take its national income (Gross Domestic Product, GDP) and subtract the interest on the national debt (the interest rate on 16 Trillion Dollars — estimated at TWO HUNDRED BILLION DOLLARS).  Once this is done the U.S. then knows the amount of money it has available to spend.  But the U.S. debt is so large, it will have to be paid out of the income of future generations.  It is a horrible burden to leave to our children.

HOW GOVERNMENT DEALS WITH DEBT.  There are only three things a government can do with its debt:  Pay it off (we don’t have the money to do this), default (politically not an option), or re-cycle our debt (get new loans to pay off the existing loans as they become due).

By extending debt by re-cycling, the government can pay off its debt using de-valued (de-based) currency.  This is the preferred way for governments to handle debt.

In olden times, with gold coins, the King reduced the amount of gold in each individual coin and did not tell anyone about it.  The King then had money to pay off debts, live well, fight wars, etc.

In current times, the government simply increases the amount of currency.  Politicians love this because the people know something is wrong with the economy but can’t blame a specific person.  The people just don’t know exactly what is wrong.

THIS ALLOWS THE GOVERNMENT TO PAY OFF ITS DEBT WITH CHEAP MONEY.  Germany in 1923 retired its WWI debt with worthless DE-BASED currency.  Governments have used this technique since money was invented.  But if currency de-basement is taken too far, then the people lose faith in the currency and the currency dies.

But, with cheapened money the people lose – especially savers who followed the “American Dream” (work hard, save, etc.)  The tax laws and the way that the FED has set up the economy encourages spending not saving – so much for the American Dream.

ECONOMIC GROWTH IS THE SOLUTION.  Economic growth is the solution. Higher economic growth means increased national income (more to spend and pay off our debts).  But under Obama the GDP is growing at between 1-2 percent.  Ridiculous for America.  The critical ratio in all this is the total debt to GDP ratio.  Debt is growing exponentially; national income growth is almost flat.

Economic growth is made by the private sector – individuals acting independently in the free market, starting businesses, inventing, innovating, and working hard.  The government sector in its self cannot grow the economy.  It can only print money and set up rules to help or hurt the private sector.

IS AMERICA A CENTER-RIGHT OR A CENTER LEFT COUNTRY????  America has always been an economic center-right country.    By that I mean that most economic decisions are made by the private sector – the free market.  Under Obama, America has drifted to the economic center-left in which many economic decisions are made by government bureaucrats.  This has been at the expense of the private sector.

America started as a poor country and became the richest country in the world using the free market system with necessary but limited government control.  Our country is an incredible success based upon our economic system.  This is unique in the world.

A PERSONAL OBSERVATION OF RIGHT VS LEFT ECONOMICS.  In my research, I traveled to Chile to study their economic turnaround – a great currency/economic success.  Chile was a typical Latin American country – high inflation, a left-centered economy, high unemployment, high number of people supported by the public sector, and low economic growth.

I remember asking the head of the Economics Department at the University of Chile over lunch “How did you turn your economy around”?

His answer: “Chile hired economists from the University of Chicago, Milton Friedman free market disciples.  We told them to do whatever you have to do to stabilize the economy.  They cut government expansion, put more economic decisions into the private sector, forced economic diversification, and stabilized the currency”.  Today Chile has a successful, productive, diverse economy where foreign investment is thriving.

Compare this to Argentina, just across the Andes.  Since the 1940’s Argentina has believed in strong government economic direction.  Argentina has since defaulted on its international debts, foreign investment is very low, economic strikes and riots are common, and Argentina has twenty percent inflation.

Chile’s conversion from state direct economics to free market economics produced a lot of pain – social and economic but at the end it produced a strong economy.  Left centered economics ultimately produces mediocrity or worse.

BUT THE FURTHER TO THE LEFT AN ECONOMY IS THE MUCH MORE SOCIAL AND ECONOMIC PAIN IS PRODUCED WHEN THE ECONOMY HAS TO CORRECT ITSELF.

The U.S. is going year after year after year further into debt.  This cannot continue forever (just as you can not borrow and borrow and borrow with out paying off your loans).  The economies of the world are becoming weaker and debt ridden.  World bankers are creating money with their on-going and massive loans to nations who attempt to use debt to solve their financial and political problems.  The world is flooded with debt.  There are many dysfunctions in the world economy.

As the U.S. goes deeper into debt, we too become weaker and more venerable to others telling us how our economy should be run.

In this election* the voters have a clear choice between a country which is left-leaning with strong government control or a country which is right-leaning which emphasizes the private sector.

In terms of economics the voters also have a clear choice between a man with a track record of 4 years of economic failure vs. a man with a track record of economic success.

I personally think that this is the most important election in my history.

Thomas Potase

[* I usually do not post anything that directly supports one presidential candidate over another, but this article, written by a man I know and trust, lays out exactly what has been going on in the economy and how serious it is. The debt problem has been growing for years but is now accelerating. Just voting for Mr. Romney will not solve it. He will need strong support from Congress and patience from the American people to begin to turn things around — and things must turn around or we will face disaster.]