The Inflationary Process and Its Beneficiaries

This article was submitted by Joel Bauman, SchiffGold Precious Metals Specialist. Any views expressed are his own and do not necessarily reflect the views of Peter Schiff or SchiffGold.

In my latest post titled Inflation: A Semantic Change Worth Noting, I briefly reviewed the changing connotation of the terms ‘inflation’ and ‘deflation.’

In this final post in my 2-part series on inflation and banking, I look at the inflation process who whom it benefits.

The inflationary process is facilitated by two means: expanding the Federal Reserve’s balance sheet, and through credit expansion via fractional reserve banking.

As the Fed buys assets, it creates the money to purchase them out of nothing but a promise. This is what most TV pundits refer to as “printing money.” The larger the Fed’s balance sheet grows, the more money must be created in order to finance these purchases.

The primary beneficiary of the inflationary process created by the Fed’s purchases is the US Treasury. This can easily be seen by looking at the asset allocation of the Fed’s balance sheet. Treasury bonds make up 56.8% of that balance sheet. Most of the new money created floods into the US treasury and can then be spent by the federal government.

In turn, the secondary beneficiaries of the inflation process are those who benefit directly from government spending.

The less focused yet arguably more potent generator of inflation comes out of the practice of fractional reserve banking. Historically, when an individual deposited their money into a bank, they were entrusting the bank to simply protect their funds until some future day when the depositor would return to withdraw it. Originally, the deposited funds were not being lent out, and there was no interest rate offered to depositors. Instead, the bank would charge a fee to cover the expenses of storing the money.

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In modern day finance, banks operate based on a debt contract with their clients. Rather than simply safeguarding the funds, they lend out their reserves. When banks lend out more money than what they actually have on hand, it creates new money in the form of credit.

This form of inflation benefits banks, primarily because they profit from the interest earned off the new credit. This also benefits borrowers in the form of lower interest rates. As more credit enters the market, it becomes easier it is to get a loan at a lower rate.

The banks gain off the loss of individual savers and lenders. Individual savers suffer because they will receive little to no interest on their loans. The worst victims are middle class retirees who buy bonds, fixed income annuities, or simply leave their money in the bank. Not only do they receive a low yield, but inflation will decrease the purchasing power of the very dollars they saved away.

The inflationary process is not linear; it comes in ebbs and flows. This is why we see periods of inflation and deflation, and the value of the dollar subsequently rises and falls.  For an economy to grow most effectively, it needs a stable form of money. Unfortunately, central banks do everything but provide stability, and the actions they take benefit the few.

Buying physical gold and silver helps protect investors from the effects of inflation. No matter where the inflationary storms take the value of the dollar, the value of gold and silver will never be eroded away.

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