Inflation at its most simple definition is the creation of too much money. Because of excess money creation, the value of every existing dollar is diminished. Eventually, people start to notice! It's like diluting milk by adding water. At some point, it doesn't taste good -- and you want to get rid of it.
In a period of inflation, people want to trade their paper dollars for assets that will retain their value. Hard assets such as gold, oil, farmland, most real estate and even stocks will rise in price because of the demand for real "things" as opposed to paper currency that can be created at will by the government.
During an inflationary period, it may appear that you're getting "rich" as you watch the prices of things you own skyrocket. But in reality, you're getting poorer -- because inflation destroys the "buying power" of the dollars you have saved for the future.
Interest rates react immediately to fears of inflation, even before the inflation actually arrives. After all, if you're going to lend someone money for 30 years, perhaps in a mortgage loan, you want to make sure the money you get back down the road still has some buying power. If you suspect that the money will lose value, then you'll want to charge a higher interest rate on that loan.
Today's uneasy balance
Which way will the economy tilt now? That's the huge question. Bankruptcies continue to rise, credit card charge-offs and commercial real estate loan defaults give evidence that deflation is still something to fear.
On the other hand, the U.S. government continues to spend money it doesn't have to do everything from handing out money for people to buy cars to rescuing failing banks. Remember, even the fear of future inflation can start the mad rush out of paper dollars.
Last week, Warren Buffett stated the case clearly in a public editorial. In it, he noted that our current spending binge now has government expenditures at 185 percent of revenues. That continued overspending has pushed our budget deficit to 13 percent of our gross domestic production, more than double the highest level of non-wartime years.
We borrow that money from global central banks, especially China, which has a stockpile of dollars we've sent over there to buy their products. But they'll certainly demand higher rates of return as they see signs of inflation. Or they'll switch out of dollars -- and into other assets, such as minerals and oil and natural gas -- a process that's now happening around the world.
Americans are in the midst of learning a tough lesson about overspending and overborrowing. Now it's time for Congress to learn that lesson, too. And that's The Savage Truth.