The 2% Inflation Target...

It's time we all took a sober look at the concept of 2% inflation.  As a population we tend to think of 2% inflation as a constant rate of growth, after all, a two percent increase inflation on any given year is a relatively small change right?  Don't be naive enough to think this either a small or linear phenomenon.  Lets put things into perspective.... say you had savings of $1,000 in cash, and held it in your bank account from the time you were 20 years old to retirement  (we'll say 50 years).  How much is that money worth if there was 2% inflation each year?

Certainly we remember the compound interest equation from school: $ = P(1 + r)ⁿ

To get the fraction of what you're 1000 is worth after 50 years at 2% inflation we can take:

1000(1 - .02)⁵⁰

= $364.17

So we are left with just 364.17 dollars. 

 Put in other terms, if you saved 2% of your annual salary in cash for retirement, you would retire with 1 years average salary. Yes, do the math, its right.  Lets suppose instead the federal reserve targeted 0% inflation instead, how much money would you have at retirement?  If your annual salary was $50,000, you would have: 50000(1 + .02)⁵⁰ = $134,579 if your salary stated the same throughout your life.  That is a savings of 2.69* your average salary vs 1*your average salary.   It is clear that a 2% inflation target punishes those that save in cash.

Some might say the 2% is a trade off to maximize growth and employment....oh really now.  There's a concept that needs to addressed here:  resources are finite.  Unless the supply of resources grew at an average of 2% every year, this system is fundamentally flawed.  Lets visualize it:

In the above graph, the money supply grows at 2% while the rate of hard paper money printed resembles the rates of the treasury. Paper money could be any limited resource, but for sake of a simple and compelling argument, I used a realistic rate of paper/hard money printing in the above graph.  The rate at which the treasury prints paper grows slightly each year, but not by 2%.  Why???  For one, because paper is a finite resource and it would be impossible.  We would need 2% more trees/cotton each year to make that money, 2% more printing presses, 2% more labor to operate that production.  In a finite world, you can't meet the expectation of 2% more every year, after about 200-300 iterations this starts to become nearly impossible.


Some may say: "But the fed can lower rates too, if this phenomenon occurs we can just lower the inflation target".

Here's a fun fact, deflation has NEVER been targeted by a central banking system.  Price deflation has occurred naturally through various recessions/depressions... but actual monetary supply deflation???? Unheard of.

Here's another fun fact 2% inflation target is gauged by the CPI, a synthetic number the government determines (and can adjust to a certain extent at will using goods substitutions).  In terms of monetary base, we are going much further than 2% a year.

See the graph below, its in a its in log scale.... don't misinterpret anything the fed does as "linear".  The graph also highlights our divergence from CPI, inferring inflation rates far above 2%.

If all this is true.....why don't we see soaring prices?????  In recessionary environment deflation is a natural phenomenon.  The cumulative effect of this isn't necessarily higher prices.  It can be felt in the sense of higher unemployment rates, rising poverty, and rising debt (in other words, the real wealth/money ratio decreases, whether this is inflation or not is irrelevant, it has the same cause).  Remember the following:

Without exponential growth equal to the exponential rise in debt-created money supply ,  it becomes impossible to repay debt.    In a world of finite resources, it will at some point become impossible to keep pace with and exponential money supply.

While recessions/depressions can dampen prices temporarily, prices must eventually increase to meet intrinsic values of hard assets as the difference between total money supply and growth/new finite resources grows exponentially larger.  Inflation is not myth, Inflation is math.

Money is printed as debt.  Paper money can not mathematically be printed at the same rate as the money supply is expanded, because it costs resources to print hard money, and resources are finite.