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Old 09-28-2005, 09:33 AM
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Default Savings, Compound Interest and Asset-Price Inflation

Hey folks:

Here is an interesting article concerning economic appreciation and inflation, as well as vehicles for saving (investment/retirement).


Anthony Baldwin

BTW, for those of you who have inquired about the TASA (tangible asset savings account) vs the IRA, I didn't forget you. I will respond to you shortly. Regards.

Savings, Compound Interest and Asset-Price Inflation
Michael Hudson, UMKC

- George Orwell,
"Politics and the English Language" (1946)

Since 1980 the world's advanced economies have
seen the largest creation of money and credit in
history. The ensuing bubble has prompted investors to go
into debt to buy real estate, stocks and bonds in the
hope of obtaining capital gains as prices for these
assets are bid up. Yet in the popular mind there is an
impression that the inflation problem has been licked.
Why have economists not set about explaining why
property and financial markets have boomed so strongly
while the rest of the economy suffers deflation? Wages
and product prices certainly are not advancing as
consumers and businesses are debt-strapped. There is in
fact a direct linkage between debt deflation and asset-
price inflation. While businesses and consumers are
strapped by having to pay interest and amortization to
their banks and other creditors, this debt service is
recycled into new lending - enabling buyers to bid up
asset prices all the more, by running even more deeply
into debt.
The ensuing price gains for real estate, stocks and
bonds are perceived as "wealth creation" rather than as
inflationary, even when all that occurs is a revaluation
of existing property and securities. The word "inflation"
has been reserved as an epithet for monetary and price
developments not welcomed by investors, as when rising
commodity prices and wages reduce the command of their
debt claims over the rest of the economy. But asset-price
inflation is different. It increases the power of property
and securities, and hence is welcomed.
Most people feel they are getting richer when prices
for their homes rise, even if they and their children must
pay more for housing in times to come as the entry price
for home ownership rises. If there seems to be a money
illusion when it comes to housing and stock market prices,
it is because when markets are rising, the way to get rich
most quickly is to borrow to the hilt to buy as much
property as possible, using the property's income to carry
the interest charges. The Federal Reserve Board has
endorsed this practice by pointing out that although
debt/income ratios are rising, the net worth of families
and businesses is growing even faster. The name of the
economic game has become capital gains.
People recognize inflation more when it comes to the
prices they pay than to prices for the assets they have
bought. If the bubble could go on forever a new era of
debt-financed prosperity would be at hand. But there are
reasons why this cannot occur. Property revenues shrink as
the purchasing power of labor is eroded by having to use a
growing proportion of income to service the debt overhead.
Markets and incomes shrink as the economy succumbs to a
debt-strapped austerity, third-world style. Defaults start
to occur, and asset prices start to decline. The economic
environment becomes riskier and interest rates rise,
causing asset prices to decline further. Yet the debts
remain in place, so that net worth plunges.

The article can be read in its entirety @:

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