Investing with the expectation of losing money is stupid. Locking your money into an investment that can't keep pace with inflation is the same thing. With the cost of living on the rise and interest rates on the decline, that makes bank certificates of deposit that are more than a 1.5 percentage points behind inflation a dumb idea.
For certificates of deposit, savers who locked their money in before the Fed's recent cuts, are much more likely to be ahead of inflation, and clearly should ride out the length of their term deposit. For investors with new CDs, penalties for early withdrawal could make a pull-out even more costly than simply lagging the rate of inflation.
Before I go any further, I think it is appropriate to first establish what inflation is. The popular belief these days is that inflation is the "Rise in Prices". But, something has to cause prices to rise. In his book "What You Should Know About Inflation", Henry Hazlitt sums up Inflation as follows:
No subject is so much discussed today—or so little understood—as inflation. The politicians in Washington talk of it as if it were some horrible visitation from without, over which they had no control—like a flood, a foreign invasion,or a plague. It is something they are always promising to "fight"—if Congress or the people will only give them the "weapons" or "a strong law" to do the job.
Yet the plain truth is that our political leaders have brought on inflation by their own money and fiscal policies. They are promising to fight with their right hand the conditions brought on with their left.
Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit.
If you turn to the American College Dictionary, for example, you will find the first definition of inflation given as follows:
"Undue expansion or increase of the currency of a country, esp. by the issuing of paper money not redeemable in specie."
In recent years, however, the term has come to be used in a radically different sense. This is recognized in the second definition given by the American College Dictionary:
"A substantial rise of prices caused by an undue expansion in paper money or bank credit."
Now obviously a rise of prices caused by an expansion of the money supply is not the same thing as the expansion of the money supply itself. A cause or condition is clearly not identical with one of its consequences. The use of the word "inflation" with these two quite different meanings leads to endless confusion.
The word "inflation" originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended. It is not mere pedantry to insist that the word should be used only in its original meaning. To use it to mean "a rise in prices" is to deflect attention away from the real cause of inflation and the real cure for it.
Let us see what happens under inflation, and why it happens.
When the supply of money is increased, people have more money to offer for goods. If the supply of goods does not increase—or does not increase as much as the supply of money—then the prices of goods will go up. Each individual dollar becomes less valuable because there are more dollars.
Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before. A "price" is an exchange ratio between a dollar and a unit of goods. When people have more dollars, they value each dollar less. Goods then rise in price, not because goods are scarcer than before, but because dollars are more abundant.
In the old days, governments inflated by clipping and debasing the coinage. Then they found they could inflate cheaper and faster simply by grinding out paper money on a printing press. This is what happened with the French assignats in 1789, and with our own currency during the Revolutionary War. Today the method is a little more indirect.
Our government sells its bonds or other IOU's to the banks. In payment, the banks create "deposits" on their books against which the government can draw. A bank in turn may sell its government IOU's to the Federal Reserve Bank, which pays for them either by creating a deposit credit or having more Federal Reserve notes printed and paying them out. This is how money is manufactured.
The greater part of the "money supply" of this country is represented not by hand-to-hand currency but by bank deposits which are drawn against by checks. Hence when most economists measure our money supply they add demand deposits (and now frequently, also, time deposits) to currency outside of banks to get the total.
The total of money and credit so measured was $63.3 billion at the end of December 1939, and $308.8 billion at the end of December 1963. This increase of 388 per cent in the supply of money is overwhelmingly the reason why wholesale prices rose 138 per cent in the same period.
This is the issue Ron Paul refers to in his speaches. If you didn't understand what he was talking about, you should understand now. This phenomenon is not exclusive to the U.S.A. Any country with a Central Bank will be exposed to this type of monetary inflation.
Furthermore, credit created by banks is another underestimated contributor to inflation. People believe that the money they borrow from a bank is the money of another depositor. That is only 10% true. The fact is that banks are ALLOWED to create money out of thin air. For every $1 deposited with a bank, they can create another $9 to lend to other people. This "legally fraudulant" practice is better known as "fractional reserve banking". It is also the reason why banks are tinkering on the brink of collapse. If you want more information, read The Economic Incompetence of Socialism.
Getting back to ol' Chuck's article, he continues to say that:
Clearly, certificates of deposit are not money losers. No matter how low the payout, they are better than stuffing money in a mattress, and they provide a safe haven -- with coverage from the Federal Deposit Insurance Corp. -- for investors who are skittish about the market.
But anyone turning away from market risk could be giving a big wet kiss to purchasing-power risk -- the chance that their money grows more slowly than the rate of inflation -- and there is little doubt that the majority of people investing in CDs now fall into that category. For proof, look no further than the numbers.
I have a problem with this statement. If you deduct the 2007 CPI value of 4.1% from whatever yield you are receiving now on your CD, you have a problem. Your answer is hovering close to zero. Your problem becomes even bigger if you believe CPI to be 4.1% as the government claims it to be. Shadow Stats estimates annual M3 (broad money supply growth) at around the 15% level. That is why you can't figure how CPI can be at 4.1% when you see the price of goods around you rising at a higher rate. I say CDs are money losers.
I also believe The Fed is well aware of this. Dropping rates will eventually discourage people to save. The Fed wants you out there spending, stimulating the economy with those worthless Dollars. It is not interested in you parking your savings in some CD account.
Still don't understand the consequence of inflation? Henry Hazlitt further says:
Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because:
- It depreciates the value of the monetary unit,
- Raises everybody's cost of living,
- Imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest,
- Wipes out the value of past savings,
- Discourages future savings,
- Redistributes wealth and income wantonly,
- Encourages and rewards speculation and gambling at the expense of thrift and work,
- Undermines confidence in the justice of a free enterprise system,
- Corrupts public and private morals and
- Encourages malinvestment by entrepreneurs.
I don't know. Chuck leaves me with the impression that he is marketing CDs on behalf of the banks in order to help them build up reserves. :-)
My personal investment/savings strategy: Meet or beat the annual growth of M3
