Scribble: Inflation

posted by Jonathan Logan on 2009.03.09, under Blog, Liberty, Probable Fiction, Scribbles
09:

Inflation

Bailouts, state guarantees, economic crisis… and every second pundit either warning of inflation or deflation. Enough reason to share a few thoughts about what inflation is. And why it is evil and matters a great great deal.

Contemporary news media and critics of capitalism or free markets usually refer to inflation as “the rise of prices” and blame it on greedy businessmen that are trying to make a windfall profit at the expense of the public. Politicians will in turn tell our beloved central bankers to make sure that we have only a “sound inflation”, which usually refers to a rise of inflation between one and three percent. And most people listen, nod their heads, howl a few curses at the greedy capitalists and praise politicians and central bankers to uphold monetary order. However, that is just another case where “most people” are wrong. Not because they are stupid, but because they are misinformed – or should we say disinformed.

The usual measure for inflation is based on a “basket of goods and services”. This is the standard statistical method of measuring it. Some bureaucrats write down a list of products and services that are important in an economy, collect the corresponding prices and add it up. The resulting number then gets compared to previous calculations which results in the “rate of inflation”. The proposed meaning of those numbers is “The prices of important goods and services increased by X percent over the last year.” In most western societies politicians and central banks try to keep inflation between one and three percent. And this is where thinking people should stop and wonder. How can politicians and bankers have any influence on prices if they lack such tools as laws for price-fixing? And why do they try to maintain a positive rate of inflation, instead of making prices to decrease, thus making all our lives more expensive? Because there is rarely another subject where disinformation and spin is more prevalent. Better get started at zero, and find out what this all is about:

What is Inflation???

Simple: Inflation is the increase of the money supply without a corresponding increase in the intrinsic value of the money supply. Ok, not that simple. We gonna do it step by step:

The money supply is the total available amount of money in an economy. This amount does usually consist of several types of money (yes, really, there is not just one type), but we will ignore that for this article. It just makes things more complicated and even more horrific. We shall define money supply as all money readily available for credit and spending. This money comes from the central banks (the Federal Reserve System in the US, the ECB in Europe) that provide it for use in the economy. Money today does not come into existence by someone working hard to create it (like it was with commodity moneys in history) but by government and central bank decree. The central banks can create (and destroy) money at will, thus increasing or decreasing money supply. The intrinsic value of this money is…. ehm…. zero (because it is not backed by any existing goods). So, inflation, simplified is the increase of the money supply by central bank or government decree.

So, what happens when the money supply increases? If we assume that the total value of products and services in an economy stays the same, an increase of the money supply leads to increasing prices. This is basic economics, the law of supply and demand. The amount of money increases while the amount of goods stays the same, so the same goods are bought by more money, prices go up. Another way to say the same is that the purchasing power for a given amount of money decreases. However, it is even worse then that: Most products and services actually become more available and cheaper to produce due to competition and innovation on the market place. Which means that without an increase of the money supply prices would constantly fall until they reach an imagined minimum price induced by the real costs of production. What the “basket of goods”-measurement conceals is that prices would naturally decrease without the intervention of central banks through the increase of money supply. And the central banks even admit this, but call it a necessary and positive thing to do, because falling prices mean “deflation” which is very bad and can destroy the economy (we come back to that later).

The prices on the market are thus not increased by some greedy merchants, but by an increase of money on the market. (well, sometimes, especially for monopoly protected goods like oil, there are people increasing the price of those products independent of the money supply inflation. This however only accounts for a minute fraction of total price inflation.)

If we want to know how big inflation was in the past, we should not look at the basket of goods, but only at the statistics published by the central banks concerning money supply changes. For the Euro-Zone this would result not in a low single digit inflation, but in a pretty decent double digit inflation per year, for the last five years at least. To put it bluntly: Monetary policy of the ECB has kept normal EU-citizens from experiencing a steady decline in the costs of living.

Why is Inflation bad?

Some people now will say: “Stop. If the money supply increases at the same rate that the prices increase, nothing changes, so it isn’t bad!”. This is where the real evil of monetary inflation becomes visible. The problem with newly created money issued by the central banks is that it is not evenly distributed. Just because the central bank doubles the money supply does not mean that the numbers on your bank account double. Your bank balance stays the same. So where does the fresh money go to? Imagine the economy as a pyramid. The money creation machine sits at the top. All new money gets distributed to the next lower level in the pyramid and from there on it “trickles down” to the bottom. The problem here is that the new money is not “seen” by the whole market at once, and thus does not immediately influence all prices. When the first recipients of the newborn money spend it, the money has still retained its purchasing power. Fresh money buys exactly as much as old money. But as the fresh money trickles down the pyramid, the market begins to react to it and prices adapt. The lower the levels it reaches in the pyramid the less buying power it has, and the less buying power will remain for the previously created old money. Essentially new money means a “transfer of purchasing power” from the lower levels of the pyramid (those that see the new money very late) to the higher levels of the pyramid (those that see the new money immediately). Or, to put it in plain English: Theft of purchasing power. Those at the top gain, those at the bottom loose. So far, all I wrote is basic economics and totally undisputed and unpolitical. Let’s get political now:

Who sits at the top of the pyramid?

Who sees the new money first, and who is the beneficiary of the purchasing money theft? In short: The State and commercial banks. Those two entities are who receive the stolen purchasing power by receiving the new money first. Those that work for them are receive loans from them are those that benefit a little less, and on it goes trickling down the pyramid. I prefer to call the “top of the pyramid” the political market, and those at the bottom the “independent market”. The political market consists of government, bureaucrats, state sponsored projects, big business with access to fresh credit from the commercial banks. The independent market is everyone else: Workers, smaller businesses, producers of consumption goods, everyone with a cent or more in savings. It is clear now that monetary inflation is actually a way to redistribute wealth from “the little man” to the politically connected, which is why it has often been referred to tax. It is a tax on all you have saved, all you own, your paychecks, everything. And it hits the smallest guys worst: The grandma with a few thousand in savings in case of medical emergency, the fixed income worker, the small landlord, the small merchant. This might only get you to shrug your shoulders, and mumble something like “Death and Taxes….”. But it even gets worse: It destroys liberty and society.

The effects of inflation

We already saw that inflation is bad for the small guys. It is even worse for everyone trying to save some money to create wealth in the future. Because the money you save loses value every day, you are forced to invest it in markets you are no expert on. You are forced to speculate in stock, currencies, fonds and every other financial instrument presented to you just to retain the purchasing power of what you saved. And with it comes risk. It is important to see what this really means: Because of inflation you are forced to invest your money in exactly those enterprises that are mostly part of the political market that has stolen the purchasing power from you in the first place! This is not even close to a win-win situation, it is more like: You lose. They win. And it gets even worse. Because it is so hard to save enough money for a meaningful investment in your own business, financing your spending and investments through debt becomes much more interesting. Just repeat it in your head: The money I save looses value, but the future money I use to pay down my debt is also worth less then the initial debt. Both of these statements are equally true: Future money is worth less then current money. Ergo: Financing by debt is not just attractive, it is almost unavoidable. And again you are thrown into dependency, the interest you serve on your debt ends up mostly with those that are part of the political market. Only a small fraction actually ends up with other savers (there is an additional reason for that: Fractional Reserve Banking. But I wont talk about that today, too much horror). And if this wasn’t bad enough already, the interest rates you as a small business owner get are far worse then those of the big corporations that are part of the political market – competitive disadvantage anyone?

All those little horrors can be summed up in a few statements:

  1. Savings driven investments are discouraged.
  2. Wealth accumulation by production is discouraged.
  3. Immediate spending of income is encouraged.
  4. Debt financing is encouraged.
  5. Independent market wealth decreases.
  6. Political market wealth increases.
  7. Waste increases.
  8. Dependency on the political market increases.

So, why? WHY? Why is this going on? If you ask a central banker you will get the resounding answer: Because otherwise we would see deflation which would destroy the economy.

Deflation is the opposite to inflation, and it basically means that the purchasing power of money increases. The fear of the central bankers in this regard is that consumers and investors will refrain from spending money because the money you spend today would have bought more tomorrow. And because of that the economy would come to a standstill and everyone would starve. And, they are partially right. If the money supply is artificially deflated (decreased) this will for sure be the effect, because everyone would need to expect that a future deflation will take place as well. But think about it for a second. What would happen if the money supply was kept exactly the same? Innovation and competition would drive down prices at a natural rate, but that would not keep people from taking part in the economy. It would only shift their motivation for consumption from “getting rid of money that is worth nothing tomorrow” to “buying what I need and can pay today”. Just because prices decrease does not mean that I can wait forever to buy the bread that will stop my hunger. Just because prices go down does not mean that I would not buy a new and better computer. Because, after all there are hundreds of products where the price decrease by innovation and competition outpaces inflation. And maybe just by accident those sectors of the economy are the fastest growing. The effect of natural deflation will first be that spending, consumption and investments are brought back to healthy and natural levels. Second it would allow people to create wealth again by hard work and honesty. Third it would reduce waste and dependency on debt. Fourth it would force producers to create more lasting products and be demand (instead of marketing and fashion) driven. No one in his sane mind could opposed that, right?

Why inflation is wanted, needed, and wont go away.

There are huge interests in the cementing and prolonging of the current inflation driven system: The political market. This does not just include big commercial banks and huge corporations, but – maybe first and foremost – the State and his government. Inflation allows the government to spend money that it could not press out of the productive citizens by taxes, it allows government to have the biggest leverage on new government debt, and spend all that on … on what?

Apart from special interest groups and their little wasteful projects, much of today’s government spending goes into corporate and citizen “welfare”. Corporate welfare is nothing else but bailouts, special deals and inflated prices for products sold to the State. Again, the participants of the political market profit. But none of that could go on forever, because people could wake up to it and say “Stop, enough stealing!”. So modern states introduced welfare for their citizens. Workers that lost their jobs, bad teachers, incompetent bureaucrats – they all want to survive. And their means of survival is welfare. In return for their welfare they vote for the right politicians, and defend the state. Isn’t it cruel irony, that those people that are hurt the most by the system, workers, workers that loose their jobs without savings, old grannies, are exactly those that are duped into supporting the system for a meager handout? It is truly one of the most evil schemes ever invented.

What you say cannot be true

What I wrote so far could easily be dismissed as an outrageous conspiracy theory. I could even claim that the system was created exactly for the political goal of keeping workers poor, destroying independent businesses, increasing dependency on the state, and eradicating a liberty loving middle class. As I always says: Take everything I write with a truckload of salt, it is “Probable Fiction”. Therefor I shall end this article with a few quotes and refrain from further comments.

The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.

Vladimir Lenin

The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

John Maynard Keynes

I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments.

Friedrich August von Hayek

Inflation is taxation without legislation.

Milton Friedman

There’s nothing more to add….

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