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What is Inflation?

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From the Archives : Originally published June 30th, 2002
647 words - Reading time : 1 - 2 minutes
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Category : Fundamental





"The reality of inflation is that governments steal money from their citizens with absolutely no intention of repaying that money." (John Maynard Keynes, The End of Laissez-Faire)


Imagine a counterfeiting printing enough money in his basement to provide every member in his community with an extra million dollars. Could we say that every member of that community is wealthier? It would depend...within the community the differences in wealth would have shrunk.


Lets imagine that Peter the barber had saved $200k and Paul had only $20k before the counterfeiter began his endeavour. Peter had ten times the wealth of Peter. After both receive the million from the counterfeiter, they are much closer.


Now that every member of the community is a millionaire, businesses would naturally begin to charge higher prices for their goods and services. This is the essence of inflation.


Inflation Defined


Inflation is not a general rise in prices but an increase in the supply of money, which in turns sets in motion a general increase in the prices of goods and services. Inflation deals with volume as in the concepts of inflating a balloon, or inflating the money supply (volume of money).


"Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. . . . As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation." (Ludwig von Mises, Inflation: An Unworkable Fiscal Policy)

The irony of today is that the central bank is commonly viewed as an inflation fighter when in fact it, along with the fractional reserve banking system, is the actual source of inflation.


Additionally, the various and unavoidable effects of inflating the actual money supply, such as rising commodities prices and increasing worker wages, are seen as the causes of inflation!


This represents a complete reversal of cause-and-effect! An increase of the money supply leads to an increase in the cost of goods and services, not the other way around!


Below is a chart showing the credit expansion of the US Money supply since 1981. Note that on March 23, 2006 the USFed ceased to release figures on M3 (the broadest measure of money supply) claiming that it was costing too much to calculate. Strange to hear that coming from the very institution that has the ability to create money.




Resources:


  • Methods of a Wall Street Master by Victor Sperandeo.
  • Mises.org a website devoted to the Austrian School of Economics, a school of economic thought founded by Carl Menger (Feb 28, 1840 - Feb 26, 1921) with his work Principles of Economics published in 1871.
  • Money, Banking, and the Federal Reserve System is a great video that examines the formation of credit and the Federal Reserve System.
  • The Federal Reserve Bank of Chicago used to publish a pamphlet entitled Modern Money Mechanics, which explains M1, M2, and M3.





Mike Hewitt

Editor

DollarDaze.org



 


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