INFLATION ECONOMICS IN ONE EASY LESSION OR: HOW I LEARNED TO STOP WORRYING AND LOATHE THE FED

Guest Post by Stephan F. – TBP member

Ok, that’s it, I’ve had it. I’ve heard enough bantering by those geniuses who know everything about fiat money, investing, politics, globalism, and, lastly of course, the price of tea in China. I want no more talk from those idiot fakers who prognosticate by the seat of their pants, yet espouse complete omnipotence when it comes to all things economic. I can’t take it anymore. These guys have drowned me in a sea of repetition, boredom and disgust. They’ve become the very same talking heads they criticize, and create the very same results – confusion, frustration, chaos & havoc. If I hear one more pseudo-intellectual pontificating their never ending BS, I swear I’ll smash my computer. Finis! Done! Lights out! No Mas! If there ever was a subject that was so over-analyzed, yet completely misdiagnosed & misunderstood, it has to be the Fed Reserve, fiat money, and fractional reserve banking.

I’d like to try to decipher one of these issues but must first warn you: this is an opinion piece, so be forewarned and proceed at your own risk.

WHAT IS INFLATION?

“The value of money, like the value of goods, is not determined by merely mechanical or physical relationships, but primarily by psychological factors which may often be complicated.” – Henry Hazlitt

The essential question that has confounded so many for so long is this: What determines the purchasing power (value) of money, and, what causes inflation (or deflation for that matter)?

To find out we must clearly define the term “inflation”, since its meaning varies from person to person and often causes much confusion. Those with a modicum of economic knowledge tend to use the classic definition, “an increase in the supply of money”, aka monetary inflation. However, when using the term here I am referring to the more contemporary definition, which is a rise in the average level of all prices, and not just one price or some prices. You probably know this better as “price inflation.” The same holds true for “deflation”, a general reduction of prices.

So then, what does determine the purchasing power of money and what causes inflation? This question may seem highly complicated as evidenced by the thousands of uninformed dilettantes who opine on the subject. Actually it’s much simpler than you might think and it all depends on a grand total of three components.

(1) THE TOTAL SUPPLY (TOTAL AMOUNT) OF MONEY

This is the single largest factor and the most common cause of [price] inflation. Government inflating the money supply is outright counterfeiting done in secret and is the worst form of plunder. Most of its victims never fully understand what really causes higher prices, and they seldom identify the actual cause…and government prefers to keep it that way thank you very much. Monetary inflation is, in fact, a “hidden” tax. And it’s a beautiful thing for those in power because its source is so difficult to detect. When you then add the other inflationary elements into the mix, trying to determine what really pushes prices higher can get most complicated; which just reinforces why there’s such rampant confusion, even among so-called experts. And it seems everyone loves to take their turn trying to pin the tail on the donkey for being the culprit. They point a finger at practically everyone involved in trade & commerce, and curiously, never seem to blame the real guilty party. I wonder why?

In a free market economy, money supply and the value of money are both variables, meaning they tend to fluctuate — which is not something we should fear regardless of what partisan liberal economists may say. As much as we’d like it to be, there can never be money whose value remains absolutely static, and that includes gold or silver (both have proven to be a fairly reliable store of value though). But many of us (who should know better) falsely believe that divine will has blessed mankind with a natural right to have money that always has a fixed value. After all, isn’t that the way nature intended it? Not even close, and it never will as long as humans are involved. Here’s a fact that needs remembering: for money to be able to function as money, it must be allowed to trade freely & openly and cannot be artificially price-controlled. Like everything else, the price of money is determined by its market value based on supply & demand.

Consider this prototypical example: You’re on an island, population 100. You and everyone else have started out with 10 dollars (total money supply is 10×100 = $1000). Your 10 bucks represents 1/100th of all goods & services, or 1% of total GDP. Unbeknownst to you, the island’s govt creates a central bank (CB) which then prints up (counterfeits) $1000 and uses it to purchase a $1k govt bond. The govt in turn spends the cash to help pay expenses. What happens to the value of your money…? All things being equal, it has just decreased in value by about 50% due to the doubling of the money supply (this devaluation may not occur all at once). That new $1000 added to the existing money stock now represents all of the goods & services on the island, and your 10 dollars now represents about half of what it did before. Too bad. The govt & the CB have stolen half of your savings regardless of whether they had good intentions or not. Try not to feel too bad, however, because everyone money is devalued too. Misery just loves company.

But then this happens: A short time later, and with you still holding & bemoaning the decrease in the value of that $10, the govt unexpectedly receives $1k in taxes and decides to pay back the CB! The CB, having regrets for its initial counterfeiting crime, destroys the money. The result is a $1000 decrease in the money supply, and, a short time later, voila’… your $10 is back to it original par value! Remember, you never had any knowledge of the CB’s counterfeiting. As a result of all this everyone has grown suspicious of their money. You and others start to theorize that your currency must have some fatal flaw based on its recent wild swings in value, and thus a search now begins for a better form of money. Who could blame you for questioning its validity?

(2) THE SUPPLY OF GOODS AND SERVICES

This adds another variable into the equation and represents “the other side of the coin.” If the total amount of money in circulation is one side, the total supply of goods & services is the other. Because production is not fixed at some rigid pre-determined rate, the amount available for consumption always changes. Thus a balance is struck between the total of all goods & services and total money supply, again, both being variables. This observation alone makes it clear why prices can habitually fluctuate.

If you’re like most people you probably understand the first part of the equation (the supply of money). Few it seems ever contemplate this 2nd factor. The main reason why is that most of the phony so-called “money experts” are only familiar with the 1st factor, side one of their one-sided coin. They constantly beat you over the head with the only thing these one-trick ponies know, monetary inflation. If they do indeed understand the 2nd part, why have they kept silent about it? Because it’s obvious they don’t, and now you know why you hear just one explanation for a rise in the inflation rate.

Now ask yourself this: When govt increases the money supply resulting in higher prices, then shouldn’t a shortage of goods & services and a stable money supply also have the same inflationary effect? Of course it does. On one hand you have more dollars chasing a given amount of goods, and on the other you have a static supply of dollars chasing fewer goods, with the inevitable result of inflation in both cases. A simple example will help illustrate. Let’s say we have 100 widgets representing total GDP, and 100 dollars in circulation, a one to one ratio. Let’s also pretend that each widget sells for one dollar. Now if we increase the money supply to 200 dollars, the price of those widgets will naturally be bid up & we have inflation. The money-to-goods ratio is now two to one, and each widget will probably increase to about $2… Now let’s go back to our original scenario of 100 widgets & 100 dollars and say that a fire destroys 50 widgets, leaving us with just 50. We have 100 dollars chasing 50 widgets, and again we’re back to that two to one money-to-goods ratio resulting in a higher price, probably about $2. So tell me, what is so hard to understand about this simple principle that the dunces who believe in their one-sided coin theory don’t get? The bottom line is this…if the money supply remains stable, a reduction in the supply of goods and services will naturally cause inflation. Conversely, increases in production along with a stable money supply will result in deflation.

(3) WHAT PEOPLE ACTUALLY DO WITH THEIR MONEY AND THEIR WEALTH

This factor is virtually never considered when it comes to understanding the causes of inflation. People’s desire to hold cash vs. spending will have an influence on prices which, depending on their actions, can result in either inflation or deflation. They could cause a deflationary affect by destroying, losing, or hoarding & stashing their money away; just like they can have an inflationary impact by destroying (or suffering destruction or loss) or wasting goods & services. Here’s an absurd example to illustrate: Suppose Bill Gates liquidates his assets into cash (purportedly $70 billion) and promptly shovels all of it into the blast furnaces at U.S. Steel. Could that affect the value of the currency? Of course, but when would its value change and by how much? Beats me. But we do know this… assuming all things being equal, eventually the currency must rise in value — maybe a little, maybe a lot — it all depends on many factors which are impossible to calculate. But with Bill’s action causing a significant decrease in the total supply of money, its value will almost certainly go up. You may think this example to be purely academic since it couldn’t happen in the real world, right? People acting as part of the whole can collectively accomplish the same thing – differently from Bill’s action of course – but which has the same effect. Similarly, if you were to burn down your multi-million dollar mansion, that would subtract from the total wealth supply and cause a miniscule shortage of housing (one house out of millions) which is a bit inflationary. And if millions of people burned down their houses…? I think you already know the answer.

WHAT ABOUT MONEY VELOCITY?

You may be thinking by now that money velocity should be considered a relevant factor, as it surely is a determinant of inflation…that’s what money experts always say, right…? (Pssst, sorry, you’re wrong). It’s true that people acting in concert by spending their money at once to obtain finite supplies can certainly drive up prices, but that action belongs in the category of “money demand,” not rising money velocity¹. Money velocity is yet another (yawn) misnomer that is represented by a false, but seemingly legitimate, Keynesian math formula probably cooked-up by a group of math geeks to impress their colleagues.

Consider this: if a high rate of velocity causes inflation to rise, then the opposite must also be true, a low rate of velocity must cause deflation. So I ask you, where are those screamers who shout out warnings of imminent inflation when velocity starts to pick up, but these same Chicken Littles remain curiously silent about predicting deflation when we have low velocity? Maybe it means velocity is permanently stuck in high gear? Or perhaps this is one of those exceptions to the rule and the case of a one-way street of bad consequences (inflation) caused by high velocity, but we don’t get the good consequences (deflation) caused by low velocity? Or is high velocity like perpetual motion in that once it gets going it stays in motion leading quickly & inevitably to hyperinflation? And if velocity does slows down, how come we never get deflation? In the past all we ever got was “disinflation” which is a lowering of the inflation rate. The whole theory is just nuts. The gatekeepers of this notion want you to believe that money velocity is akin to holding a hot potato. Apparently people just can’t stand the idea of having money in their wallets for more than a very short time. They claim that people must immediately spend every paycheck as quickly as it comes in which is why we get the dreaded inflation. Really? This brings the term “easy come, easy go” to a whole new level. The pseudo-science of money velocity is simply a ruse that was invented to help the Fed obfuscate what it’s doing behind closed doors. It’s a counterfeiters’ favorite fall back position that gets the “get-out-of-jail-free” card when inflation really gets going. They simply trot out their standard sales pitch: “don’t look at us, it’s not our fault we have inflation, it’s you quick-spenders out there that’s causing it”…and no one ever seems to be the wiser.

BTW, how is it even possible to accurately measure velocity? Is there some super-secret formula known only to certain intellectuals at MIT or Harvard? Maybe those geniuses at the Treasury or the Fed have the answer. If you believe that I’ve got a bridge to sell. The answer of course is it can’t be measured, or at least measured accurately enough to be of any value to anyone. The Fed’s current Einsteinian formula used to measure velocity is simply a grade school idea someone pulled out of thin air. Armed with this new magic formula, the fraudsters tell us with a straight face that we’re to rely on their infallible math criterion to measure infinitely complicated interactions of millions of human beings involved in trillions of transactions. Check. Got it.

SOME RANDOM THOUGHTS

There is just so much confusion within society today regarding the current & ongoing inflation vs. deflation debate. The primary reason why is that we’re frequently told that the money supply has been expanded dramatically by the Federal Reserve — which is true — yet news sources tell us repeatedly there is absolutely no sign of inflation anywhere and what we really have is deflation! So what the heck is going on here? How is it possible to have two seemingly contradictory events occurring simultaneously? Are we in fact reliving the deflationary 30’s all over again?

The truth is we certainly aren’t experiencing deflation as evidenced by years of an overall rising price level. Even the govt admits this in its CPI numbers, but concedes the rate is “too low” at around 2% or so. I believe it to be much higher and have sources to back up my opinion. But why isn’t the inflation rate even higher than that due to massive money printing by the Fed? Shouldn’t we have the severe inflation of the 70’s at a minimum by now? Just how is this possible? And isn’t this proof that those Keynesian idiots are correct when they say monetary inflation does not devalue the dollar and so the Fed can just keep on printing until the cows come home?

Hardly. The Fed’s deliberate & ongoing monetary inflation always leads to one of two inevitable consequences assuming a constant rate of production. The first one is the most common & obvious: inflation. The second one is a bit tougher to detect, with its consequence being a close relative to Bastiat’s “What is seen and what is not seen.” It is the absence of deflation, or “missing deflation.” Deflation occurs during periods of economic contraction if the CB just keeps its dirty hands off the printing presses. But because they don’t, the Fed’s action prevents its occurrence.

Deflation is, simply speaking, the healthy process of buyers and sellers adjusting to changing prices which takes place following (1) a real but excessive & unsustainable boom, or (2) an artificial boom caused by government policy & money printing. The economic excesses & distortions built up over time must be altered or cleansed to enable the economy to return to its normal steady state, which I refer to as economic homeostasis. Eventually over-valued assets & excessive prices naturally adjust downward, but only if they are allowed to. When the CB steps in and circumvents the process we no longer get the necessary deflation. Instead, we get artificially propped-up prices which leave the economy distorted, constipated & out of whack, precisely where we stand today. What’s needed is a return to normal market prices which the economy is desperately trying to get to on it own, but can’t.

But wait, it gets even better. There is yet another unseen development (better known as a crime) that’s taken place which, once again, is almost completely missed by the masses. Many of those believe we are fortunate to have been spared the ravages of inflation because, as almost every knows, the Fed has been running its printing presses at warp speed since 2008. They realize this should have caused massive inflation and are counting their lucky stars for having to only tolerate its milder form. But what they fail to realize is this: individuals who acted fiscally responsible and economically prudent — by working, accumulating & building their savings — should have been financially rewarded as an economic consequence of the great recession. Alternatively, those who fell for the lure of cheap borrowing, and those who bought into the stupid notion that debt is a good thing and spent themselves into oblivion (which enabled them to keep up with the Jones’ of course), should have been appropriately & financially punished by the marketplace (many, unfortunately, were not, but that’s a topic for another day).

So how & why was it that the fiscally prudent weren’t rewarded in the aftermath of the last recession/depression? Because the expected, obvious, & profound “price deflation” that should have occurred during that period didn’t… it wasn’t allowed to happen. And why was this? You know why… the Fed gleefully stepped in with their printing presses and dramatically inflated the currency. The end result was that those who held savings were systematically looted. They were deprived of a just, deserved, and rightful higher standard of living that should have occurred as a result of a rising appreciation in the value of their currency, in this case dollars. People who built up savings were stolen from by the Fed just as surely as by an armed thief on the street. Because of the illegal, immoral, and fraudulent manipulation of the currency, its value was diluted & devalued. This in turn prevented the economy from making the normal & natural corrections that lead to recovery. And it’s an ongoing crime that’s still in progress.

So if you are one of the large majority of uninformed savers who thinks he’s been “spared” from the nasty effects of inflation, you simply do not understand what has been happening to you. Don’t feel bad, you have lots of company, even many of those who espouse Laissez-faire capitalism.

¹http://mises.org/library/velocity-magic

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Mark
Mark

Inflation = when public mood is confident they spend and invest money. The velocity of money tends to be high.

Deflation = when the public mood is dour they hoard money. The velocity of money turns down.

Look at a Dime or Quarter some time. See those ribs on the edges. If the value of coin was deemed by the public to be its metal content what would happen in an inflationary world verses deflationary world.

Inflationary world = the value of money decreases. I don’t except you shaved coins . They don’t have enough metal in them. Take the non shaved coins out of the jar you have buried in the back yard.

Deflationary world = the value of money increase because it is more scarce. A producer accepts your shaved coins . Mean while, you continue to burry non shaved coins in the backyard.

Money is just a commodity. It’s value fluctuates. The government can make money scarce to the public by increasing taxes and increasing regulations on private producers. If private producers are restrained from producing ( Keystone Pipeline ) and the supply of goods in the private sector decrease relative to money. Then the value of real money increases and thats deflation.

The government thinks it can fool the public with shaved coins. The smart money ( those with the most coins) invest in the private sector elsewhere or don’t produce as much. That is deflation even though the coins have been shaved.

card802
card802

Good article. Most people will never understand it all (like me) unless they are an Austrian Economics guru.

I’m happy with being told the truth, well, not really happy but content with the truth, and the truth pisses me the fuck off. Get enough people pissed the fuck off and we may see riots, not change but maybe riots, who am I kidding, I doubt we’ll see riots or change……

bb

You can surely see inflation when you go the store or out on the road.For example , this morning in beautiful Cheyenne Wyoming my favorite 20 ounces of Mountain Dew was 1.99 and a bottle( 28 ounces) of Gatorade was 2.69 .Neither have ever been this much.These are just the some of the price increases that are coming your way.
Federal reserve central banking system and Fractional reserve banking are the systems responsible for inflation. Especially Fractional reserve banking . Banks are just little money making machines.They created money out of thin air 24/7.Their job is not to protect your money. Their job is to counterfeit.

Stephan F
Stephan F

“These are just the some of the price increases that are coming your way.”

You’re spot-on BB. A title wave of higher prices is heading our way and is all but inevitable; it’s baked into the cake. The only reason it hasn’t (yet) is because by and large most are still clutching their Yankee dollars “close to the vest”; but that is now apparently changing. I’m starting to notice more & more of those stalking starry eyed shoppers coming out of the woodwork, and what is now a crawl could easily turn into a stampede in short order. I’d take some precautions now to avoid being trampled under.

Have to disagree with this comment though: “Federal reserve central banking system and Fractional reserve banking are the systems responsible for inflation. Especially Fractional reserve banking.”

The problems caused by the Fed’s monetary inflation are many, but fractional reserve banking is not one of them. It’s really just a symptom, sort of a hybrid symptom in that it compounds the problem when you inflate a currency. FRB doesn’t cause monetary inflation, just like pouring gasoline on a fire didn’t actually start the fire; but it sure as hell made it worse.

Here are a couple links to some outstanding articles John Tamny wrote on the subject of FRB:

http://www.forbes.com/sites/johntamny/2012/07/29/ron-paul-fractional-reserve-banking-and-the-money-multiplier-myth/

http://www.forbes.com/sites/johntamny/2014/08/17/the-closing-of-the-austrian-schools-economic-mind/#comment_reply

Overthecliff
Overthecliff

Walmart raising wages? Other retailers following suit?

Thinker

Cliff, yes, there are a few other retailers following suit — TJX is one of them, but they’re a drop in the bucket compared to others. Some people point to “retail quits” (number of people no longer employed in the retail sector) as “proof!” that the jobs market is improving. But we all know that more retail stores are closing than anything, thus leading to the increase in quits.

In reality, the large big-box retailers have more of an interest in staving off proposed minimum-wage regulation in various states than anything. That would cost a hell of a lot more than upping wages among a fraction of their workforce, particularly when they have a churn-and-burn model as it is.

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