Inflationomics

Symptoms of the Three Phases of Inflation

Inflation, of course, is the expansion of the money and credit supply (cause) beyond the expansion of the underlying goods in the market.  In time, this expansion tends to raise prices (effect).  When rising prices are perceived by most people, people begin to expect rising prices and adjust their behavior accordingly.

In the short run (first phase), the following symptoms occur:

  1. Debtors gain and creditors lose money.  In other words, debtors benefit from the decline in the purchasing power of the money they are using to repay their debts.  Creditors lose purchasing power with the money they are receiving (as compared with the money they lent).
  2. Vendors shorten the payment terms or require cash in advance.  Variable rates on loans become more fashionable.  Thirty-year loans become fewer and farther between.
  3. Vendors provide fewer goods for the same amount of money.  Think about cans that have 11.2 ounces in them instead of 12 ounces, but cost the same as the 12 ounce cans used to cost.
  4. People start buying used goods more than new goods.  Maintenance becomes more important as goods must last longer before being worn out/thrown out.

In the medium term (second phase), when prices start to rise a little faster, the following symptoms occur:

  1. Some people wait to get married until they can better afford marriage, and couples have fewer children.  Birth rate declines.
  2. It becomes harder to save and invest in things that will maintain their value in the long run.
  3. Theft increases.  This includes Ponzi schemes (think Bernard Madoff), theft of copper from utilities and houses, rip-offs, scams, and counterfeiting (think rare gold coins, collectibles, and gold bars, as well as paper money).
  4. The same amount of money buys cheaper quality goods (or you have to pay more for the same quality goods you used to get).  Ever buy something requiring assembly and the pieces just didn’t quite fit together properly?  Get used to it!
  5. Businesses, including banks, fail in larger and larger numbers as financing (and collection of customer funds) becomes more difficult to come by.

In the long run (third and final phase of an inflationary bust), you’ll see the following symptoms:

  1. Student loans dry up and unemployment goes up.  Colleges and universities fail.
  2. People make do with necessities and forego luxuries. (The definition of what is a necessity may also become more spartan.)
  3. Capital goods prices deflate as no one can afford them any longer.
  4. Capital markets are destroyed.  No more financing is available.
  5. Division of labor breaks down.  Everyone must become much more self-sufficient.  Think food and energy.
  6. Barter becomes commonplace.  Commodities become currency, until…

Someone comes up with something that people can believe will maintain its value over time. Traditionally, this has been gold and/or silver.  And from the way many central banks are collecting gold these days, it may just happen that way again.

Robert Jackson Smith

 

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