How Inflation Misallocates Resources

A friend recently asked me how one prepares for hyper-inflation. I told him that the short answer is to buy a lifetime supply of everything he will need now, before prices rise. Of course this isn't something most people can afford to do. What's more, even if you could afford such a purchase, where would you store everything? You would either have to build, rent, or buy a storage facility. In short, the expectation of inflation changes what we do. It re-arranges our priorities. While we may only buy an extra year's supply of things, not a lifetime supply, it nevertheless makes us stock up on things we otherwise would wait to purchase, like food, supplies, tools, even gold and silver. And it makes us spend more on storage. When we must purchase things we otherwise wouldn't because we anticipate rising prices, our stocking up is a misallocation of resources.

What's worse is, it makes our suppliers do the same thing. Everyone tries to beat the coming price increases by stocking up. This extra demand creates shortages and supply chain backlogs...and more resources spent to create more storage space...all things that wouldn't occur without inflation. Because this is not the most efficient use of resources, we call it a misallocation of resources.

It's also a misallocation of resources when resources are diverted from profitable endeavors to loss making endeavors...think many government expenditures such as wars (drugs, Iraq, Russia) or paying people not to work (welfare, unemployment compensation, stimmie checks, etc.), or bureaucratic red tape. Unfortunately, since it is governments that create inflation through money printing, they have the first chance to spend the newly created money, before it loses its purchasing power. Thus, government boondoggles receive top priority when it comes to misallocating resources.

I might add that when thousands of businesses are shut down and caused to go out of business because of a government mandated shut down, this is a gross misallocation of resources, too...not to mention the money spent on vaccines and enforcing the shut down.

As inflation worsens, so do the supply chain problems. By way of an example, let's assume our friendly neighborhood printer needs some paper with which to print some books. He orders a skid of paper that costs $5,000.00. A year later, he needs another skid of paper, but this time he expects inflation and so he orders two skids of paper for $10,000.00. When that paper runs out, he must purchase another skid, but this time it costs $7,000.00. Over time, the prices continue to rise until he can no longer afford a skid. His orders shrink in size until he goes out of business...or his supplier can no longer produce the paper he needs because his costs have gone up, too.

It starts out slowly, but over time it becomes a growing problem, until one day, it's out of control, and even higher interest rates can't solve the inflation problem. That's when the real problems start. Better stock up now while storage space is still relatively cheap!

Robert F. Sennholz

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