The Confusion about Inflation

I recently read an article in which the author defined inflation as a “sustained increase in the price of goods and services.” While this definition is quite common, it is not accurate. Inflation is the increase in the supply of money and credit, pure and simple. This may lead to rising prices of goods and services (price inflation), but to say that the rising prices are inflation confuses the cause and effect of the rising prices. This is important because if we don’t understand the cause of price inflation, we don’t know where to look to stop it. If we think that inflation means the rise of prices of goods and services, then we might conclude that any person who raises the prices of his goods and services is the cause of inflation.

When we understand that inflation is an increase in the supply of money and credit, we know to look at the source of the money/credit supply. Who controls the supply of money and credit?  Who is legally allowed to increase the supply of money and credit? In each country, it is generally the central bank. This also explains why the inflation rate in each county is different. In other words, it is possible to have little price inflation in one country, the United States, for example, and much more price inflation in another country, Argentina or Zimbabwe, for example.

Most people are interested in price inflation, not inflation, so let’s talk about price inflation…it comes in three stages. In the first stage of price inflation, when the government, or its central bank, prints more money, prices may rise only slightly. Think 1961 to 1973 and 1983 to 2020 in the U.S. dollar. During this stage, people may save more, work harder, and forgo current consumption to try to compensate for the rising prices and hope that prices will stop rising soon. This behavior may actually retard the rise in prices and delay the second stage. People still have total faith in their currency during this stage.

During the second stage of price inflation, goods prices climb at a faster rate than that of the currency inflation by the central bank/government. (When I refer to a central bank, it is synonymous with the government because any central bank that refuses to do the bidding of its government will soon be stripped of its color of independence. In short, they are one and the same.) Think 1973 to 1980 (and starting again in 2021) for the U.S. dollar. It’s during this stage that rising prices really become noticeable. As the hue and cry resulting from rising prices reaches a crescendo, the people call upon the government to “do something” to stop the pain. Using the definition of inflation as being a “sustained increase in the prices of goods and services,” the government usually imposes price controls and blames greedy businessmen for raising their prices. Capital controls, money laundering rules, and other socialistic measures may also be imposed. People start to question whether the government is in control of the situation and they anticipate higher prices.  They look for ways to spend their money sooner rather than later, and they borrow money to buy hard assets (gold, silver, land, etc.) as a hedge against price inflation. Longer term investments start to dry up. People focus on the short term. Everyone becomes a speculator.

The third and final stage of price inflation occurs when the currency becomes worthless. When the people ultimately lose faith in the ability of the currency to maintain its value, they dump it and either turn to barter, or they find a different currency to use instead. At that point, the government will be forced to have a currency reform in an attempt to maintain law and order and control.

Today, there are no currencies that are backed by a hard asset. They are all fiat currencies. What’s more, they are all being inflated at an accelerating pace. This makes it unlikely that people will be able to turn to an alternate currency when their currency is destroyed. The obvious choice is to have a currency reform that backs the currency with a hard asset such as gold. The problem with this idea is that such a currency would limit the government’s spending to the amount of gold on hand. After giving away trillions of dollars and spending trillions more to maintain its super-power status, the U.S. legislators and their dependants may not have the self control needed to limit their spending. Martial law will probably be the next step after the U.S. dollar is destroyed. We’ll see.

Robert F. Sennholz

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