Monday, December 28, 2009

What is Inflation?


We have been taught to think of inflation as rising prices. The image at right conveys this misconception.  But rising prices and inflation are two completely different things.  Inflation is an increase in the money supply.  Generally rising prices are only a consequence of that increase.


When government inflates money supply, privileged parties (banks, government contractors, etc.) get the new money BEFORE it has forced prices to go up. Ultimately, though, the privileged spenders of inflated money cause prices to go up long before the rest of us get our annual raises. That's why it seems we are always getting further and further behind--because usually we really are. Inflation hurts people on fixed incomes (such as retirees) most.

Inflation reduces peoples' standards of living. Inflation is a very successful means of ensuring that poor people stay poor and that third-world people remain as third-world people. Inflation is thus a great benefit to the already rich people who falsely claim that man is having a significant effect on climate change.

When you and I spend our money for goods and services, we spend money that we have worked hard to obtain and for which we have produced and contributed something valuable to the economy. The privileged spenders of inflated money get to spend the inflated money without having produced and contributed anything to the economy. It has the same effect on the economy as theft, and in actuality it is theft.

Because it makes your money less valuable, inflation discourages you from saving and thrift, but it encourages you to spend profligately and to practice immediate gratification. The average rate of inflation has been higher over the last several years than the average savings interest rate.  Without inflation, you would be able to comfortably save for your retirement, knowing that you would have sufficient for your needs when you retire. Inflation, however, entices you to gamble your retirement funds in stock market in order to get what you would otherwise be sure of. Inflation is insidious in that it makes you expect that you will not be able to retire as comfortably as you once hoped. It may even make it so that you can't retire at all.

Because inflation is an increase in money, inflation means that newly created money has to enter the system somewhere. Inflation thus gluts lending institutions with money, enticing them to loan to more and riskier borrowers than they normally would.  Inflation causes lenders to go into overdrive in enticing people to purchase homes for which they are not economically qualified.

If our government were required to stay on a gold and silver standard, it would be nearly impossible to inflate the money supply. Inflation thus allows government not only to bail out failing institutions and businesses, but also allows it to pick and choose which businesses it will bail out. Government usually chooses to bail out the "too big to fail" banks and other companies, but it usually chooses NOT to bail out smaller companies. Inflation leads indirectly, therefore, to larger companies accumulating more and more riches and smaller companies being forced out of business.

Gold and silver can be inflated, but not nearly as easily as paper money. It's much harder to dig gold out of the ground than it is to run paper through a printing press.

Inflation is often much higher than it seems. Abundance and productivity gains cause the prices of things to go down. For example, when computers were first introduced, they did not have color monitors, and they provided a tiny fraction of the memory and disk space that today's computers have, but they cost well over $3,000. Without improvements in the ability to manufacture computers, inflation since then would have meant that computers would cost nearly $10,000 in today's prices.

If some products become in short supply and their prices rise, this is not inflation, even if the prices of some other things are also caused to rise. The rising price of oil, for example, may cause the prices of oil-related products to rise, but many other prices will remain unaffected. In reality, if people are compelled to spend more money on oil products, such as gasoline, they will have less to spend on other products, influencing the prices of other products to go down.


When government creates inflation, it invariably causes economic problems. It also invariably blames those problems on the "free market", and it uses problems that it caused as an excuse to attempt to place greater regulations and restrictions on our freedom to buy and sell things.

5 comments:

  1. Frank

    Actually inflation isn't even a rise in money supply, however that certainly causes it. Inflation is actually the loss of buying power. There was a time where you could buy a fine tailored suit for $20.00. That same suit may now cost $1000 dollars. The value of that original $20 has dwindled dramatically.

    What is interesting is if you had $20 dollars worth of gold back then it would have about the same buying power as the same amount of gold today. You could still buy that same fine tailored suit for the same amount of gold. That is because gold does not inflate. Only the dollar that we measure it with does.

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  2. Which makes me all the more ticked off at my company's benefit administrators, who are dumb enough to think that gold wouldn't be a good part of my retirement portfolio.

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  3. Oh, so that is the truth of the inflation.As your saying, the cause of inflation is government?

    Thanks and Happy new year! Hope everything will become better this year.

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  4. Nimokon: I wouldn't say necessarily that government is the cause of ALL inflation. An example of how it might not be is if a nation is on the gold standard and someone suddenly discovers a huge gold mine.

    In American history, banks have contributed to inflation, but as a general rule the far greatest amount of inflation has occurred when central banks have ruled the country.

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  5. I tend to disagree with your clear and well thought article on inflation.

    Price inflation "the loss of buying power" seems to depend on what gives currency value. Ultimately and intuitively IMO, the value of a nations currency depends on that nation's productivity. A nation, like a business, of good workers who have good tools and good management, can pay its debts.

    Wasting money (on recent US wars, for example) even if it takes currency out of circulation, devalues the currency. Spending to improve education, medical care, and "hard" infrastructure, even if it puts more currency in circulation, maintains the value of the currency.

    Sadly, any company's benefit administrators tend to work for their own benefit rather than ours. Another reason I like Social Security better. ; )

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