Inflation Revisited

T he newest post on Mises.org is excellent. It's about the effects of inflation, mostly as it has to do with investing, but also its general effects on society. I've also written on similar subjects in the past here and here. The global economy is sick with the fiat money plague and there is little chance of it regaining a sure footing without a serious correction. I firmly believe that central banking and paper money are the primary evils of our age. Without them, governments would have little chance of funding all the various wars and schemes that are destroying the fabric of our social and economic lives. I've decided to go into the archives and republish an earlier piece I wrote on this very topic. Here it is in its entirety along with some significant changes.

The modern world is enamored with inflation. Never before in the history of this planet has inflation been so easy, so ubiquitous, and so accepted by both rulers and the ruled. Where once it was recognized as a scam, a fraud, and a form of robbery, it has now been legitimized, politically institutionalized and morally and economically justified. None of this changes the nature of inflation or its consequences, it simply changes the way we have come to view it.

Before we look at the effects of inflation on society, we must first understand what it is. Semantics has long been a favorite toy of politicians and swindlers everywhere and perhaps nowhere have they been more successful in its use than with the term inflation. Today we are told that the CPI (Consumer Price Index) tracks inflation. We are told that right now annual inflation is low. We are also told that it is one of the main jobs of those at the Federal Reserve to prevent and control inflation. Sometimes the big wigs at the fed are even referred to as “inflation hawks.”

What all this implies is that inflation is a general rise in prices. We are taught that when prices go up it’s called inflation and when they go down it’s called deflation. This is absolutely not true. This kind of thinking confuses the effect with the cause. Inflation is not a rise in prices. If we look in Merriam Webster’s Collegiate Dictionary inflation is defined as: “an increase in the volume of money and credit relative to available goods and services resulting in a continuing rise in the general price level.”

Inflation is essentially the act of making money out of thin air, and the result is that prices rise because there is more money chasing the same amount of goods. This is a highly significant distinction. Once we know what inflation is, we can see through all the rhetoric and justification. We can see that the CPI does not track inflation, it tracks the effects of inflation and it does that very selectively and therefore poorly. We can recognize that the Fed is not an “inflation hawk,” but rather the source of inflation.

The idea of inflation is as old as the idea of money itself. Why sweat and toil to earn an income if you can just make something that looks like money and then spend it right along with the real stuff? For governments, which are always and everywhere short of cash, this idea has been irresistible. This is one of the main reasons why precious metals, especially gold, have historically been the best medium of exchange. They are rare, and extremely difficult to counterfeit, thus making it hard for governments and crooks to defraud the people by inflating the money supply.

While there isn’t room here for a closer look at the history and implications of inflation, there are numerous books and essays devoted to this topic. Two I would recommend are “What Has Government Done to Our Money?” and “The Case Against the Fed,” both by Murray N. Rothbard. For the more advanced and determined reader, “The Theory of Money and Credit,” by Ludwig Von Mises is an excellent and more complete source.

The effects of inflation on an economy and on society in general are many. Perhaps the most important, but least recognized is that over time it distorts an economy’s production structure and leads to misallocations of capital and investment resulting in cycles of boom and bust. It hampers and eventually destroys the proper functioning of capital markets because it colors and misconstrues the signals that traditionally direct investor capital into its most urgent and therefore most productive uses. It serves to prop up bankrupt governments and allows even the "freest" of republics to engage in wanton public spending and even total war. One of the great ironies of our age is that the very source of depressions and economic downturns, wars, the welfare state, and in many cases poverty, has been sold to us as the cure. But that is a much longer story for another time.

Perhaps the most pernicious effect of inflation is what it does to savings and the ability of individuals to plan for the future. Under normal circumstances, in a free market economy where money is sound and not subject to counterfeiting, saving is a highly effective way of planning for future security. Simply setting aside a small portion of current earnings can reap huge benefits over the lifetime of a working person and should allow them to comfortably retire when they can no longer work. In fact, the normal market trend is for the general price level to gradually fall, increasing real wages and the value of each person’s savings.

This was precisely what happened in industrialized nations before inflation was enthroned as a permanent fixture. From 1800 until around 1916 prices in America fell steadily (the Fed was formed in 1913). Increased capital accumulation, invention and innovation raised worker productivity. Over time wages tended to rise slightly or hold steady while the prices of goods and services fell. What is so misleading about trying to track and analyze inflation by simply watching for price increases is that it does not take this trend into account. If the trend is for prices to fall but they hold steady, then prices have actually risen above what they would have been. Since this rise is not visible and is impossible to measure, it is not even considered. Considering the dramatic, technology driven increases in worker productivity we have witnessed over the past two decades, and considering the fact that the general price level has steadily risen over that same period, we are looking at a price increase that is possibly many times greater than the official statistics claim.

Under our current inflationary circumstances, if a person tries to save throughout their life, by the time they reach retirement their savings will be worth a pittance of its original value. One dollar from 1950 is worth about 13 cents today. The result is that people are either forced into the financial markets in hopes of making a great enough return to at least offset inflation, or they demand a pension from the government or from the company they work for. Both of these solutions are problematic.

Successful investing requires experience and know-how. To gain a return on money also requires placing that money at risk. The stock market, once the arena of capitalists and professional speculators, is now home to virtually everyone. Many people have and will continue to lose their nest eggs because of bad investments or bad timing. Sadly they have little choice but to sit back and watch the value of their money erode, or go back into the market again seeking profits. This is the reason why we have seen such an explosion of growth in the financial industry, especially mutual funds, over the past twenty years. People are trying to find a way to effectively save for retirement, but are unsure of how to navigate the markets. Professional money managers may solve that problem for some people some of the time, but they cannot eliminate risk.

The other solution is even less effective. Employer pensions and government social insurance programs are both subject to the same inflationary erosion as personal savings. Over time they become increasingly expensive and difficult to fund. We can see this happening with large corporations like GM, which is going bankrupt trying to meet its pension obligations, as well as with Social Security and government medical insurance.

As the economist Ludwig Von Mises wrote in 1950, “No solution can be found for this dilemma. In an industrial society all deferred payments must be stipulated in terms of money. They shrink with the shrinking of the money’s purchasing power. A policy of deficit spending saps the very foundation of all interpersonal relations and contracts. It frustrates all kinds of savings, social security benefits and pensions.”

Welcome to America 2005. We have a potential retirement crisis on our hands. Almost everyone is counting on a mix of government or corporate payments and continually rising asset prices to fund their retirement. Many will undoubtedly be disappointed. America’s spendthrift ways, its lack of personal savings, its mountains of consumer and government debt are not the result of cultural phenomenon or simply of irresponsible behavior on the part of its citizens. They are the result of a policy of constant and unrelenting inflation.

The demise of the culture of thrift and frugality is not a product of consumer capitalism or moral decline. It has been destroyed by the fact that a dollar today is not a dollar tomorrow. Inflation is a hidden tax on savings. When the government or private banks create new money and spend it, it is the same as if they were to draw the money straight out of your bank account. All those who hold and deal in the depreciating currency are subject to an invisible tax; one that cannot be measured, evaded or properly planned for. Those who then get this newly created money first profit at the expense of those who get it later on after it has worked its way through the economy causing prices to rise. This system is dishonest, it is fraudulent, it is immoral and it attacks the very foundations of society and the market economy.

To grant the government a monopoly over money, is to place the key to the vault in the hands of thieves. It is to place the most vital component of a modern industrialized economy in certain danger. We cannot do so without placing our future welfare at serious risk. To believe that inflation is beneficial or that it can make us wealthy is to believe we can get rich by simply printing paper bills and calling them money. It is to fall prey to one of the oldest and most foolish of delusions; the idea of a free lunch. Money is not nor does it produce wealth. Only increased production funded by real savings can make us richer. Sadly, it is near impossible to believe that the fiat money plague will end any time soon. It is also foolish to believe that the current system can continue indefinitely. Eventually the house of cards will come tumbling down. As an individual, there are steps we can take to protect ourselves and our assets from future disruption, but as a society and a global economy, there is little hope of a soft landing. For sowing the wind, we will reap the whirlwind.