Inflation: The Hidden Tax

The media and the Central Bank (i.e. The U.S. Federal Reserve aka. the “FED”) tells us that a little bit of inflation is a good thing. Inflation gets the ball rolling, greases the wheels of commerce, and stimulates the economy. The FED sets as a goal 2% inflation, so inflation must be good for us, right?

Two Forms of Inflation

Well, it is good for someone but not necessarily for you i.e. the consumer. The first problem comes because there are two different types of “inflation” and by interchanging them we end up with a form of Orwellian “double-speak”. The first kind of inflation is “monetary inflation” i.e. an increase in the overall money supply. This is accomplished by a complex process between the government, the central bank, the open market, and the member banks. For more information see our article “How the FED Controls the Money Supply”.

The second form of inflation is an increase in the price that consumers pay, which is the result of an increase in the money supply and it is more accurately called “price inflation”. Price inflation reduces our purchasing power (as prices rise each dollar in your bank account buys less) and thus makes us poorer.

The Effects of Inflation

Because things are getting more expensive and savings are becoming less valuable, price inflation discourages saving and encourages spending. This is how it “stimulates the economy” but it also encourages misallocation of personal resources. Because people are motivated to spend now, they end up chasing short-term goals rather than long-term goals which might actually have been more profitable and in their best interest; but they no longer appear so because of the distortions caused by inflation.

Inflation also increases wealth inequality.

Those who get the money first get the most benefit because they can buy before the increase in the money supply has had its effect. People who get the money last and those on fixed incomes are in the worst situation.

Who Benefits From Inflation?

As we’ve seen consumers are hurt by inflation, so who benefits? Debtors benefit from inflation because they borrowed relatively more valuable dollars and are able to pay off their debt with “cheaper dollars”. An extreme example would be in the case of hyperinflation. In hyperinflation prices rise rapidly, possibly doubling in a few days or weeks. So, if you borrow $10,000 to buy a car and two weeks later it takes $20,000 to buy the same car and then two weeks later it takes $40,000 before long the price of a cup of coffee will allow you to repay your car loan. So basically, you got your car for free. Of course, that is an extreme example, but even in the case of ordinary inflation, the same thing is happening it is just less obvious.

Because the Government is the largest debtor in the country, they benefit the most from inflation but that isn’t even the primary reason they like inflation so much. The primary reason is that they get to spend the inflated money first. So, they get to spend it at its old value (even though it is newly printed) and so the people who accept it assume it is one value but as it begins circulating it becomes worth less and less until the value of the new money is totally diluted.

Why Inflation is called a Hidden Tax

Because the recipients of this inflated money were unaware that it was really worth less than they thought it was it is certainly “hidden”. And because the primary beneficiary is the government you can rightly say that inflation is a “hidden tax”. Every time someone has to pay an increased price for what they want they are paying this hidden inflation tax.

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