In today’s article, J.R. MacLeod looks at the effects of inflation, the fraud it perpetrates on the population, and who benefits and who loses from inflation. He also shows that “Inflation is not necessary for real wealth and real growth… inflation is completely unnecessary for a growing and prosperous economy”. ~Tim McMahon, editor
Inflation, the Price Level, and Economic Growth: Everything the Elites Tell You about It Is Wrong
Fundamentally, inflation is fraud. The central government or bank printing more money lessens the value of the money already in circulation. A truckload of sand isn’t particularly valuable in Saudi Arabia. An increased supply of money means that ultimately prices denominated in that money will go up. Unless you are the one to receive that new money at its point of entry, and thus keep pace with the inflation, the real value of your money holdings will go down.
So, in essence, the government has taken wealth from you, and offered nothing in return, except the vague promise that the inflation will grow the economy, from which you will subsequently benefit. As we will show in this article, that is a false promise that has never once worked, and there is plentiful evidence against it ever working. Fortunately, there is another way.
If inflation is a fraud on the general populace in that its false promise of improved growth rings hollow time after time, it is more specifically a fraud on ordinary working people. When new money is created, it enters the economy through the government, financial, and corporate sectors. The distributors and initial recipients of this new money obtain it before prices go up, in fact, prices are driven up by their spending of the new money. Those responsible for the inflation are thus ahead of the inflation curve.
Ordinary people, however, are behind the inflation curve. The new money only works its way to them after prices have already increased. And if the inflation is continuous, then they are already behind the next wave of money printing and price increases.
Even if there is a limited burst of inflation which is then totally halted, the elite still benefit at ordinary people’s expense. The new money is printed, and the first holders spend it when prices are still low, this spending drives up prices, the money then works its way through the economy in a more general distribution, and ordinary people are right back where they started: with higher nominal wages but having to pay higher nominal prices too. Meanwhile, the elite gained increased real purchasing power at the beginning, without doing anything to earn it, instead just having the right connections to obtain the newly printed cash.
Thus, inflation can only ever benefit the elite at the expense of ordinary people. This is hardly surprising given the revolving door between the federal reserve and the financial sector. The same people who control the power of inflation are the ones who can directly benefit from it.
However, inflation is completely unnecessary for a growing and prosperous economy. Under a strict gold standard, inflation, defined by Mises as the printing of money by a government entity, does not take place. Thus the only way price inflation, or more aptly, price increases, can take place is due to natural economic or environmental factors and government folly other than inflation.
The Natural Order is Deflation (i.e. Price Decreases)
Though there may be price increases in specific areas, under a strict gold standard, the guaranteed general trend is for price decreases. How so? If the government isn’t printing money, then prices are dictated fully by the market.
In a free-market, competition and innovation drive prices down. To stay in business, firms must make a profit; to make a profit, they have to attract customers; to attract customers, they have to offer higher quality products at a lower price than their competitors.
This process has taken place consistently throughout economic history. Take, for example, the pocket calculator. Free inquiry and the ability to make a profit led to the innovation of the first commercially available calculators. Initially, they are very expensive as cutting-edge products. However, over time the price came down as near-universal demand for the product combined with the effective resource marshaling of a free and competitive market made pocket calculators widely available at a low price.
And yet, despite a lowering of prices, economic growth occurs as more people have new and useful products in their hands. Furthermore, at the same time that the price came down, competition led to the product becoming sleeker and more powerful.
Inflation is pursued as a fundamental misconception of the nature of wealth and economic growth. Money is not wealth, printing more money does not lead to growth in the real economy. Were all those trillionaires in Zimbabwe in the mid-2000s wealthy… even though, in real terms, they could purchase fewer goods than previously? Why was their economy declining if they were printing so much money?
Rather, wealth and growth are defined by the standard of living. While this has a subjective component, common sense can inform us of some objective ways to gauge an individual’s material well-being.
Inflation Isn’t Necessary for Economic Growth
Inflation is not necessary for real wealth and real growth. These things are obtained by producing more goods and services available at the lowest cost. A declining general price level takes place as a consequence of true economic growth and wealth generation.
It is logically impossible that under a strict gold standard with no inflation, combined with a free market in goods and services, there could be any situation other than economic growth at the same time as a declining price level. But this is also backed up by the empirical record.
In the late nineteenth century, both the UK and America had strict gold standards and declining price levels. This was also the period of greatest relative advancement in economic history when both countries asserted themselves as truly industrialized economies and the most powerful nations in the world.
See here, for example. Or, for a lengthier (yet still pleasantly concise) discussion of this subject, see George A. Selgin, “Less than Zero: The Case for a Falling Price Level in a Growing Economy”
This article by J.R. MacLeod originally appeared here and has been reprinted under the creative commons license.
Editor’s Note:
One could make the argument that if the money supply were to increase at exactly the same rate as the increase in GDP, then prices would remain stable. To some extent, this did happen under the gold standard because the supply of gold was able to increase (due to mining). But it wasn’t perfect because at some points in history, the gold supply jumped far faster than the GDP i.e. during a “gold rush” or new massive discovery. If there was some algorithm to increase the money supply by exactly the increase in GDP, it could possibly work… if bureaucrats could be trusted not to fudge the algorithm for their own benefit. But all that begs the question, Why bother? What’s wrong with falling prices? In our article, What is so bad about Deflation? we look at falling prices and who benefits and who loses. And why governments fear deflation so much.
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As always, the anti inflation crowd has forgotten to point out any positive points of inflation.
The latest figure I saw stated that 70% of wealth was owned by the top 10%. In a world without inflation, the money supply would stop growing, so those people would have 70% of a pie that would never increase in size.
Those few who were wealthy would have no reason to enter a market where they could lose money, so 70% of wealth would leave the market. Those people would basically become noble people.
After awhile, they might buy up items to make them more money and pretty soon own even normal people’s homes and the other 30% they don’t already own. And remember – with no inflation, the money supply is stuck where it is!
It would be ignorant to keep the wealthy from needing to invest to avoid inflation.
There is the Goldie locks amount of inflation that you can argue about but inflation is an important part of markets.
Neiwei,
Inflation helps debtors and hurts those on fixed incomes. The biggest debtors are the U.S. government. So they have an incentive to create inflation. but too much inflation angers the masses and cuts off their lenders (i.e. those willing to buy government debt), so the gov’t can’t get away with inflating their debt away too quickly. In addition, any inflation creates “malinvestment” i.e. people think they are richer than they are so they spend more than they prudently should, it encourages debt, thus the rich get richer ane the poor get poorer.
Neiwei,
I just read a post by David Stockman that addresses your issue. “The assumption that market capitalism is working according to the scriptures penned by St. Adam Smith is dead wrong, and has been for decades now. That’s because today’s bailout-ridden crony capitalism is not remotely the real thing, and because free markets can’t function efficiently and productively when they are flooded with cheap credit printed by the central bank.” ~David Stockman
So basically, he is saying the opposite of what you are saying i.e. by the Central Banks creating money they are helping the rich and hurting the poor.