Inflation. Yes, again.

Note: I had written a whole play-by-play analysis of this section (pages 366-373) of Basic Economics by Thomas Sowell, but it is so boring and long I’ve decided it isn’t worth being put on a blog. 

We are going to whittle this down drastically and not trouble ourselves with all the different ways Sowell errs on inflation. I’ll try to simply give an explanation of what inflation is while keeping his errors in mind. There will be coverage of this section of Basic Economics in more detail in an eventual upcoming e-book and you can join The Mean Austrian email list for updates on that.

So, let’s get down to it: (Pry those eyelids open and try to not run away. It may sound familiar, but I promise it’s – relatively -short.) 

– The Mean Austrian

 

Scarcity is one of the key features of money and an important feature to keep inflation from drastically hitting an economy. When government has control over the money supply, and that money supply is paper backed by nothing of true worth – as the U.S. currency is today – there is nothing to stop the government from printing out more money. And more money. And more money still. This inflates the money supply (i.e., inflation).

The result is that as more gold comes on the market, it is valued less. The more there is of something the less it is worth. On the flip side, generally speaking, the less there is of something the more valuable it becomes. This is true of everything from bread to baseball cards. Pretty basic stuff.

“Hold up, Mean Austrian! Might gold ever be affected by inflation?”

Yes, inflation can happen even with gold. Enter, History:

After the New World was discovered by Europeans, gold mines in America were opened and gold flowed back to the old country where this new money bid up the price of goods. But it was very minimal and happened gradually over the course of a century.

The difference between gold mines in the New World and printing presses in the U.S. is that to mine gold out of the ground and ship it across the Atlantic was a costly and risky venture. It took a lot of tangible resources to bring that gold into circulation and thus the inflation was limited by the pocketbooks of the entrepreneurs and their backers. Under the Federal Reserve, there is nothing limiting the the increase in money. It is little more than a matter of paper and ink. No risk, high “reward”.

While there can be inflation with gold-based currency, that inflation would never be runaway inflation. The only thing keeping us from experiencing the runaway inflation the Wiemar Republic went through, and that Venezuela is currently experiencing, is the relative good sense of Janet Yellen.

WHY GOVERNMENTS CAUSE INFLATION

Governments, in some sense, ultimately rest upon the acquiescence of the people. If the taxes get too high, people become unruly. The solution then is to tax as much as you can get away with, and for whatever expenditures remain unmet, simply print the money.

Yes, you guessed it: This inflates the money supply! It devalues the money already in circulation and it steals the purchasing power of every consumer in the country. This is a hidden tax and the most regressive tax. A sales tax may be at 8% of every dollar a poor man spends, but inflation takes 2% of every dollar the poor man doesn’t spend every year. This flat-out discourages saving money and if the man wishes to improve his current financial situation it makes it all the harder.

I’m pretty sure we’ll deal with other aspects of inflation as we move forward.  Deflation is right around the corner, so I’ll leave it here for now… I wouldn’t want to overexcite anyone all in one post.

I should also apologize for the delay. Blame my cows and computer. I know I do. For those of you who are still following along despite the delay, I really do appreciate you!

When Do People Not Want Money?

When do people not want money? The question arises from a passage of Basic Economics found in chapter 17, pages 365-366, that reads, “Usually everyone seems to want money, but there have been particular times in particular countries when no one wanted money because they considered it worthless. In reality, it was the fact that no one would accept money that made it worthless […]”

If we are referring to natural and unmolested money that hasn’t been debased, the answer is never. However, there is another kind of money we haven’t covered yet: What about fiat money?

Fiat money isn’t the sort of money that develops naturally and spontaneously between market participants like anything Tom Sawyer and his cohorts might have considered money amongst themselves.

Fiat money is, and can only ever be, backed by law. Our money, which started out as bits of gold with inherent value, is nothing today but government issued paper.*

Just suppose gold was money and people decided they didn’t want to use gold anymore. They could still melt down their gold and reform it into jewelry. Your options with dollar bills, should they become unwanted on the market, is limited to either birdcage lining or tiny pieces of origami. Fiat currencies are pretty good at being divisible and fungible, but scarcity is another matter.

With something along the lines of gold (or silver, salt, cattle, et cetera) as money, anyone may enter into the “production of money”. The idea is, if you can bring in more precious metal (or salt or meat) for society, then you’ve earned your reward and good for you. Of course, there are some risks in this. Cattle can catch plague and be wiped out, and the expenses of mining might exceed the amount of gold or salt that you can obtain. When we have a fiat currency, not just anyone can produce money. Because it is far too easy a production, there are no risks and with virtually no costs or limits of paper and ink, one could invest a miniscule amount in paper and ink, and print out a million fiat dollars.

Thus, it becomes necessary for one entity to have the power to produce money, and thereby control the supply. They can print out new notes faster than old notes wear out and flood the money supply with them. This is the essence of inflation. Alternatively, they can stop printing notes altogether. As notes wear out, and they fail to replace them, this will cause the money supply to deflate. It is no longer a market operation, but a command and control operation. This is the same sort of thing the Kremlin did with bread and coats. Sowell seems to be critical of this inefficiency, yet the Central Banks continue to do the same thing with money today and all we seem to get are a few protests from Sowell saying  that the power they hold isn’t the problem – it’s their failure to wield this power wisely.

Sometimes the entity in control of the money makes really poor decisions, doubling and tripling the money supply by the day. As this new money enters into circulation, the value of the money plunges (i.e., inflation at work). There has never been a time in history when the economy was fine and the money was stable, and the next day the money is worthless. There is always some lead time where the money is still accepted, but at a discount. The value of money will always follow the laws of supply and demand. When money is first discounted, and then later not accepted at all, it is because the quantity of money has been drastically increased and is expected to increase significantly more in the near future.

In summation:

  1. Sowell is saying people not accepting money is what causes it to be worthless.
  2.  We of the Austrian school say that the money is being made worthless by inflation, followed by hyperinflation, and this is what causes people to not accept it.
  3. It isn’t a disastrous error in and of itself, but this is a proposition that rests on fundamentals and it’s important to have clarity as we move forward.

We’ll continue exploring inflation and deflation in the next few pages of Basic Economics. For more on this topic, help yourself to a free download of  The Ethics of Money Production by Hulsman head over to amazon.com for a hardcopy.

*5/1/16 ETA: In the comments, Dan Bonin brought up a good point that neither gold, nor anything else for that matter, has inherent value. Though gold does have inherent qualities which are almost universally considered valuable.

The Standard of Living. Chapter 16: Part 3 of Basic Economics

We’re finally about 1/2 way through chapter 16 and boy is it tricky. Sowell finishes up explaining GDP and GNP and goes into the standard of living and the consumer price index, or CPI. That is a collection of goods commonly bought whose prices year after year reflect the changing value of the U.S. dollar.  Sowell is keen to point out that there are goods in the CPI today that were not a part of the CPI 10 or even 5 years ago. He gives an example of the cassette video recorder which was sold for $30,000 when it first hit the scene, and was only included as part of the CPI after the price had fallen below $200.00.  He points to trends like this to argue that inflation is not as bad as is shown in absolute terms. A 3% inflation rate would actually be closer to 2% (a big difference when it adds up year after year).  Hhe argues that the standard of living is in fact on the rise; you might look again at the ever improving auto industry with standard features today that only the top of the line had 5 or 6 years ago—side impact airbags, increased fuel efficiency etc. Even features that used to be optional are now universal; all cars coming out today have power windows and powered locks. These are all signs that the standard of living is on the rise.

Now, I’m not here to tell you that it isn’t true, but I do want to be a counter weight to his argument.  In the first place, it matters who we are talking about. The standard of living for who?  Yes, I think the standard of living is improving for the wealthy and upper middle class unequivocally, For the poor, it is getting better in some ways, but how much does it really matter if new cars have power windows and side impact air bags if the cars are too expensive to be bought by folks of modest means? Even 3 and 4 year old used cars are out of reach for those on a tight budget. The trick is that so much of these “advancements”, especially in the auto industry, are not the result of market forces, but are instead the direct product of government regulations. True, fuel efficiency would continue to improve over time, but the government has imposed mileage standards on automakers, which has undoubtedly made them quicken the pace. Not to mention safety standards: curtain airbags, roll proof rooves, crumple zones, etc. It’s just fine for these things to be available, of course, but choice should not be eliminated for those who would like other options.

On another front, as far as inflation not being so bad, I’ve thought a lot about how to break this down into a readily comprehensible analogy, but for the most part I’ve come up short. Yet, I’ll try out what I have. Our economy is like a man walking up a flight of stairs, advancing with better methods of production, improved technology, and an ever-increasing capital structure. Yet, the monetary inflation created by the central bank and the fractional reserve banking system (we’ll get to these in later posts) is like an escalator moving the man slowly back down.  Now, I am willing to concede, or at least not contest, the assertion that Sowell makes that the standard of living is going up. However, inflation really is a bad deal, and it really is at 3%. Without inflation, the economy—the man climbing the escalator—would be further along than he is with inflation. The fact that he is still moving doesn’t make the downward motion any less bad, or decrease the amount of its effects—not even in the slightest.

True, we might not feel the full effects, just as we might not feel the effects of the sun coming out on a winter afternoon because just as it peaks out from behind the clouds the wind also kicks up and whatever increase in temperature we might have felt is totally negated by the wind chill factor. Had the sun not come out from behind the clouds we would have sure enough felt it get colder.

This is where yesterday’s post concerning the GDP PPR and GPP come into play. Now we’re able to measure, at least to some degree, the changes in standards of living, but this is, I think, beyond the scope of the topic.