Inflation

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One of the things I brought up in my objection to “UBI”, and one that defenders of the concept tried to elide over was that of inflation.  Most people use inflation to mean rising prices, and there’s some justice to that but the rise in prices is a consequence of inflation, not inflation itself.

When I was about…eleven I think… I had read in the World Book Encyclopedia and Book of Facts (my family had a set which I dearly loved, along with the late 60’s “Childcraft” supplements) about the US Mint and printing money.  Prices were a big concern.  President Nixon was implementing wage and price controls.  I asked my mother why, if prices were such a problem, the government didn’t just print more money to be able to pay for it.  She explained, as if to a child (well, yeah) that that would just increase inflation.

That was my introduction to the concept of what inflation actually was.  It was also my first lesson in the science of economics.

Put simply (very simply), inflation is an increase in the supply of money relative to economic output.  “Economic output” is simply the sum total of goods and services produced by the society in question.  I would also add “traded for” as part of that.  Basically, it’s everything that can be purchased in a society.  On the one hand, you’ve got the economic output.  On the other you have money.  You can increase the economic output (this is called “economic growth”) or you can decrease it (“economic recession”).  You can increase the money supply and you can decrease it.

So long as the money supply and the economic output remain consistent, prices remain stable.  When some prices go up–more money being spent on that good or service–that generally requires other prices to go down because there’s now less money to be spent there.

It’s when the money supply increases faster than economic output that you have inflation.

At first, an increase in the money supply can look good.  It looks like “economic stimulus.” Consider.  People buy SharpieTM pens.  They have more money, so they buy more at the local store.  Local store sees them moving faster so they order more from the distributor.  Distributor sees them moving faster so they order more from the manufacturer.  Manufacturer is selling out so they increase production, ordering more raw materials and maybe hiring more people to produce more pens.

And that’s great, so far as it goes.  Now, normally, people buying more SharpieTM pens will buy fewer MicronTM or BicTM or whatever.  And the reduced demand on those will lead to them buying less, using less in the way of raw materials and hiring fewer people.  The result being the moving of resources from an area of less demand to an area of more demand.

But in the case of inflation, it’s not more SharpieTM and fewer MicronTM and BicTM.  It’s more SharpieTM and more MicronTM and more BicTM.  So, they all end up trying to grab more of the same scarce resources that have alternative uses.  This bids up the price and so the cost of those resources to those manufacturers goes up, forcing them to raise the price of their product, and that works its way down the line to higher prices of pens (and everything else–pens was just an illustration of the general concept) in the stores.  So while people have more money from that increased money supply, the increased prices means they can’t buy any more than they could in the first place.

If it were just that, inflation would be neutral.  Increasing money supply increases prices so that buying power remains unchanged.  But that’s not the only effect.  The steady state of “this much money supply” and “these prices” neglects the factor of time.  And this effect can be brutal on people who invest.  In investing one buys an asset (including stocks) or makes a loan (including “buying” bonds) in the hope of exchanging it later for more money.  To a certain extent assets can accommodate inflation.  The price of the asset will be inflated along with everything else.  Loans, including bonds, are a different matter.  These generally specify a fixed rate of return.  Inflate the money supply and suddenly their value plummets.  Now, if the inflation is known in advance, that can be dealt with.  You simply specify the rate of return to take inflation into account.  However, fail to do that, or get caught flat-footed by an unexpected increase in inflation and the loan can soon descend into worthlessness.  This makes people unwilling to lend money or only to do so at interest rates high enough to compensate for the risk, both of which tend to stunt economic growth.

When inflation gets really bad, termed “hyperinflation”, in the time between when one can get paid for a transaction (receive a paycheck from work, sell something, whatever), and go to buy something else (dinner, say), prices can change drastically.

In the end, what you want is to keep the money supply roughly commensurate with economic output.  This keeps prices stable and, indeed, as a greater variety of goods and services become available (economic growth) many things end up being cheaper individually.  Thus, entry level and economy cars have features today have features and amenities that would have been more at home on high end luxury cars of a generation ago.  Thus, I have a computer in my pocket, costing about a week’s pay, with the power of high-end supercomputers of a (human) generation ago which ten years of my current salary might, possibly, have paid for.

Thus, the poor of modern America have wealth beyond the dreams of those a century agone.

I’ll deal with money supply and what affects it (it’s not just government printing presses) another time.

28 thoughts on “Inflation”

  1. And of course, there’s the opposite number: deflation. But as Milton Friedman pointed out, that’s easy to cure. Just print money.

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  2. I entirely agree, but would extend. In the 20th Century, America never had an inflation. We had currency devaluation. Gold was taken from $20/oz to $35/oz. Bad Monel replaced silver. Nixon put the wage-price freeze in when he broke the link between the dollar and – anything. It worked; he got a slow take-off for the 70’s inflation. We took the copper from the one-cent piece. And in 1999 we took 2/3rds of the nickel out of our ‘silver’ coins. Gresham claimed his victims. One cannot have a hyperinflation while change is in free circulation. Scrap metal prices buoy the currency.

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    1. Tomato, Tomahto. “Devaluation of currency” is simply a mechanism of inflating the money supply. And The Powers That Be have been inflating the money supply in that manner practically since coinage was invented and even before. Traders used to have a stone, a “touchstone” against which they would swipe a piece of gold specie just to check the purity of it because mixes of gold with less valuable metals was a common way of “stretching” the gold supply. Archimedes famous jumping from his bath and running through the streets shouting “Eureka!” was over a similar situation involving a crown.

      Some people have this fascination with “hard” currency (chiefly the Gold Standard, but silver and copper included) but the issues remain the same. Currency, whether “fiat” or “hard” is simply an agreed upon medium of exchange. And as I discuss elsewhere, the mere existence of an agreed upon medium of exchange is of enormous economic value. If I make chairs, and I want apples, I don’t have to find a person who both wants a chair and will trade apples for them. I don’t have to buy an entire chair’s worth of apples. I can trade the chair for someone who wants chairs receiving the agreed upon medium in exchange, then take part of that medium of exchange, and trade it for just as many apples as I actually want, using the rest for something else. The value of that in making transactions easier is huge whether the medium of exchange is grams of gold, dollar bills, or quatloos.

      Hard currencies do have the sometime advantage of limiting the money supply. This is a hedge against inflation at least somewhat (although not entirely as the above shows). The problem arises when you have a vigorously growing economy increasing in economic output and the money supply cannot keep up. Then you get deflation. This can be nearly as much of a problem as deflation although the problems aren’t as obvious to the consumer (how, after all, can lower prices be a problem? ).

      The problem isn’t gold standard or fiat currency. The problem is those who control the basic money supply having the discipline and political will to hold it stable. The problem is that the short term benefits of increasing the money supply can look very attractive and by the time the negative effects roll around it’s easy to blame them on something else (particularly if a new administration is in power by the time those effects work their way through the economy.

      It’s enough to make a man snatch off his hat, throw it on the ground, and stomp on it. 😉

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      1. IIRC that was supposed to be the point of having the Federal Reserve Banks. Their job was to ensure stability free from the political process. How’s that working out? Not well, I would say but perhaps better than the alternative?

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        1. Milton Friedman went into it in some detail in his book “Free to Choose” ( https://amzn.to/2QHL6z4 ). At first, the Federal Reserve worked quite well, “damping out” some of the spikes in the economy. But then, 1929 rolled around, there had been changes in the management and organization of the Federal Reserve and, in response to the October crash, pretty much every move they made was wrong. Oh, sure, Hoover screwed up too and the Roosevelt came along and doubled down on Hoover’s screw ups (while claiming Hoover was doing nothing).

          So, a Federal Reserve that implemented sound monetary policy could be a good thing. What we’ve ended up with? That’s, perhaps, a whole other ball game.

          Ever since the series of panics which prompted the creation of the Federal Reserve, whenever there was a major stock market crash and associated economic “crisis” the cries to “do something” get loud. And politicians do “something”. It might be the wrong thing, but at least it’s something. However, when Black Monday happened in 1987, Reagan decided to just ride it and let it work itself out. The result was one of the faster recoveries. And yet still we get the cries to “do something” whenever things take a downward dip.

          And so politics trumps sound monetary policy. Every. Single. Time.

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          1. One of the problems is that the Fed is mandated to maintain full employment, so every time there’s an economic downturn and people are laid off while the market adjusts the Fed injects more money into the economy. Afterwards they may pull some of it out (though I don’t think that’s happened this century) but they don’t get it all before the next downturn of the business cycle.

            I’d like to see the Fed given a mandate to just control inflation. Keep it between 1% and 3% and let the rest work itself out.

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            1. One of the things about Keynes is that he gets a lot of kicking around but nobody ever actually implemented his recommended policies. Yes, he suggested deficit spending during economic downturns to stimulate the economy and bring things back up. But he also recommended cutting spending during growth periods to pay off the debt accumulated during the downturn. This second part never happened. Both parts were essential components of his recommended policies. The idea was to use government spending like a “flywheel” to smooth out the ups and downs. It might well have had some validity if actually implemented as recommended but, all we ever got was the “spend more” side. Kind of like a surgeon performing an appendectomy doing the cutting part but not bothering with the “sewing things back together” part and wondering why the patients keep dying.

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              1. Frankly, observing this ever accelerating behavior over the past thirty or forty years has led me to conclude that the American experiment is drawing to an unfortunate conclusion. Sooner or later, interest payments on the ballooning national debt will become utterly unsustainable, and then what will happen? The United States is arguably too fundamentally wealthy, too replete with natural resources such as arable land and oil to suffer total economic and social collapse, so what? A return to fortified, wealthy communities surrounded by vast slums unaffected by outdated laws surrounding habitability, much like Brazil’s favelas? Private militia savagely enforcing anti-vagrancy ordinances in the aforementioned enclaves while an impotent, bankrupt federal government roils with much hot air and little action? Rural communities struggling to survive periodic assaults from murderous, roaming gangs of outlaws? States like Texas and California repudiating the federal national debt and tearing themselves away into semi-autonomic regions with no taxes going to Washington, D.C.?

                I honestly have no idea how to begin to anticipate what might be the fallout from such a historically unique financial collapse in a fundamentally wealthy country with a powerfully burgeoning industry of home manufacturing capabilities and computers up the wazoo. I don’t even know what questions to ask. Should I plan now or later to escape the city for a remote community with defensible barriers against starving gangs of inner-city gimmedats who no longer have access to EBT benefits from a bankrupt federal government?

                Oh, brother. The recent spate of Marxist-driven riots have jolted my former semi-complacency into a deepening sense of worry about the near future. -_-

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              2. True, but Keynes still has a problem in the fact that government spending isn’t the same as private spending. The private sector buys and sells things because doing so creates wealth. The government buys things based on political considerations. For example, SLS.

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              3. Oh, I wasn’t saying that Keynes’ proposal was a good one. Even if one were to use government policy as a “flywheel” to help smooth out the economy there are better ways than via deficit spending. Simply pointing out that such value as it might have has never been accomplished because they never do the second half.

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              4. When you read Keynes, the biggest thing you learn, is that most of his critics and supporters never have. (Seriously, I nearly lost my fricking mind when Barry O. was going down a bloody checklist of everything Keynes warned *never* to do, and was being praised/condemned for being Keynesian.)
                .
                The biggest economic events of his earlier life were The Great Depression, The Weimar Hyperinflation, a command economy on a desperate wartime footing, and (on a more personal level) losing his shirt on relatively “safe” investments.
                Those had a very large effect upon the policies he advocated.
                .
                The guy was a proponent of sound money, (even if he was flip about it in public debates), and condemned inflationary policy with what can only be described as moral outrage.
                .
                If you were to boil Keynes’ writings down to the nutshell version, they would be:
                Confidence drives the business cycle.
                Uncertainty freezes liquidity.
                Decreasing liquidity drives increasing uncertainty in a vicious cycle.
                Economic measurements are lagging indicators.
                A government can act proactively (and largely symbolically) to decrease uncertainty and increase confidence.
                {Insert Schrodinger’s cat here}
                .
                Sure, there may be a complimentary flywheel effect, but the major point of the exercise is to be promptly and confidently seen *doing something* to counter a problem that is only starting to come into existence.
                Foster trust in the experts, and the experts can talk a live cat into coming out of the box.
                It’s psychological manipulation on a societal scale. (And Keynes himself was uncomfortable with the manner of men undertaking this, and the ignoble ends they started pursuing.)

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            2. And that reminds me of an old joke. A surgeon was visiting his wife’s family for thanksgiving. While the father-in-law was carving the turkey, the man asked the surgeon what he thought of his technique. The surgeon sat and observed until the man was done carving then said, “Now, put it back together.”

              The key element isn’t the cutting but the putting it back together. That’s a metaphor for much of life.

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  3. I recall at least one biography (not sure if auto…0 of Albert Einstein who made the mistake of converting the Austrian money sent him to German as soon as he got it – during the hyperinflation times – rather than immediately before making purchases. Yes, even a genius in one area can get things horribly wrong.

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    1. There have been a number of “geniuses” — i.e., persons who have demonstrated great expertise and/or insight in a particular subject — who have gone on to foul their own records by posing as “Anything Authorities.” Such persons include several whose names virtually everyone will know: Linus Pauling and Richard Dawkins come to mind at once. With the assistance of the media, which purely loves having famous persons spout unsupported (often insupportable) opinions to the masses, those folks have done considerable harm to the body politic.

      To make matters worse, credentials are often flaunted as a substitute for genuine intellectual power. But that’s best reserved for another tirade. At any rate, always remember the best definition of the expert: “A person who knows more and more about less and less.” The asymptote of that progression — the ultimate expert — would be the man who knows absolutely everything about absolutely nothing. So maintain a healthy skepticism about the pronouncements of “geniuses” and “experts.” Demand evidence. Insist on seeing the lab notebooks. And ask where and by whom the experiments or studies were replicated…if they were.

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  4. As you mention the value of stocks going up, that neglects one old-fashioned concept of stocks: dividends.

    Dividends were one way of dealing with inflation, as they were a constant source of money, based on the solidity of the business.

    Stocks (at least for the drivers of the indexes) now are primarily based on “growth” of the company, which leads to some false economic signals. (You can ‘grow’ your company by buying out a competitor; yes, that increases your size and product availability, but it doesn’t actually increase the economic pie, for example.)

    “The stock market” has added two digits to its value in my lifetime. It seems a bit… ‘house of cards’ at times. (And, hence, why the incredible outcry for “Do something!” whenever it stumbles a bit.)

    Different point entirely: One pernicious thing that bringing inflation into the public awareness did was to make the economy more political. In this case I mean things like defining inflation and defining the “strength of the economy”. To hear the gov’t talk, we ain’t had no inflation in a decade or more. All the while we all see prices actually going up on the things we actually buy.

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  5. First, what the hell is that thing in the picture? That has got to be one of the creepiest, most disturbing images I’ve ever seen. I wouldn’t want to be in the same room with that abomination let alone touch it. It’s got to have been photoshopped, right? Right? O_O

    Second, I’ve never understood the apparent reality of inflation as opposed to the theory. In today’s economy, true inflation as would be suggested by a bloated money supply seems to be hiding far under the surface of a deceptively peaceful, if hideously complex, sea of economic activity. If the loudest alarmists were to believed, we’d have had dollar hyperinflation ten, twenty, even thirty years ago. Yet actual inflation seems to have remained stubbornly low. Where is the Leviathan? Is the dollar’s enduring status as the world’s reserve currency acting as a gigantic brake on richly deserved runaway inflation and a collapse in the dollar’s perceived value? Something else entirely? What strange psychology lies behind this mysterious phenomenon?

    Third, what the hell. You’re a smart guy. If you feel like it, I’d like your opinion on an idea that’s been floating around in my head for years … well, over a decade at least. What’s to stop a bunch of well-funded folks from establishing an alternative currency with a predefined, continually restabilized value as reflected by a complex basket of commodities? Is there a fundamental flaw with the idea of maintaining a currency that ideally never strays far from a baseline value? I was thinking further of durable, lightweight, translucent plastic coins that range widely in value from the close equivalent of perhaps $0.50 through $1000 and that combat counterfeiting in part with embedded holograms and in part by incorporating random, unique patterns of colored microbeads recorded in a blockchain-secured public database available for downloading by anyone to use in a inexpensive local coinage and currency reader for real-time authentication. Does that make sense?

    Fourth, goddamn if I’m not worried about the impending impact of tens of millions of residential evictions on the value of the dollar once the widespread eviction moratoriums expire, perish, and fall like dominoes in an orgy of court proceedings to toss out non-paying tenants. The temptation to print yet more gushers of cash to bail out all these unemployed, now-homeless folks will doubtless be almost impossible to resist, and the somnolent Leviathan will bulge into hitherto unimaginable dimensions. This nightmare scenario has been rumbling and tossing in my mind. I wish I was smart enough to figure out whether it’s just a nightmare or else a genuine, slow-motion economic and political disaster awaiting the riotous chaos of a post-election America. -_-

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    1. The picture is a water balloon at the instant of bursting. I was looking for a good picture of a balloon popping, but water balloons were the only things I could quickly find for which I would have unequivocal right to use. Plenty of “image may be subject to copyright” not so much “you can use this as you wish.”

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      1. Oh. I wonder what it says about my mind that it immediately saw explosive tendrils of mold on a reddish lump of meat rather than harmless jets of water spraying from a collapsing balloon. Maybe I’ve been watching too many horror movies. O_o

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  6. One of the things I always scratched my head about was that the Quantative Easing (printing trillions of $) following the 2008 crash never created any inflation. Same thing is happening this year with Wuhan Flu stimulus $ – another $4 T or so. So what is happening?

    Best explanation I get is from the Singularity guys who believe that the penetration of technology into the economy is profoundly deflationary. Solution is as mentioned in a previous comment, to simply print enough money to cause an inflation rate around 2%. Problem is that penetration accelerates and over time, you have to print an increasing amount of money.

    This is described in a site called The Futurist and an online book called the ATOM, which is the name of the money printing regime. Well worth your time to look into. Cheers –

    https://www.singularity2050.com/

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    1. Well, there are conflicting forces at work but at least part of it was that a lot of that money was going overseas where it’s sat. People complain about that but, really, what it does is reduces the local money supply and thus works to stem inflation. It may turn around to bite us later when/if they dump that money back on the market.

      I am very concerned about the effect the COVID19 stimulus will have. It takes time for the inflationary effects to work their way through the economy. And since the inflationary effects of the stimulus are paired with reduced economic output from the various shutdowns, this can be doubly bad once it fully plays out. I hope I’m wrong and there’s some counter that keeps it from blowing up in our face, but I am not sanguine.

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      1. Perhaps one counter is that if economic conditions are poor enough across the globe to stir up greatly increased activity in overseas stores of dollars, the U.S. dollar will nonetheless still hold enough value relative to other currencies that people overseas will still want to rely more on the dollar than on their national currencies, thus significantly ameliorating any inflow back to the United States. That is, as bad as prospects might be for the dollar, they might very well be worse for other currencies, which is admittedly a depressing thought. Just speculating off the top of my head, though. 🙂

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        1. No, you’re on to something. One of the benefits to being the world’s reserve currency is that when things start to get rough people around the world start to hoard dollars. And yes, every other economy in the world is in worse shape than ours.

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  7. When I was teaching economics I would always take time to explain that the uneven distribution of wealth and income was a good thing. I would also argue that there was no such thing as ‘price gouging’. These were hard sells. But important observations.

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    1. Price conveys important information. Allowed to function, it works to direct resources (scarce resources that have alternative use) from where they’re less valued to where they’re more valued.

      Tried to explain to my daughter that the “price gouging” of things like hand sanitizer when a particular area was short of it actually worked to the advantage of the people there. If one could really sell hand sanitizer at a hundred times the price it went for locally, I might well have loaded up my own car and carried a load down. That would have gotten hand sanitizer quickly from here (where it was much cheaper) to there (where people were demanding it). As more people responded to those price signals, competition would tend to drive the price down there (and up here) with the result of moving it from where there was no particular demand to where people were clamoring for it.

      Her argument about the “old lady who can’t afford the exorbitant price” I tried to explain that that old lady was no worse off than if the person hadn’t brought a load of hand sanitizer down. Cannot buy because not available ends up the same as cannot buy because too expensive.

      Also, as prices go up, people are more likely to ration themselves, to buy only the minimum they believe they need, thus allowing the limited amount of the product to end up in the hands of more people.

      On the flip side, a friend of mine, AF Reserve, was involved in relief efforts for one of the big storms some years back. They were handing out cases of canned drinking water free. People were coming through the line three or four times, collecting far more than they actually needed and creating shortages for people who only got there later–and with transportation disrupted by storm damage you can’t really fault people for sometimes taking time to get to the aid station.

      Springboarding to illustrate the point for the readers since I’m sure you’re aware of all this. As for my daughter. She’s got a good head on her shoulders and a good early grounding so I trust the indoctrination she’s receiving will wear thin as she gains a bit more experience in the world.

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