01 December 2011

Inflation: Just Another Form of Government Theft

Karl Denninger explains inflation in rather graphic terms:

Let's assume a 2% productivity increase per year over 30 years.  Let's also assume a 2% inflation rate over 30 years.  This is what it looks like, starting with a baseline of "10,000."
Your cost of living has gone up by 78% in notional dollar terms but it should have gone down by 44%!
The spread between those two lines was literally stolen by the banks and government acting intentionally as a group.  They defrauded you, stealing your economic output and improvement in productivity, using it to hide the impossibility of continual deficit spending.  Summed, the line is flat—but it should not be; that improvement in standard of living belongs to you, not them.

Basically, as production becomes more efficient the cost of products should decline.  For example, computers that once cost millions of dollars in 1970 should cost roughly $50 today.*  Instead, it costs six times that.  What’s amazing is that efficiency of production has increased so dramatically for computers that the nominal price has decreased in spite of the dollar’s purchase power declining by roughly 83%.

At any rate, inflation works as a form of theft because it robs people of the benefits of their increased productivity in the form of higher prices.  This happens because of the very simple rules of supply and demand.

Nominal price is determined by demand of a product relative to supply of a product relative to the money supply.  Products with high demand low supply will generally have high prices; those with low demand and high supply will have high prices.  As long as the money supply remains stable, nominal prices will be mostly contingent on the supply and demand of the product in question.

If, however, the supply of money fluctuates, nominal prices will fluctuate accordingly.  Decreases in the money supply will lead to decreases in the nominal price, assuming that supply and demand remain unchanged.  Conversely, increases in the monetary supply will lead to nominal price increases, again assuming that supply and demand remain unchanged.  The reason for this is simple:  the monetary base does not, in and of itself, make more things available for purchase.  If you have ten cars, it does not matter if the monetary base is ten units or ten thousand units; fluctuations in the monetary base don’t change the underlying reality that there are a finite number of goods available for purchase.

Now, what makes inflation so pernicious as a form of theft is that it requires that the increased money supply make its way into the economy.  This is not accomplished smoothly or evenly (i.e. the government doesn’t dump in all the money at once, and doesn’t distribute the extra money to everyone in the economy).  As such, the government must give the money to someone.

In recent cases, the recipients of inflation have been major banks.  Because they get the extra money first, they benefit from the effects of the increased money.  While markets are efficient, they do not act instantaneously to new information, which is a fancy way of saying that it takes some time for the new money to make its way into the economy.  The early recipients take advantage of the lower prices by buying more, which drives up the price of goods.  The later recipients of the money see the prices rise before they get the extra money.  Basically, then, inflation works as a tax on the politically disconnected (usually the poor and middle class) since the rich tend to get the money first and buy at low prices which drives up the prices for everyone else.  Thus, inflation is basically a form of income redistribution.

Since the government has control of the money supply and gets to pick the initial recipients of inflation, it is therefore fair to say that the government is stealing from the poor and middle class and giving to the rich because it is basically robbing the poor and middle class of their increased productivity (which should be seen in the form of lower prices) and giving to the rich (who get to purchase at lower prices before driving them up).  Thus, it should be clear that inflation is nothing more than outright theft, and should be viewed as such.  The government, then, deserves the outrage of all of its productive citizens.

* It’s impossible to match machine specs across eras, so I simply took the cheapest computer available today, which is this HP desktop and adjusted the price for inflation using Tom’s inflation calculator. The dollar amount was 300, the starting year was 2010, and target year was 1970.  Data for the cost of the best computer of 1970 was found here.  Note that that Wal-Mart’s crap computer is still superior to the best the 1970 had to offer.

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