FUNDAMENTAL TRUTH #3 “Inflation is just another name for irresponsible government.” -Old Pithy

Posted by PITHOCRATES - March 2nd, 2010

INFLATION CAN BE a complicated thing.  When there’s inflation, prices rise.  But it’s not because evil business owners raise their prices.   It’s because the government made money worth less.  Let’s illustrate this with a simple example.

Let’s use a lotto.  Everyone understands how the lotto works.  Those who have winning tickets win the prize.  If there is only one winning ticket, the winner claims the whole prize.  If there is more than one ticket, the winners split the prize evenly.  The more winners there are the smaller each individual’s prize is.

Let’s say the winning prize is 10 gold bars.  And let’s say there is only one winning ticket.  That one winning ticket is ‘worth’ 10 gold bars.  If there are 2 winning tickets then each ticket is ‘worth’ 5 gold bars.  If there are 5 winning tickets then each ticket is ‘worth’ 2 gold bars.  If there are 10 winning tickets then each ticket is ‘worth’ 1 gold bar.  Etc.

If you have one of the winning tickets, you see the value of that ticket decline as the number of winners increase.  In the example above, your ticket ‘worth’ in gold bars went from 10 to 5 to 2 to 1.  The more winning tickets there are, the less ‘purchasing power’ your winning ticket has.  Substitute ‘money’ for ‘winning tickets’ and you have inflation.

NOW LET’S LOOK at prices.  The ‘price’ for all 10 gold bars is the total number of winning tickets.  In the above example, the ‘price’ in winning tickets increased from 1 to 2 to 5 to 10.  The ‘price’ of those 10 gold bars, then, increased as the number of winning tickets was inflated.

This is why business owners raise their prices during periods of inflation.  Are these business owners greedy?  No more than you.  Let me ask you something.  If you paid $50,000 for a starter home and put it on the market after it appreciated to $75,000, are you going to sell it for $50,000?  Or are you going to be greedy?

All right, let’s say you’re an altruist.  You care about people, not profit.  You sell your home for $50,000.  Now let me ask you something.  Do you know what kind of house you can buy for $50,000?  Probably not like the kind you just sold.  Houses like that now cost around $75,000.

Inflation makes things more costly.  And if costs go up, prices go up.  They have to.  If a business doesn’t cover its costs it will go bankrupt.  As would you.

SO IF INFLATION is bad, why do ‘they’ increase the money supply?  Here’s the short, short answer.  Because ‘they’ like to spend more money than ‘they’ have.  I say ‘they’ because it’s complicated who ‘they’ are.  The Federal Reserve is responsible for monetary policy.  The federal government spends the money.  But don’t sweat the details.  Suffice it to say that ‘they’ are responsible for inflation.  And ‘they’ aren’t business owners.

High taxes have consequences.  Usually at the polls.  So government looks for other ways to raise money.  They can sell debt.  Or simply print money.  Neither says ‘I’ve increased your taxes’.  But they both have the same affect.  The inflation they cause increases your cost of living just as a tax increase would have.  But it’s hard to blame your misery on the government when they weren’t taking (taxing) but giving (pork barrel spending).  Quite the devious bastards, aren’t they?

Not only does the cost of living go up, but the value of your savings decline.  If you saved $10,000 in the bank, inflation will make the purchasing power of that $10,000 worth less.  $10,000 today won’t buy as much as $10,000 did a decade ago. 

This is how inflation destroys wealth.  The flip side is that it also reduces government debt.  At your expense.  If you own government bonds, inflation makes those bonds worth less.  You lose wealth.  Because they’re worth less, it is now cheaper for the government to buy them back from you.  The debt sold a decade ago is ‘cheaper’ to pay off today.

SHORT TERM DEFICIT spending can be beneficial.  If it’s used to cut taxes to stimulate the economy (like JFK and Reagan did).  An increase in economic activity can generate more tax dollars even at a lower tax rate.  This can close the gap in the budget between spending and revenue.  However, if government continues deficit spending only to buy political favor (like FDR and LBJ), there will probably not be a corresponding increase in economic activity.  The gap between spending and revenue will probably not decrease.  In fact, it will probably increase.  And unchecked deficit spending will most probably result in runaway inflation.  Sooner or later.  And you know what the consequences of that can be.  If you don’t, you can ask Jimmy Carter. 

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