Inflation what is it?

Hi everyone. Today I'd like to examine inflation.

Inflation is not just the price of living going up and up. There is an underlying cause for it. Right now, as far as I can tell, there is no country in the world using money, they are using currency. Money, currency, same thing, different name, right? Wrong.

Money: In order for money to be money it needs to meet a very defined set of conditions. They are: a store of value. That means if you have enough money to buy a tank of gas today, after ten years under your bed, it should still buy a tank of gas. Fungible: The money needs to able to change without loosing value. Say a gold coin is worth ten silver coins. That ten silver coins can buy just as much as the gold coin and at will turned back into a gold coin. Both the gold and silver will hold their value in the economy for purchasing power. The third requirement of money is as a medium of exchange. This means everyone knows what it is worth. In other words if you go from New York to Los Angles the money remains the same.

Currency: Currency can be a lot like money, it can act like money, but it can also be manipulated. In order to increase the money supply with gold. Someone has to go out and dig it up, refine it and cast it. This take man hours to do. Currency is different. In todays systems it add currency a few key strokes will do it. Can currency be like money? Yes, it can as long as the government issuing it is a good steward of it. Unfortunately, as we will see, they are not.

Okay, back to inflation. In order for an economy to work effetely, there has to be a medium of exchange. Bartering becomes much to cumbersome. How many chickens do I have to give you to get an air conditioning unit? Cumbersome. Enter the medium of exchange. Now we know if you want a chicken, it will cost you $5 and if I want an A/C unit it will cost $1500 dollars. The transaction becomes easy and smooth.

Okay, but where does money come from? In our society today it comes from government, okay, really the central banking system, please see my post on the Federal Reserve Bank. The money/currency is issued by the central bank at the request of, and sometimes not, of the treasury departments.

Example time. The country has a million people and a million dollars in circulation and a loaf of bread cost $.50. Now, if the population grows to two million people and the central bank issues another million dollars, because the economy has grown by a million people. The price of the loaf of bread will remain at $.50. If we go back to the one million people and the central bank now issues two million dollars, then the loaf of bread will become a $1 because the money doubling without the economy growing has caused the currency to become less. A balance must be kept. Can this happen with both money and currency? Yes. Open a new mine, flood the economy with gold and the value of gold goes down. Balance. As long as everything is kept in balance we will not see inflation or deflation, inflation going backwards, things getting cheaper.

A note: Things can go up without inflation. Lets say I have something, oh, I don't know, maybe tulips. My tulips bulbs sell for $.50 each, but suddenly everyone wants my tulip bulbs. I can now raise my price to $1 or even $2, more if people keep buying them. This is supply and demand, it can also be a bubble, the price going up beyond any reasonable value of the underlying asset. None the less the price went up because of demand. When demand tapers off the tulip bulbs will come back down to $.50 again. If people get sick of them, I may even have to sell them for much less. This is not inflation.

Inflation is when everything through out the economy gets to be more expensive, wages go up along with everything else, at least in theory. So now you are making a million dollars, but a loaf of bread cost a million dollars. Are you any better off than when you made a dollar and a loaf of bread cost a dollar? Actually you are worse off as wages will inflate, but they will also lag behind the inflation of goods and services.

So why would any government want to inflate things? To cheat. Example: After World War I Germany was required to pay back the cost of the war to the allies. There was no way to do this, it would bankrupt the country which was most likely the point. The German government turned on the printing presses and churned out Papiermarks like there was no tomorrow. The currency became completely worthless. If you wanted a loaf of bread, you'd get the good ol' wheelbarrow, load it up with as much currency as it would carry and cart it off to the market. This is happening right now in Venezuela where merchants are now selling things for pounds of currency instead of looking at the denomination. Germany paid off it's debt to the rest of the world in Papiermarks costing the government paper and ink. They then changed the currency to the Deutsche Mark and the story started all over again.

While this was good for the government, paying off a huge debt with worthless currency, it was absolutely devastating for the people of Germany.

While gold or silver, both monetary metals, can inflate, it is a lot harder. The metals must be mined and refined giving it value. Will we see inflation again? The Federal Reserve Bank is screaming from the top of their lungs they want 3% inflation. If you do any shopping at all you already know we are well past 3%. Could the Federal Reserve Bank be looking to buy off a lot of debt for worthless money?

Please leave your comments below.

Thanks for reading.