Inflation Destroys

Inflation is one of the worst economic consequences of having a fiat money. That is a money not backed by a commodity. Our dollar today is a fiat money because there is no backing of real value, only the faith in the government. When you have a money backed by a commodity, the supply of that money can remain relatively stable. Sure if you have a money backed by say, gold, you can mine more and inflate the money supply, but the mining required labor and capital. With the allocation of resources a requirement for the expansion of the money supply, standard free market forces apply. If more gold is mined, the value of all existing gold in circulation drops. However because gold is less valuable, mining it becomes less valuable and thus the mining industry will slow and equilibrium will be met. The opposite is true, if gold becomes scarce, the value goes up and the return on investment in gold mining increases and more gold will be produced.

The downfall of a fiat money system is that no capital or labor is required to create more. The money can simply be created out of thin air. Because of this, the supply and demand is skewed. The moral hazard inherent in the ability to essentially legally counterfeit money is impossible to overcome. Especially when a government is the entity with the sole capability of creating new money. Because the government wants to spend but doesn’t want to tax, the only option left is to print. Whether this printed money is used to spend directly or if it is used to pay back debt obligations is irrelevant. The money has to come from somewhere… actually nowhere.

So when the government creates more money (Via the Federal Reserve and our banking system, but that is another article entirely.) it increases the money supply. In other words the total amount of money in circulation. Because there is more money chasing the same amount of goods, the real value of each dollar is reduced. Money exists like any other commodity subject to the laws of supply and demand, the more of something there is, the less it’s worth.

This may seem harmless, as long as the rate of inflation remains constant over all dollars at the same time, it is. If gas prices rise by 10% due to inflation, it doesn’t matter as long as wages also increase by 10%. However therein lies the visciousness of the problem.

Say the government or the Fed prints a $100 bill and gives it to a bank to be lent out to another bank, so on and so forth, eventually landing in your pocket after years of meandering through the system. At the time of printing that bill was worth $100 dollars. With it you could buy $100 dollars worth of any commodity or product in the world. Now assuming the cycle of government spending and printing remains a constant, which indeed history would show us it has, by the time that bill ends up in your pocket years later it is still worth numerically $100 but in terms of real value it has dropped. Let’s say it took three years for it to get to you and the annual rate of inflation was 5% year. That means it lost 5% of it’s real value each year ending up at the real value of about $86. Now the point is, in numerical terms it is still a hundred dollar bill but it’s purchasing power dropped by 15%.

A more concrete example would be in the mid 60’s they stopped putting silver in quarters and indeed backing our money with a commodity. At that time you could buy a gallon of gasoline for a quarter. It now takes about two dollars to purchase the same gallon of gasoline. However, if one were to exchange a 1960 quarter for it’s value in silver… one would receive enough money in today’s terms to purchase a gallon of gasoline. The quarter is still a quarter numerically and if taken at numerical value it has lost it’s purchasing power… a quarter’s worth of gasoline today is a fraction of what it used to be. However if you take the real value, the commodity value of the quarter’s silver and exchange it, the price is stable.

The main point is inflation does not spread evenly amongst the economy. The ones who print the money receive the benefit of spending it at it’s current purchasing power. The one’s who are hurt by the inflation are the average people who rely on wages. Their money has been in existence the longest and has been depreciated accordingly. Each year that the government prints more money, our costs increase but our wages do not, or do so at a slower rate.

Ask yourself if times seem harder now then you remember them as a kid, or any length of time ago? Are you making more money now then you were ten years ago? Does it seem like, even if you are, your costs seem to have gotten higher? In light of the recent bailouts and extreme government spending, how do you now feel about the debt our country is in? Im sure you do not want to carry the burden of taxes, but do you want to carry the burden of inflation?