Why Inflation Is Likely Here To Stay: Part 1 [Pete Bog]

Over the last 18 months or so inflation has crept back into the headlines. For years the statistics were hovering around 2%. During that time, we heard the real danger was deflation, or falling prices and values. Supposedly China and the rest of the undeveloped nations were industrializing so rapidly that prices were going to collapse in the face of relentless globalization! That doesn’t seem to be a problem now, and the theme is a perfect illustration of the difference between values and price levels.

Economists talk about “the medium of exchange”. That means rather than a barter system where goods or services are traded directly between parties there is an agreed measure of value which is substituted. Simply put everything has a price that can be measured in the local currency. This is typically expressed as “20 dollars, same as in town”. This means the recognized value of a service or product is 20 dollars. For simplicity’s sake we will call it a Thing. The Thing is worth $20. If somehow the supply of Things were to increase dramatically, we all know what would happen. The value of the Thing would fall. Meaning we could buy more Things for our $20. Notice the word change in the previous sentence from price to value. Value is what something is worth, price is how value is measured. Here in the USA we tend to use the terms interchangeably, and we all understand supply and demand of Things impacting the value of a Thing.

Here is the knicker twist. Supply and demand impact the value of a dollar as well. If the supply of dollars increases you will want more dollars in return for the Thing. That is inflation! Inflation is always a product of monetary policy. For years our government has been increasing the supply of dollars, all at the bidding of the Congress and the President. Regardless of party they all love to spend money. When they spend more than they take in the Treasury can do two things. They can borrow dollars from the public, or they can print more dollars.

When a government borrows dollars by issuing government debt bad things happen in the economy and the government’s budget. The chief problem is interest rates go up as the demand for dollars has increased but not the supply. But with this one simple trick the government can avoid high interest rates! Print more money; that’s the ticket! No one will even notice.

Have you ever had someone repeatedly disappoint you? You give them lots of chances to reform, maybe quit selling Things on the side, but they don’t really change? When you finally accept what they are, you have lost confidence in their promise. Inflation is what happens when the government’s promise only to print dollars when economic growth allows is broken. Our government has been printing trillions of dollars over the last 20 years. Because lots of people around the world have faith in the value of the US Government’s promise of a stable dollar, they were willing to hold dollars and use them in trade practically everywhere. Turns out our faith was misplaced.

How do you ever restore faith? You change your behavior. Any chance of the government doing that?

posted by Open Blogger at 12:00 PM

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