Econ 101: Inflation

What Is Inflation?

Inflation is an increase in the quantity of money.

This simple definition eludes hundreds of millions if not billions of people all across the globe. And yet, despite its simplicity and truth, almost no one knows it. So why is there so much confusion? The answer, is that decades of deliberate, self-serving "misinformation" has been spoon-fed to the public by corporate talking heads and other mouthpieces for the regime to convince you that it's no one's fault!

In almost every instance in which inflation is spoken of, a graph is presented on a screen and a corporate media analyst tells the audience what the inflation rate is now compared to last month, versus last year, versus when Trump was president. But these analysts never bother to say what inflation is or who's responsible for it. Why?

Those of you who are so unfortunate as to watch the corporate news have no doubt suffered through many such monologues. And furthermore, in the midst of your suffering, you are also just as likely to have been fed a false definition of inflation.

Just as Joe Scarborough concludes an incredibly boring and exceedingly obvious comment about how expensive groceries have become, Jeff Stein chimes in to define inflation for their viewers. According to him, inflation is an increase in prices! And since inflation is an increase in prices, it can be caused by bad weather, freeway closures, European wars and the eminently dreadful "corporate greed!"

These ideas are not only incorrect, they are deliberately disseminated to confuse the public and to absolve those truly responsible for inflation of any accountability.

For hundreds of years inflation has been understood as an increase in the quantity of money. The 19th century British Currency School defined it this way, the Scottish philosopher David Hume understood inflation to be a monetary phenomenon, and Webster's American Dictionary of the English Language defined it as “undue expansion or increase, from over-issue.”

But sometime in the 1960s the definition began to change. In a 1964 essay by Henry Hazlitt, the American College Dictionary said inflation was the "Undue expansion or increase of the currency of a country, especially by the issuing of paper money not redeemable in specie." But the second usage in that entry said this: "A substantial rise of prices caused by an undue expansion in paper money or bank credit." 

This second usage underwent still further changes before severing the linkage between money and prices entirely. Today's Federal Reserve uses the following as their working definition of inflation––with no reference to money at all: "Inflation is the increase in the prices of goods and services over time."

A paper by Michael F. Bryan published by the Federal Reserve Bank of Cleveland explains this change in definition and correctly assigns blame to those most responsible for the confusion regarding inflation:

To be fair, it is completely understandable why people believe inflation is an increase in prices. After all, an increase in prices is one of the most important effects of inflation. But if we define inflation as an increase in prices we will be at a total loss as to why prices have risen in the first place, and completely incapable of preventing its recurrence.

If we do not separate the cause from the effect, we will never be able to combat inflation and its devastating effects.

Inflation's Effect on Prices

Inflation is an increase in the quantity of money. The effect of this increase is a general increase in prices.

If an economy has $1 million worth of notes in circulation and the quantity of money increases to $2 million, prices, in general, will rise. This is explained by supply and demand. When the supply of a good goes up it becomes more abundant and its price goes down. If $1 could get you one loaf of bread, an increase in the supply of bread could mean that $1 now gets you two loaves of bread. In other words, if you are the owner of bread, you now need more bread to get one Dollar because the price of bread is lower.

The same is true for money. If $1 gets you one loaf of bread, but the supply of money goes up, now one loaf of bread could require two Dollars––only half a loaf is now required to get one Dollar since the price of money went down. Notice, also, that while goods at the store all have prices in terms of one good (money), money has prices in terms of millions of goods! 

And since money has so many prices, when speaking about its general price we use a term called purchasing power. Purchasing power can be understood as the "strength" or "potency" of a money. Money's power is how much of it you need to attain a good––or how "far" your Dollar goes. 

In 2018, a relatively powerful money, like the U.S. Dollar, could buy a whole chicken for $2-3. But in Venezuela, whose money is the Bolívar, you needed more than $14 million Bolívars to purchase just one chicken! This is because Venezuela hyper-inflated its money supply for many, many years––printing Bolívars with face values of 1 million! While the U.S. tries to inflate by about 2% a year, Venezuela inflated at a rate of 1,700,000% in 2018 alone! 

This is obviously inconvenient but also economically disastrous. Inflation ruined the Venezuelan economy and impoverished its people. Their savings were destroyed, investment stopped and their economy collapsed. The Bolívar became so worthless that the money littered the streets––so worthless that no one even bothered to pick it up.

It couldn't buy anything anyway!

Other countries, too, like the Weimar Republic of Germany and Zimbabwe of Africa had central banks that created hyper-inflationary environments. In the post-WWI era, Germany was burdened with draconian reparations that they were not able to pay.

To finance the payments required by the Treaty of Versailles, the Weimar government inflated the money supply so much that people began to us it as wallpaper. Employers paid their employees three times per day and allowed them to go purchase necessities before prices could rise and make their paychecks worthless.

Zimbabwe's situation was so extreme that they ended up printing Zimbabwe Dollars in denominations of 100 trillion Dollars! If you've ever longed to become the world's first trillion, I hate to break it to you, but every citizen of Zimbabwe beat you to the punch years ago!

However, if you are still inclined to acquire the title of "trillionaire" you can easily join that prestigious cadre by purchasing some of Zimbabwe's notes on Amazon. But if you do, keep in mind what those inflated notes represent. They represent a currency that has been increased over, and over, and over again. The result of which is a decrease in the money's purchasing power. 

This decrease in purchasing power means that more money is required to buy the same goods. Because of its diminished purchasing power, prices must rise to achieve an equilibrium between supply and demand, and any money you have––whether in your wallet or your savings account––has had its value reduced. This is why Friedman, Mises, Sowell and so many others constantly refer to inflation as "a tax on savings."

All that said, if inflation is so damaging why, then, did these countries inflate their money supplies?

Or rather, who inflated the money supply?

Who Creates Inflation?

Inflation is an increase in the quantity of money. The effect of this increase is a general increase in prices. Inflation is created by a country's central bank. In the U.S., the central bank is the Federal Reserve.

Inflation is everywhere and always a monetary phenomenon. Today, money is controlled by countries' central banks. Governments have given their central banks monopolies on the supply of money, and consequently, central banks bear sole responsibility for inflation––no one else.

In the video above, the great Chicago School economist, monetarist and Nobel Laureate, Milton Friedman, states clearly and succinctly who exactly is responsible for inflation. Spoiler: it isn't any of the things Jeff Stein says it is...

Friedman, as per usual, is exactly correct. "Inflation is not an act of God... Inflation is a policy." And it is a policy that is supported by virtually all Americans, wittingly or otherwise. They support it when they demand to pay fewer taxes; when they demand that government provide them with this service or that amenity; when they complain that mortgage rates, personal loans and capital investment are too high or too hard to come by.

Then, government officials, ever beholden to satisfy those of the electorate who pay their salaries and finance their campaigns, oblige themselves to these constituents. To grant these three wishes, Congress passes an unbalanced budget that spends more than it collects in taxes. The difference, or deficit, must then be financed by the government taking on debt. This debt comes in the form of U.S. Treasuries––short-term "bills" and longer-term "bonds" to be repaid with interest.

Most of these Treasuries are owned by members of the U.S. public, but others are purchased by foreign citizens and governments, while others are purchased by the U.S. central bank.

For the most part, it is the central bank's purchase of these Treasuries that has created inflation. But to be more specific, their purchase of Treasuries is just one way in which they manage to create new money. Broadly speaking the FED has three tools at its disposal to change the quantity of money:

• Open Market Operations

      ––When the FED buys an asset: Treasuries, Mortgage-backed securities, school desks, stocks... anything at all!

• Reserve Requirements

    ––How much money the FED requires banks to keep "in reserve"; the percentage of a bank's deposits they are not allowed to loan out.

• The Discount Window

    ––The interest rate the FED charges to members who borrow money directly from the FED.

When the FED was first created the Discount Window was their favored policy tool but over time, they began to rely on Open Market Operations (OMO) more and more. Gradually, that too was phased out. Since the 2008 recession, the FED's tool of choice has been what's called Interest on Reserves (IOR), where the FED pays interest to member banks who keep money in their Federal Reserve accounts.

While all of these tools effect change in different ways, they all result in the same thing––a change in the quantity of money. Since Open Market Operations have been so fundamental to achieving the FED's policy goals, let's look at how this tool creates inflation.

1. First, the U.S. government issues debt in the form of Treasuries to cover the deficit.
2. Primary Dealers purchase most of the Treasuries.
3. The FED buys Treasuries from the Primary Dealers by adding money to their Federal Reserve accounts.
4. New money is created.
   

Despite claims that the FED is a private bank (more or less true) operating in total secret (also very true) we, as members of the public, actually have access to a great deal of information regarding what the FED owns and does. For example, the FED publishes their balance sheet every month and regularly announces its future policies. For example, below is the FED's latest balance sheet (Aug, '24).

As you can see, Reserve Bank Credit is the FED's total assets. According to their books, the FED owns more than $7.1 trillion worth of assets. And what do these assets consist of? Securities, of course! Purchased from primary dealers!

Of the total $6.7 trillion worth of securities, $4.4 trillion are U.S. Treasuries––roughly 62% of all Federal Reserve assets and 8% of the Federal debt. Perhaps of interest to the reader is the fact that almost every other security owned by the FED are Mortgage-backed Securities amounting to more than $2.3 trillion... 

Now you know how the 2008 "financial panic" was resolved––the FED bailed out banks by buying their Mortgage-backed Securities. In exchange, you––the normal, everyday person––financed it all by allowing the FED to tax your savings and raise the prices of goods you depend on.

Look at the chart below and take note of how the money supply increases as the FED increases their assets.

The above is the real chart of inflation that CNN and MSNBC never show and never will show.

Now, to be clear, the FED doesn't have to increase the money supply and create an environment of perpetual inflation that redistributes wealth from poor Americans to the wealthy and politically well-connected banks and businesses who encourage the government to pursue economically disastrous policies for their own benefit––but it does.

On very rare occasions the FED actually decreases the money supply; usually because they have no other choice (stay tuned for another entry in the Econ 101 series about Booms and Busts). But overwhelmingly the FED's policy is to create money, not destroy it.

After all, it's part of their "Dual Mandate" to keep unemployment low and to ensure price stability. Creating money accomplishes the first mandate (in the short-run) by causing workers' real wages to lag behind general increases in the price level, making labor artificially cheap and boosting employment by reducing workers' incomes. But the second mandate is only accomplished by guaranteeing a steady increase in prices.

This means the FED can claim they have achieved price "stability" by avoiding price "volatility." But in reality, they have really only prevented prices from falling by guaranteeing that prices will steadily increase throughout the economy, forever. And if that upward volatility happens to be the product of an artificial "Boom" created by the FED, then it results in downward price movements anyway! The FED's mandate, therefore, is an intractable paradox.

Why Do They Get Away With It?

Inflation occurs because the public wants it.

In the video above Milton Friedman correctly identified the real reason for inflation. It's an answer that many will not like but is nevertheless true: inflation occurs because the public wants it. Importantly, the public doesn't even have to know that they want it. As Friedman explained, those who want to pay less in taxes but receive more in government benefits are necessarily asking for inflation.

This is probably dismal enough for many a reader but allow me to make it even more dismal. Inflation would likely still occur even if most members of the public didn't want it. Here's why: government officials, in general, do not cater to the public at large but to special interests. So long as there are powerful interests that benefit from inflation, governments will be inclined to inflate the money supply if they have the power to do so.

To understand why we have to take a page out of Public Choice Economics. This field of economic science was first suggested by Adam Smith who had many remarkable insights on the nature of man and government:  

Insights like this laid the groundwork for modern Public Choice Theory which was later thoroughly expounded on by Gordon Tullock and James Buchanan, the latter of whom won the Nobel Prize in 1986. As Smith explained, men always act in their self-interest. This self-interest can be malevolent or benevolent but always aims at improving the satisfaction of the acting person no matter their goal.

And since government officials are (barely) people, their actions are self-interested as well. The unique contribution of Buchanan in this regard was to explain that government policies which are a net harm to society make economic sense. So why are bad policies turned into law? Because of concentrated benefits and dispersed costs.

Those who benefit from "bad" policies have much to gain and little to lose by lobbying politicians. It might cost a business $10,000 to hire a lobbyist on their behalf but they could stand to gain thousands, millions or even billions of dollars if their lobbyist is successful. If they do succeed, their policy likely taxes each person in the community just a little bit––so little that the normal person won't even notice it. Therefore, spending a little bit of money to get a few Dollars from thousands or millions of people adds up to huge sums of money, and is precisely the reason special interests lobby against the public. The benefits are concentrated on the lobbyist while the costs are dispersed to the public.

On the other hand, you benefit very little from counter-lobbying and would likely incur far greater costs. To be effective, you would probably have to write several letters and make dozens of phone calls to your local representative. This would take hours to accomplish and is still very likely to fail because the representative you are petitioning has received $10,000 from your opposition and only angry correspondences from you! Which is more likely to persuade?

Finally, the time you would have to invest would amount to a savings of only a few Dollars. And economics teaches us that decisions which are not profitable do not occur at all or do not occur for long. Sooner or later, the public quits protesting.

If we carry out this logic to the fullest extent possible we arrive at a situation in which special interests impose harmful policies on the public that are not worth the time spent to oppose them. You can object to this fact all you want, dear reader, but first recount the number of hours you have spent inside your State Capital and then consider how many the lobbyists have spent.

Yes, this theory is bleak but it explains perfectly the reason for our perpetual inflation. If the above can result in contractors securing for themselves above-market-value government contracts at the local level, what makes you think the situation is any different at the national level where trillions are on the line?

Why Do They Lie?

If the public knew that the government was responsible for inflation the State would have no reason to save you from the chaos they create.

Make no mistake, they know exactly what they're doing. The media talking heads, the FED Chairman, the Secretary of the Treasury, the representatives, bureaucrats, economists, politicos, journalists, academics and Washington think tanks all get kickbacks for perpetuating the inflation-is-an-increase-in-prices myth.

But it is not enough to merely believe the myth. To ascend to a position of status and influence within the clergy one must actively preach this false gospel in the squares of public opinion. And in every venue where citizens might be lurking––where any voter might fall within earshot of a revealing confession––it is considered the most egregious of heresies to admit the sins of the Papacy. Too much is at stake to permit dissident truth-telling in any place not concealed behind closed doors and in only the closest of company.

Just as the Emperor wears no clothes the Federal Reserve does not protect the economy. To the contrary, the Federal Reserve rigs the economy against the consumer and in favor of the political class. Do you think it's a coincidence that those who created the Federal Reserve System happened to be the nation's wealthiest, most successful bankers? No. Not at all.

The intent of the Federal Reserve System is clear as day: government issues debt, big banks buy that debt, the FED buys it at above-market value to create new money, big banks receive that money, spend it on things they couldn't otherwise afford, and then, if their investments don't pan out, the FED creates more money to bail them out. 

At the exact same time that all of this is going on they will say that "market forces," "wild optimism" and "reckless spending" on the part of consumers and businessmen created unsustainable economic conditions. But no, the real recklessness is theirs and theirs alone. They deliberately create conditions that incentivize moral hazard and precipitate the destruction of entire industries and countless livelihoods––all because Capitalism is too hard a game for them to win.

And worst of all, to finance all this destructive cronyism their counterfeiting racket taxes your savings, reduces your wages and increases your grocery bill every. single. day. This is why they lie and why they will never admit to any of this.

Conclusion

Inflation is an increase in the quantity of money. 

The effect of this increase is a general increase in prices. 

Inflation is created by a country's central bank. 

In the U.S., the central bank is the Federal Reserve. 

Inflation occurs because the public wants it. 

If the public knew that the government was responsible for inflation the State would have no reason to save you from the chaos they create.