Topic: Economics
TheTrouble with Inflation Inflation is a catch-all for any rise in prices. Those that want the dollar tied to gold use inflation as their proof. The Federal Reserve uses inflation as an indicator that may say the economy is growing too fast? Could they both be wrong?by EJ Moosa
(libertarian)
Thursday, February 21, 2008
Generally speaking, I do not see the world as most others do. To put it mildly, most of the people that know me consider me a contrarian. I am certain others have more colorful ways to describe me. So before reading on, I will state now if I ruffle your feathers on this topic, I apologize.
Frankly, I do not buy into all the hogwash I hear about inflation. I have read about the evils of inflation starting the first day I read the financial section(and that was before I had two pennys to rub together). The reasons are rather simple and I will describe them for you.
Inflation is reported as price increases year over year. Yet not all price increases are created equally. Let's look at the cost of energy for a moment. The cost of energy has been cited as one of the contributers to the inflation reported by the Fed at this time. We are paying more for the same gallon of gas or the same barrel of oil. But is that not what is supposed to happen when demand is growing and supply is not? Can anyone with a high level of accuracy tell us what part of that price increase is due to demand and what part is due to a weakening dollar? Would the anti-inflation crowd only be happy if all prices stayed the same forever? Feel free to respond.
The second reason I am suspect of inflation and how it is being used is related to wages and reported wage inflation. A company pays its employees a higher wage year over year and that is inflationary, and if it is too high, the Fed is likely to express concern, and eventually raise rates to squash that trend. An employee earning more must be bad in the eyes of the Fed. Yet, if the company is paying an employee 5% more year over year yet is getting a 10% improvement in their performance how is that detrimental? Higher wages will bring more supply in terms of labor to the market. Isn't that how things are supposed to work?
Yet the entire increase in wages and oil prices are inflationary. And the Fed will take decisive action to keep those forces in check. Are they not really working to keep demand in check? If so, who are they do decide what should be our growth rate?
We also have the housing bubble and the inflationary pressures there. What has driven up housing prices is demand for houses, not the weakening dollar. Sure a weaker dollar may play a roll in it, but can you tell me when I sell my house how much of the increase was due to demand for the location where I am and how much was due to a weaker dollar? No you cannot. So what the Federal Reserve does is lump the entire increase into the inflation category.
Do we as an economy believe that supply and demand are not good and effective ways to allocate resources? If we do, is it fair to raise the flags of caution and doom when price increases are due to inflation and not due to the weaker dollar?
What I see instead is a system that is supposed to be a free market system where supply and demand are critical components. Only we have a reporting system on an item called inflation that is used to curb demand whenever prices start rising.
Who decided that we must curb demand at any price? Demand represents a growing economy. Demand represents opportunity. Demand brings new capital into research and development. Why are we so adamant about controlling inflation that we will act to kill demand?
If you know where to find inflation numbers that remove the issues of supply and demand of the components of inflation and show just the relative amount of inflation due to monetary policy, would you please point me in that direction.
Otherwise, I must conclude that inflation is just another one of those mystical creatures that are being used to scare us and control our behavior.
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Posted By: Walt Thiessen
Date: 2008-02-21 22:14:26
Hi EJ,
Your article (for me) proves just how important it is to define our terms clearly. The government, politicians, leading economists, Fed chairs, etc. have so misused the word inflation that it no longer has any real meaning for most people. This is what you've tapped into, either intentionally or unintentionally.
Inflation is nothing more and nothing less than expansion of the money supply. Such expansions eventually lead to some price increases in some areas of the economy, but they are rarely uniformly distributed. Nor, as you point out, is inflation the exclusive contributor to price increases. More importantly, monetary expansion leads to market distortions, particularly the way the government expands the money supply. It is these distortions which ultimately wreak economic havoc on the world in a variety of forms. Price increases are only one aspect of that havoc.
We must stop confusing the issue about inflation and start being precise about what it is. Otherwise, there will be no way to accurately discuss whether it is a problem, what the problem really is, and what can be done about it.
While I do tend to agree inflation may not accurately defined always. There are factors that show the effects of the declining value of the dollar.
What has driven up housing prices is demand for houses, not the weakening dollar.
This was caused by artifically low interest rates. The demand for homes would have worked to increase value but the demand did not rise as quick as homeprices were. Homeprices were artificial as the interest rates were being kept down and thus gave people a false sense of value of property and helped fuel the boom that we are now paying for.
If you know where to find inflation numbers that remove the issues of supply and demand of the components of inflation and show just the relative amount of inflation due to monetary policy, would you please point me in that direction.
The price of an ounce of gold to the dollar would give you a good idea of inflationary monetary policy. Why does your dollar buy consistently less gold? Gold is the standard the stronger our money is worth the better is weathers the increased demand for gold.
Thanks for the feedback. I have written in the past on misused language. So it is indeed one of my objectives.
Inflation and Global Warming have a lot in common if you look at how they are presented to us. Both deal with lots of numerical data that are not precise. Both deal with lots of historical data when the world was a lot different(in the 1800's people grew most of their own food, made their own clothes-how can anyone report inflation accurately relative to today), and both may have a bit of truth in them, but no one can pinpoint how much truth.
As for Gold, it's price can be manipulated as well. Millions of Chinese and Indians wanting and having funds for gold earrings for the first time could be enough to drive gold prices higher. And with the markets allowing people to buy, sell, short, use of options, etc with gold, how much of the price is speculation today? Just like a barrel of oil, we know the price has a good deal of speculation priced in, but we cannot say how much.
With so many aspects suspect at least to me, and with so much of it potentially manipulated by the powers that be, I will never trust Gold as a standard either. Remember the Hunt Bros and silver?
The question in both global warming and the gold standard is who will profit and who will lose. Despite the gloom and doom forecast by both camps, neither has yet materialized.
Regarding the price increases for commodities like Oil and Gold.
I believe you can effectively seperate the 'demand' and 'inflation' portions of the price increases by comparing the prices of those commodities in other currencies.
Compared to the Euro, Canadian dollar, Pound, or even the Yen... Oil and Gold prices have gone up but at a much more reasonable historical rate. Without quoting the numbers I don't have on hand... Since the early 2000s oil and gold have increased by 150% and 200% in dollars. However most other currencies have only seen 50%-60% increases. (Again I'm paraphrasing from some informal research I did some time ago, correct me if I'm wrong)
Modest inflation more-or-less balances out regarding prices of goods and wages, over time. If my wages increase 5%/year, and inflation is 5%/year it's more or less a wash.
As was touched on above, as the supply of money is increased at ever greater rates that supply is distributed less and less evenly. The average worker will still see his 5% increase in wages, but is loosing ground if goods, services, energy, whatever, is increasing at 12%. Somebody else is reaping the benefits of the increased supply.
The eternal problem with any increase in the volume of money over time is that it erodes savings. It only makes sense. I have a fixed amount stuffed under the mattress, but if the supply outside is ever-increasing then the money in my mattress has less and less demand.
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