Reader Mail: Inflation Debate Rages

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We’ll have to cut the market coverage short today. There are a few details to attend to before hitting the airport and flying off to Canada. But there was more mail in the mailbag yesterday. Who knew that inflation could stir such passions?

Dear Sir

You are playing a semantic game. Inflation is defined in Merriam Webster as

2: a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.

All other web-site definitions (that I checked) of (economic) inflation = price growth/increase.

You are defining inflation by its cause. You might be right in terms of cause and effect, however a cart is not a horse. You may wish to emphasise the cause of inflation by referring to it in terms of money supply, but that does not mean it is correct to say that the cause is the same as the effect.

I put up with hyperbole in your email reports by applying a filter, however I object to your messing with definitions and logical relationships.

Michael P.

Au contraire! We are merely affirming logical relationships and trying to call things by their right name. An effect (rising prices) cannot be a cause (an increase in the money supply). As for hyperbole, how outrageous!

Here is the important point, though. The key word in the dictionary definition is “general.” Prices can rise for a given good or service and not be a sign of inflation. Changes in supply and demand (shortages, fads, panics, manias) change the price level for specific goods and services all the time.

Our point was, and is, that a general rise in prices can only come about from an increase in the money supply, not an increase in demand. The government would like to blame rising prices on reckless consumer demand. But the reality is that a general rise in prices is the result of a deliberate monetary policy that tolerates 2-3% inflation per year. We’ll leave it to Murray Rothbard to explain why governments do that below. How about more mail?

Good afternoon/evening Dan

Always enjoy your thought-provoking articles…as I did today. But I believe you have partly got it wrong today. There is nothing wrong with the RBA’s definition of inflation. It IS a rise in the general level of prices. Note, the RBA , in its definition, does not say what causes inflation. Doesn’t have to. I agree with you that excess money supply has a lot to do with causing inflation…but I cannot agree with you, Milton baby and all his acolytes, that it is the SOLE cause of inflation. It beggars belief that the rising cost of oil is not jacking up prices of goods and services all over the economy. In other words, you cannot deny that cost –push inflation exists.

Regards,

Bob M.

Perth

Thanks Bob. But we can and we will deny cost push inflation. But we do so cheerfully in the spirit of your comments. The “jacked up” prices of goods and services that stem from rising oil prices have their origin in a weaker U.S. dollar, plain and simple. The oil price would be rising anyway, given the troublesome supply and demand picture. But as far back as 1973 when OPEC first raised the oil price, oil prices have been inherently linked to dollar weakness. This is clearly a monetary cause.

If higher oil prices are being passed through into consumer goods, it’s not cost-push inflation (where inputs are higher and so finished goods prices must be higher). That would just be rising prices reflecting scarcity. A big part of oil’s rise is the dollar’s weakness. And a big part of the dollar’s weakness is that the supply of dollars is growing a lot faster than the supply of oil. If there’s inflation in the oil price, it begins with unsound money.

Speaking of sound money, Friedman famously said that “Inflation is always and everywhere a monetary phenomenon.” He didn’t deny that rising prices are perfectly natural, given changes in supply and demand in the real economy. He wanted to point out that inflation is perfectly unnatural. It always results when the supply of money exceeds natural demand for money.

Money, after all, is a commodity. It’s a medium of exchange. Gold is especially useful as money because it has certain attribute (it’s portable, divisible into smaller units, it’s the same everywhere, it’s nearly indestructible, and it cannot be counteirfitted, and its value rarely changes.) What makes government manipulation of the money supply is that leads to volatility in the price of things, causing distorted values (both economically and, we would suggest, morally).

Hi Dan,

Great write about inflation, I totally agree, and it is startlingly obvious- is that why everyone is blind to it? Or is it a clever wedge tactic? I have a question; are the price rises caused by a high oil price considered “inflation”, or is that just a convenient term? Oil itself going up I would tend to put in the category of consumer demand, but the knock on effect?

Scott.

As above, a big (but not the only) explanation for higher oil prices is the growth in global money supply. Oil is also in demand. But yes, if we had sounder money (not printed willy nilly) we’d have more stable commodity prices.

Thank you Mr. Denning for your inflation explanation. I’d like to contribute this simplification. Consumers always demand things, but they don’t always have the money to bid-up prices. Withhold money, and prices fall – add money and prices inflate. You can experiment with inflation at home – all you need is 1 monopoly board and 2 wads of monopoly money.

Some people are reporting, “Hooray, inflation is under control – all is back to normal.” Even if this was true, all is not well. Inflation is bad for two reasons; it erodes value; and it tricks people into doing stupid things. Lots of people have taken on lots of debt believing prices were rising for genuine reasons. They are now stuck with homes and investments that are far more expensive than they could have imagined. There’s a lifetime of pain to come…

Those who issue inflation deserve punishment far more than those who ‘control’ it deserve praise.

Mick W.

Rockhampton, QLD

G’day Dan,

The RBA’s published definition of inflation is not what the RBA believes inflation to be but rather what the RBA would like us to believe inflation is. It is really that simple. Stupidity does not prevail at this level. Everything is measured and planned. “Conspiracy Theory” I hear them calling … well, maybe so … but the world makes far more sense that way than subscribing to the the alternative “Coincidence Theory”.

Keep Well,

Allen D.

Determining the proper supply of money in an economy is a big subject. It’s too ambitious for a Friday. But we will leave you with the words of Murray Rothbard on the subject, taken from part three of his work, “What has the government done to our money?”

“On the free market, money can be acquired by producing and selling goods and services that people want, or by mining (a business no more profitable, in the long run, than any other). But if government can find ways to engage in counterfeiting—the creation of new money out of thin air—it can quickly produce its own money without taking the trouble to sell services or mine gold. It can then appropriate resources slyly and almost unnoticed, without rousing the hostility touched off by taxation. In fact, counterfeiting can create in its very victims the blissful illusion of unparalleled prosperity.

“Counterfeiting is evidently but another name for inflation—both creating new “money” that is not standard gold or silver, and both function similarly. And now we see why governments are inherently inflationary: because inflation is a powerful and subtle means for government acquisition of the public’s resources, a painless and all the more dangerous form of taxation.”

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Thanks for talking sense on inflation Dan.

    How hard is to understand that if the pool of money is constant in an economy, a price rise in one good will be offset by price drops elsewhere?

    A general price rise through the economy can only be facilitated by a pool of money that is growing/inflating in size.

    travelite
    July 18, 2008
    Reply
  2. haha made me laugh when someone mentioned cost-push inflation.

    It’s almost like trying to invent a self-perpetuating energy machine – you’re forgetting about the conservation of energy; or in this case, the conservation of money.

    Reply

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