November 2023
“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin.” Earnest Hemingway
For many years, the word inflation was not a statement about price levels, but a condition of paper money; specifically, a description of monetary policy. Consider the following excerpt from the Federal Reserve Bulletin in 1919, Inflation is the process of making addition to currencies not based on a commensurate increase in the production of goods. It was universally understood by policymakers and academics alike that inflation referred to the central bank increasing the money supply faster than the growth in production/output. It was a noun, not a verb. In stark contrast, inflation has become synonymous with a rise in prices, and its connection to monetary policy is overlooked, if not overtly refuted.
A scant two generations later, the Fed issued the following statement; Most prominent among these inflationary forces were a drop in the exchange rate of the dollar, a considerable increase in labor costs, and severe weather (FRB 1978). Record scratch! The 1919 Fed clearly stated that inflation was caused by a single phenomenon; increasing the money stock without a commensurate increase in the production of goods. Less than sixty years later monetary policymakers instead blamed rising price levels on a falling dollar, rising wages, and climate change. And for the record; a falling dollar isn’t the cause; it’s the effect. Inflation/inflating the money supply devalues the dollar.
What was once a word that described a monetary cause, now describes a price outcome. This shift in meaning has complicated the diagnosis of the problem as well as the remedy. If you don’t understand the cause, how can you possibly prescribe an effective cure?
Currency devaluation schemes are nothing new. In fact, they’ve been around for over two thousand years. At the height of the Roman Republic, the denarius was 90% silver. However, beginning around 200 BC, Roman emperors began to increase the copper content/decrease the silver content, and consequently reduced its value. This process is known as currency debasement. At the end of the Roman empire, the silver content of the denarius had fallen to just 2%. What was once the most recognized and sought after coin in all of the lands had become shunned by merchants and citizens alike.
It wasn’t until the gold standard was successfully murdered, dead and buried, that fiat currency claimed its place as the coin of the realm; much to the delight of politicians and central bankers alike. Unlike (precious metal) currency debasement, which is a slow, expensive, and ponderous process, inflating the money supply of a fiat currency is faster, cheaper, and far simpler. Governments no longer need to reissue coins with increased base metals content. Instead, they impel/compel their central banks to print as much money as their profligate hearts’ desire.
Why do bureaucrats secretly welcome, if not encourage, currency debasement? Self-interest; it’s bad for you, but good for them. Inflation is nothing short of a hidden tax. Like the adage about boiling frogs; a gradual currency devaluation scheme does a variety of things, including:
- Bracket creep-wages rise with inflation, and in a progressive tax structure, tax rates increase with nominal income, as do federal tax receipts.
- Sales and property taxes are correlated with retail prices. As prices/values increase, tax revenues increase as well.
- Reducing the real (inflation-adjusted) amount of government debt. A dollar of debt issued twenty years ago is only worth sixty-seven cents
- A falling dollar/rising price levels incentive present consumption, since every year you delay the good or service will cost you more.
It’s important to understand that money isn’t wealth. Rather, it’s a medium of exchange. We trade hours for dollars, then trade dollars for stuff. Increasing the money supply doesn’t make us richer; innovation, technology and corresponding increases in output do. In other words, the ability to make a better widget, produce it quicker, and with less input costs creates wealth. The inviolable law of supply and demand makes it clear that increasing the money supply absent a corresponding increase in output merely means we pay more for the same item.
In conclusion, the corruption of the term inflation from its historical definition as a monetary phenomenon to its contemporary association with rising prices has profound implications. This semantic shift not only complicates the diagnosis, but muddles the path to an effective treatment. Before policymakers can fix the problem, any problem, they must first reach consensus on cause and effect. Absent a precise definition of what words/terms mean, we’ll continue to get imprecise solutions and unsatisfactory outcomes.
Mark Lazar, MBA
CERTIFIED FINANCIAL PLANNER™
pathwaytoprosperity.com
Economic Semantics
November 2023
“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin.” Earnest Hemingway
For many years, the word inflation was not a statement about price levels, but a condition of paper money; specifically, a description of monetary policy. Consider the following excerpt from the Federal Reserve Bulletin in 1919, Inflation is the process of making addition to currencies not based on a commensurate increase in the production of goods. It was universally understood by policymakers and academics alike that inflation referred to the central bank increasing the money supply faster than the growth in production/output. It was a noun, not a verb. In stark contrast, inflation has become synonymous with a rise in prices, and its connection to monetary policy is overlooked, if not overtly refuted.
A scant two generations later, the Fed issued the following statement; Most prominent among these inflationary forces were a drop in the exchange rate of the dollar, a considerable increase in labor costs, and severe weather (FRB 1978). Record scratch! The 1919 Fed clearly stated that inflation was caused by a single phenomenon; increasing the money stock without a commensurate increase in the production of goods. Less than sixty years later monetary policymakers instead blamed rising price levels on a falling dollar, rising wages, and climate change. And for the record; a falling dollar isn’t the cause; it’s the effect. Inflation/inflating the money supply devalues the dollar.
What was once a word that described a monetary cause, now describes a price outcome. This shift in meaning has complicated the diagnosis of the problem as well as the remedy. If you don’t understand the cause, how can you possibly prescribe an effective cure?
Currency devaluation schemes are nothing new. In fact, they’ve been around for over two thousand years. At the height of the Roman Republic, the denarius was 90% silver. However, beginning around 200 BC, Roman emperors began to increase the copper content/decrease the silver content, and consequently reduced its value. This process is known as currency debasement. At the end of the Roman empire, the silver content of the denarius had fallen to just 2%. What was once the most recognized and sought after coin in all of the lands had become shunned by merchants and citizens alike.
It wasn’t until the gold standard was successfully murdered, dead and buried, that fiat currency claimed its place as the coin of the realm; much to the delight of politicians and central bankers alike. Unlike (precious metal) currency debasement, which is a slow, expensive, and ponderous process, inflating the money supply of a fiat currency is faster, cheaper, and far simpler. Governments no longer need to reissue coins with increased base metals content. Instead, they impel/compel their central banks to print as much money as their profligate hearts’ desire.
Why do bureaucrats secretly welcome, if not encourage, currency debasement? Self-interest; it’s bad for you, but good for them. Inflation is nothing short of a hidden tax. Like the adage about boiling frogs; a gradual currency devaluation scheme does a variety of things, including:
It’s important to understand that money isn’t wealth. Rather, it’s a medium of exchange. We trade hours for dollars, then trade dollars for stuff. Increasing the money supply doesn’t make us richer; innovation, technology and corresponding increases in output do. In other words, the ability to make a better widget, produce it quicker, and with less input costs creates wealth. The inviolable law of supply and demand makes it clear that increasing the money supply absent a corresponding increase in output merely means we pay more for the same item.
In conclusion, the corruption of the term inflation from its historical definition as a monetary phenomenon to its contemporary association with rising prices has profound implications. This semantic shift not only complicates the diagnosis, but muddles the path to an effective treatment. Before policymakers can fix the problem, any problem, they must first reach consensus on cause and effect. Absent a precise definition of what words/terms mean, we’ll continue to get imprecise solutions and unsatisfactory outcomes.
Mark Lazar, MBA
CERTIFIED FINANCIAL PLANNER™
pathwaytoprosperity.com