From last week’s AP article titled, “Led by Gas Prices, Consumer Inflation Surges Higher”:
“Consumer inflation surged by the largest amount in more than two years in November, led by gasoline prices. The cost of clothing, airline tickets and prescription drugs also jumped. The Labor Department said its closely watched Consumer Price Index rose 0.8 percent last month, the biggest one-month increase since a 1.2 percent surge in September 2005, when the country was hit by rising energy costs in the wake of Hurricane Katrina. Core inflation, which excludes volatile energy and food prices, also accelerated in November, rising by 0.3 percent, the biggest increase in 10 months.”
Consumer inflation was led by gasoline prices? Hmm…that’s an interesting perspective, but one that reverses cause and effect. Given that inflation affects all of us directly, one might expect it would be better understood. Unfortunately, inflation is constantly reported as a general increase in prices. The implication is that inflation just happens by itself, and is as natural as the weather. By thinking of inflation solely in terms of prices, we confuse the symptoms of the disease with the disease itself. If the problem is misdiagnosed, it is unlikely that the proposed treatment will be effective. And by carefully avoiding the question of causality altogether, we are lulled into meek acceptance of the destruction of our wealth.
Inflation is an increase in the money supply. Prices for goods are affected by both real factors (changes in supply and demand) and monetary factors (changes in the money supply). Let’s take gasoline as an example. If demand for gasoline increases, then we would expect the price to go up. However, an increase in the price of gasoline in and of itself would not be referred to as inflation. When talking about inflation, we’re thinking of the prices of just about everything going up year after year. If the price of gas were to increase, but the prices of all other goods and services remained flat or even declined, then no one would be screaming about “inflation.” They’d just be complaining about high gas prices.
Let’s look at it another way. We all understand that prices are driven by supply and demand. Is the overall supply of goods higher or lower today than it was fifty years ago? Obviously, it’s higher. Are the prices for goods in general higher or lower today than they were fifty years ago? Obviously, they’re higher. How is this possible? If supply has increased, then the natural pressure on prices is downward. There has to be something else at work if prices have increased along with increases in production. That something is the money supply.
As the supply of money increases, each individual dollar buys proportionally fewer goods and services. Money is simply a means of exchange. As the supply of money increases, prices must increase as well. If we had a fixed money supply, then it would be impossible to have a general increase in the prices of all goods and services. You could have an increase in the price for a given good driven by real factors, but that increases would have to be offset by a corresponding drop in other prices.
Imagine an economy that had a fixed money supply of $100, and four goods (A-D) available for consumption, each priced at $25. If demand for Good A increases, the price for A might rise to $30. But since the money supply is fixed at $100, that $5 increase for A would have to offset by a $5 decrease across goods B, C, and D. We would not have an increase in the prices for all four goods, even if real factors like demand increased for each of them. It is only possible to have an increase in the prices of all goods if we eliminate the constraint around the money supply and allow it to increase as well.
This is important to understand, particularly when listening to media reports of the Consumer Price Index. The CPI is not inflation. It is a crude means of describing the price increases that have been caused by inflation. If the price increases for the specific goods included in the CPI calculation were offset by corresponding decreases in the prices for everything else, then no one would be worried about inflation per se. Another important point to consider about the CPI is that it is defined by government. The goods included in the metric are always subject to change according to political expediency. For example, the CPI excludes “volatile” goods like housing and energy, but no one would claim that our standard of living is not affected by increases in the cost of those items.
Inflation robs us of our wealth. It punishes savings and encourages debt. It allows the government to live far beyond its means. The next time you hear Ben Bernanke discuss steps to curb inflation, consider the source. His organization is the cause of inflation. Period. If he really cared about solving the problem, he would announce the Fed’s going out of business plan.
