Inflation

What Is It? Why It's Bad—and How to Fix It

Nathan Lewis, Steve Forbes, Elizabeth Ames

• Publisher: Encounter Books
• Year: 2022
• ISBN:
  9781641772440
• Topic: Economia
• Subtopic: Teoria economica

INFLATION: What is It? Why It's Bad—and How to Fix It explains the forces behind the epidemic of soaring prices squeezing individuals and businesses still struggling in the aftermath of the COVID pandemic. An alarming rise in the cost of living has stoked fears of a new crisis resembling the decade-long inflation of the 1970s. Some even raise the specter of a descent into the kind of Weimar-style hyperinflation that has torn apart so many nations. Can this be true? If so, what should be done? How should we prepare for the future? INFLATION answers these and other questions in an engaging conversation that speaks to a wide audience. Drawing on examples from the headlines and from history, the book gives readers an understanding of what inflation means for the economy and society, while also addressing everyday concerns—such as steps to take to protect your wealth. INFLATION also debunks longtime misconceptions that may be setting the stage for a new crisis. Among them: The notion that 'a little inflation' helps the economy. The book explains why this is misguided and why the current rage for the heedless money-printing prescribed by so-called 'Modern Monetary Theory' may lead the nation—and the world—down the road to disaster. INFLATION draws on the expertise of its two distinguished co-authors: Nathan Lewis, internationally renowned scholar and author of definitive books on money and taxation; and Steve Forbes, Chairman of Forbes Media, noted author and commentator, acclaimed for his insights on money and the economy.Edited by author and journalist Elizabeth Ames, INFLATION will foster an understanding of this important subject that should be critical to navigating the days ahead. It is a must-read for anyone concerned about the nation's future.

CHAPTER ONE ________ What Is Inflation?

THE NATION of Zimbabwe is one of the world’s most notorious inflaters. At one point its hyperinflation got so bad that the government issued a $100 trillion note. Eventually the country had to throw out its currency and start over, which they’ve done more than once. Misconceptions about inflation may not literally outnumber Zimbabwe dollars or, for that matter, Venezuelan bolívars, or Argentine pesos (two other hyperinflated currencies). But sometimes it can seem that way.

Throughout history, inflation has been blamed on everything from bad weather, to unions, to Wall Street greed. In the early 1920s, Germans blamed the Weimar Republic’s infamous hyperinflation on Jewish shopkeepers and bankers. Centuries earlier, the ancient Romans blamed theirs on Christians. In medieval times, inflation was blamed on witches.

Discussions of the subject are rife with fallacies and mistaken assumptions. Consumer price increases, for example, do not automatically signal inflation. Even the much-used description of inflation as coming from “too much money chasing too few goods” can be misleading. While inflation can bring on a soaring cost of living, it can also occur quietly without dramatic increases in consumer prices.

The broad lack of understanding is the reason why policymakers too often resort to misguided “solutions.” In the early 1970s, President Richard Nixon blamed a mild inflation on “international speculators” who, he insisted, were driving down the value of the dollar. His response was the infamous Nixon Shock: a series of initiatives featuring wage and price controls, along with tariffs on imports. Most notoriously, it ended up destroying the Bretton Woods monetary system under which the dollar had had a fixed and stable value defined by an ounce of gold.

The measures were supposed to be temporary. But Nixon’s “cure” set in motion the decade-long Great Inflation and the energy crisis of the 1970s, not to mention Nixon’s impeachment proceedings and eventual resignation.

We will see later on that the Nixon Shock was typical of most so-called inflation remedies, which more often than not end up making things worse. Their damage to the economy, as well as society, can be lasting.

That was especially true of Nixon’s destruction of the Bretton Woods monetary system, which ended the US dollar’s long history on the gold standard, the monetary principle that the US had embraced practically since its founding. For nearly 180 years, with only a few interruptions, the value of the dollar was linked to gold. The United States rarely had a problem with inflation and became the most economically successful country in the world.

A SLOWLY ERODING DOLLAR

The end of the Bretton Woods gold standard gave us what we have today: a monetary world order where all currencies, including the dollar, are floating “fiat money.” Their values are no longer set, but depend on the whims of currency traders and the policies of central bankers.

This chaotic system has been in place for barely five decades. However, it is rarely questioned and today is considered the norm. People too young to recall anything else do not perceive the destruction it has wreaked. That includes, for starters, the devastating inflation of the 1970s, followed by a gradual, low-grade inflation that began in the mid-1980s. Since 1970, the dollar’s purchasing power has been reduced by 86 percent, according to a calculator from the Bureau of Labor Statistics, based on its official cost-of-living measure, the Consumer Price Index (CPI).

Critics, however, point out the index, which doesn’t measure certain expenses (most notably, the cost of health insurance) understates the true effects of inflation. The dollar’s decline is even more dramatic if we look at the price of gold, the traditional measure of currency value. In 1970, it took $35 to buy an ounce of gold. Today, it takes around $1,800—a 98 percent drop in value.

Oil is another inflation indicator. In the 1960s, oil cost $3 a barrel and oil companies were profitable. By mid-2021, oil cost $75 a barrel, and oil companies could barely get by. (In 2019, many were at risk of defaulting on their debt.) What does this tell us? Oil is certainly not twenty-five times more valuable than it was in 1965. At least until the recent inflation, gasoline has remained cheap enough to enable automakers to churn out big, powerful, luxurious, gas-guzzlers. What the price increase reflects is a sixty-year slide in the value of the dollar.

Two more examples: a Coke and a McDonald’s Big Mac. Back in 1970, a 12-ounce can of Coke cost a dime. A Big Mac cost just 65 cents. Fifty years later, the price of the burger has increased nearly eightfold—to around $4.95. You’d be lucky to get the soda in a vending machine for a dollar. Obviously, these products haven’t changed. So why the hefty cost increases? The reason: a shrinking dollar.

The dollar’s steady, inflationary decline is one reason that people just starting out today often wonder why they can barely make the rent when, years ago, their parents, who made far less money, could afford to buy a house. The primary reason is inflation. Yes, your parents may have earned fewer dollars. But those dollars were worth much more.

WHAT INFLATION IS VERSUS WHAT PEOPLE THINK IT IS

So, what exactly is inflation? The word, as used today by the media and in conversation, has a number of different meanings.

“A Dramatic Change in the CPI.” The cost of living, or Consumer Price Index (CPI), is produced by the US Bureau of Labor Statistics and tracks the cost of living based on the prices of assorted goods and services, along with energy and housing costs. Some people say there’s inflation when the CPI shows a sufficient rise in prices to suggest a decline in the purchasing power of the dollar.

Economists and the media first became concerned about “inflation” in the spring of 2021 when the CPI recorded an increase of 5 percent over the previous year. It was the biggest jump in more than a decade, beyond the annual 2 percent rise that the Fed’s economists believe constitutes monetary “stability.” (Actually, pushing up prices by 2 percent each year is hardly stability. But more on this later.)

“Price Increases Over Time.” According to the Federal Reserve, “Inflation occurs when the price of goods and services increases over time.” The Fed claims that it can occur when demand exceeds supply (what it calls “demand-pull inflation”). Or, it can happen when the cost of supplies increases (“costpush inflation”).

A Consequence of “Class Struggle?” Or, how about this take on the subject from the authors of the socialist textbook Macroeconomics: “Conflict theory situates the problem of inflation as being intrinsic to the power relations between workers and capital (class conflict), which are mediated by government within a capitalist system.”

Let’s just say that last one’s a bit too far out to address. As for the other definitions, they may score points for clarity. Yet they, too, are off the mark. Why? Because they focus on increasing prices, which are only the symptoms, and not the cause of inflation.

The Truth About Prices. Defining an inflationary malaise simply as “rising prices” does not really describe what is taking place. Economists love to talk about the need for “price stability” in a healthy economy. That idea is fallacious. In a normal economy, prices rise and fall all the time.

The economist Friedrich Hayek famously explained how prices constitute a system of communication that allows markets to allot resources in a way that best meets society’s needs and wants. For instance, it’s natural for the price of sneakers to rise based on real-world demand for a “hot” new design. Those rising prices signal to producers, stores, and others, that the fancy sneakers are a hit with consumers.

Higher prices also serve another purpose: the lure of potential profits attracts competing sneaker manufacturers to the market. New and even better offerings start popping up. Consumers get more to choose from. Market competition increases, and those hot designs may actually become cheaper. Similarly, if the sneakers fail to sell, discounters will start cutting prices. Manufacturers will stop making those sneakers and redirect their resources into designs that people like better. Rising and falling prices, therefore, are critical to enabling markets to meet the needs of people and create abundance.

Prices tend to rise in an economic expansion where there’s increased demand, and decline in a recession when people are tightening their belts and budgets. This is true even when a currency is reliably stable in value. Prices also tend to rise when nations become more prosperous. Prices in Cambodia, for example, are lower than in wealthy Singapore. If Cambodia becomes as wealthy as Singapore, prices in Cambodia would likely rise to Singapore’s levels.

Two other examples are Japan and Germany. After World War II, they rebuilt devastated infrastructure, homes, and businesses. The standard of living in both countries improved. Demand for all kinds of goods and services soared. Prices went up.

The increase in prices seen by the US and other nations in early 2021 was to some extent the result of this “natural” increase in demand. The global economy was starting to recover from an historic trauma caused by a year-long shut-down due to the COVID-19 pandemic. People were beginning to go back to work, travel, eat out, and start shopping again. Labor costs were also rising. Individuals who were thrown out of work were getting new jobs and negotiating higher salaries. Companies were competing with emergency unemployment subsidies that were encouraging employees to stay home.

TWO KINDS OF INFLATION?

Observers who’ve attributed pandemic-era price increases to such supply and labor disruptions, therefore, are partly right. That’s why it’s often said that inflation comes in two varieties: “monetary,” and “non-monetary.” To understand what’s going on in the economy, it’s important to know the difference between the two.

Non-Monetary Inflation. Some economists call those broadbased price increases resulting from real world changes in supply and demand “non-monetary inflation.” This kind of inflation occurs in response to market events. But it usually corrects as markets stabilize. For instance, bad weather leads to impaired crop yields and lower harvests. Prices rise. Farmers looking to cash in increase crop production. What happens? Prices gradually come down.

Non-monetary inflation can also result from artificial shortages created by government interference in a market. Rent controls that discourage new housing construction, for instance, or a government-mandated, higher minimum wage, may both result in higher prices and changes in the CPI. These price increases, too, can come down if regulations are lifted. In other words, non-monetary inflation tends to be a short-term phenomenon that, one way or another, eventually resolves.

However, this kind of inflation is not what we’re writing about, and it’s not really inflation in the true sense of the word. Inflation, as most people think of it—and as we refer to it here—is not simply price increases. It’s about the distortion of prices that results from the debasement of money.

Defining inflation simply as “rising prices” does not convey the sense of unease commonly associated with the term—the feeling that something isn’t right about the prices of goods and services that seem to be shooting up for no apparent reason.

Monetary Inflation: The Corruption of Money. Those sneakers that cost $100 a year ago suddenly cost $150. Or your weekly grocery bill used to be $100 and now it’s approaching $200. You wonder: Is all of this really due to the pandemic? Those grocery bills seem a little too crazy. Besides, things started going up even before COVID. Like that house you bought back in the year 2000 for $600,000. You didn’t spend a dime to renovate it and it’s in need of repair. No one’s flooding into the neighborhood. Plenty of other houses are for sale. Yet in 2021, a little more than two decades later, your house ends up selling for just under $930,000.

You’re thrilled about that “profit,” until you discover that $930,000 in 2021 will barely get you into another home of comparable value to the one you have just sold. You may even have to put a little cash toward buying something new, or else take a step down.

That’s inflation. This brings us to a more concise definition:

Inflation is the distortion of prices that occurs when money loses value.

Deflation is the opposite phenomenon—a drop in prices caused by ...