What Is Inflation, Really?

“All the perplexities, confusion and distress in America arise, not from the defects in their constitution or confederation, not from want of honor or virtue, so much as from downright ignorance of the nature of coin, credit, and circulation.”
John Adams, letter to Thomas Jefferson,
August 28, 1787

When everyone is honest, bankers, government workers, wealth creators, and taxpayers all benefit.

But what happens when people are less than honest?

Let’s follow the thinking of the goldsmith on Silver Island, who sees things just a little different from the goldsmith on Gold Island.

Like the goldsmith on Gold Island, the goldsmith on Silver Island creates paper notes (IOUs) to represent the actual money (gold and silver) that people deposit with him.

The amount of the notes exactly equals the amount of gold and silver coins he has on deposit. If there are 100,000 oz. of gold and silver on deposit, there are notes equaling 100,000 oz. of gold and silver in circulation.

How much money is there in total?

If you answered 200,000…
No! No! No!
The total is still only 100,000 in money.

Only the gold and silver coins on deposit are money. The paper notes are symbols of that money.

Paper notes are NOT money.
They are currency.

But the goldsmith on Silver Island notices that almost everyone who uses the paper notes thinks of them as money. Some people almost never come to redeem their notes for actual money.

They are happy to use the paper notes for trade and payment.

Workers begin asking employers to pay them in paper notes rather than gold and silver coins. The workers know they can trade them in at any time, but why bother?

Paper notes are so much more convenient to carry.

The Silver Island goldsmith then has a crafty idea.

What if he printed up extra notes?
And spent them?
Who would notice?

You can see how tempting it would be to the goldsmith who is normally honest, but who suddenly has a medical expense.

Remember, this is Silver Island. The people here are a mix of good and bad. Sometimes they know it, and sometimes they don’t.

On Silver Island, some otherwise good people can rationalize something bad as being good.

The goldsmith’s child needs help and he is short on money.

Why not just “borrow the money” now by printing up a few extra paper notes to pay the doctor?

Then just pay it back later by destroying the other paper notes when he collects his storage fees?

No one would know. And besides, it’s good for the child.

So the goldsmith does print up the extra notes. And nobody notices. And the child gets better. And the goldsmith pays back the “money.”

What he does is a good thing, right?

As time goes by, the goldsmith rationalizes other bad actions as being good.

Why not print extra paper notes to buy better food, pay someone to rebuild the fence, and get his wife a nice gift?

He figures that since nobody notices, why should he even pay it back?

He works hard for a living. So what if he has a few extra nice things. Nobody notices. Nobody cares.

Soon for every 100 oz. of gold stored, there are notes circulating for 110 oz. of gold.

And prices around town
begin to mysteriously rise.

What the goldsmith on Silver Island does not realize, and almost everyone else as well, is this:

When more paper notes are “spent” and put into circulation, merchants notice that more goods are in demand.

When demand rises, the value of what people buy rises, and therefore merchants naturally charge more.

More paper notes = Rising demand = Rising prices

Supply and demand. Cause and effect. Choice being exercised in a free society.

A year later, the goldsmith on Silver Island decides to support another islander for election to the local council.

Together they hatch a scheme to outspend their opponent. The goldsmith prints up a lot of extra paper notes and donates it to the candidate’s campaign.

Because, you know, his opponent has bad ideas, so the extra paper notes are really a good thing, you know, for the good of everybody.

More notes begin to circulate as the candidate spends the extra notes for political influence.

And prices mysteriously rise.

The candidate is elected and begins putting pressure on the goldsmith. Print up more notes so that the government can hire extra people. And spend money on community projects.

The goldsmith does.

And prices mysteriously continue to rise.

Who is to blame for the higher cost of living?

The politician blames the greedy merchants. And the merchants don’t know what to say. They do not understand the real cause of the rising prices.

But the merchants, and actual creators of wealth, continue to be called greedy and uncaring.

They do not realize that the rising prices are a natural result of the inflation.

What is meant by inflation?

You know what happens when you inflate a balloon. As more air is pushed into the balloon, the amount of air increases.

What increases when you have economic inflation?

The supply of paper notes (currency).

Government, and people who make a living off of debt, will tell you that inflation is rising prices, just a natural force of nature, without anyone causing it.

Right?

Wrong!

Inflation is NOT rising prices.
Inflation CAUSES prices to rise.

As the currency supply increases, prices are forced to rise.

If you think the definition of something makes no difference, then you are a good target for con artists.

What if I can plant the idea in your mind that inflation is merely the rising of prices?

I can keep you from seeing the cause-and-effect relationship between printing paper notes and rising prices.

And if I can plant the idea in your mind that government debt is a good idea, then government can continue creating money out of thin air.

To do what?

To finance projects, wars, entitlements, and many other government “goods.”

Who pays?

Workers who create wealth and become taxpayers are the ones who pay. Not the ones whose income is paid out of tax money.

The bankers and politicians on Silver Island soon tell the public that they have to withdraw gold and silver from circulation.

Why?

Because there’s not enough to go around, and besides, the paper notes work well as money.

And almost everyone believes them, except a few kooks who talk about some kind of conspiracy between bankers and politicians.

But nobody really believes them.


from Money and Wealth

2. Money and Wealth thumb

 

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