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What Is Inflation?

Inflation is the opium of the people.” – Henry Hazlitt

Proponents of inflation say it will “get the wheels of industry turning” and that it will bring “full employment.” But, inflation historically leads to economic disaster. Deficit spending or printing money does not create wealth, for money is not wealth. Inflationists confuse money with real wealth by suggesting new “purchasing power” can be created out of thin air by printing dollars, when purchasing power for goods is priced only in other goods. We all measure our income and wealth in terms of money, so it is easy to see how inflation can be mistaken as wealth creation, although this is merely an illusion.

“This notion that you can send cheques out to everybody is not true, obviously,” said Elon Musk on the Joe Rogan Podcast. “Some people have this absurd view that the economy is like some magic horn of plenty–like it just makes stuff. There’s a magic horn of plenty and the goods and services come from this magic horn of plenty, and if someone has more stuff than someone else, its because they took more from this magic horn of plenty. Let me just break it to the fools out there: If you don’t make stuff, there’s no stuff. So, if you don’t make the food, process the food, and transport the food—[or do] medical treatments, [like] getting teeth fixed– there’s no stuff… You can’t just legislate money and solve these things. If you don’t make stuff, there is no stuff.”

In other words, wealth is created through production and consumption, and includes, for instance, food, clothes, houses, railways, roads, cars, ships, planes, factories, schools, churches, theaters, music, instruments, art, and books.

Adam Smith wrote two centuries ago: “That wealth consists in money, or in gold and silver…is a popular notion which naturally arises from the double function of money, as the instrument of commerce, and as the measure of value…To grow rich is to get money; and wealth and money, in short, are, in common language, considered as in every respect synonymous.”

The conclusion that, because the government issued more money, we have all become richer or even that our wealth maintained, is naive. The obvious extension of this view is that all of our problems could be solved by the printing of money.

The increase in the supply of money reduces purchasing power of each individual monetary unit––for instance, the Federal Reserve Note––which leads to an increase in commodity prices.

Let’s look at the Payroll Protection Program, the most recent government stimulus program designed to send money to those small businesses who keep their employees. Those small business owners and their employees enjoy higher dollar incomes as a result of the program, and spend the money they’ve received for the goods and services they want. In turn, the sellers of these goods and services can raise their prices as a result of this increased demand. The sellers then, in turn, buy more goods ands services from a third group, which then can rise prices due to increased demand, and buy goods and services from a fourth group.

Eventually, everyone has a higher dollar income, but, if the productions of goods and services has not increased, then the prices of goods and services increase. The first groups to receive money benefit the most, for they receive money before prices have increased. The later groups receive money after prices have somewhat increased. Those groups which did not receive stimulus must pay higher prices, lowering their standard of living. The stimulus recipients benefit at the expense of those who receive the stimulus money later on in the inflation process. The latter groups can only buy from other producing groups in the community as much good and services as they could before the inflation. Inflation benefits in the short-term chosen groups at the expense of other groups.

Inflation distorts economic relationships and the delicate balance between production and consumption. It also distorts the subjective valuation of a devalued money. As Hazlitt writes in Economics In One Lesson, “each person’s valuation of money is affected not only by what he thinks its value is but by what he thinks is going to be everybody else’s valuation of money.”

Inflation reduces wages by increasing the costs of goods. Those jobs represented by powerful unions will argue their wages needed to be raised along with the increase in the cost-of-living index at the expense of those who have no powerful union representation looking out for their interests.

Paper money is not a form of wealth. Wealth cannot be created at will by printing money, which does not solve depressions caused by maladjustments in wages and prices, between prices of raw materials and prices of finished goods, or between one price and another or one wage and another.

Inflation dis-incentivizes production and grips the nation by depression. Inflation distorts economic reality and, therefore, is a tool of choice in centrally planned economies. “For inflation throws a veil of illusion over every economic process,” wrote Hazlitt. “It confuses and deceives almost everyone, including even those who suffer by it.”

When a crisis is paid for by deficit financing––that is, government borrowing or the printing press––the nation has not received something for nothing. The borrowing must be repaid, for debt cannot pile up indefinitely, and one day the nation goes bankrupt.

“When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid,” wrote Adam Smith in 1776. “The liberation of the public revenue, if it has ever been brought about at all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.”

As the debt comes due, government resorts to heavier and heavier taxation, which destroys the jobs the initial inflation was purported to create. The taxation takes away purchasing power, destroys incentives to be productive, and reduces the wealth and income of the nation. Moreover, stimulus programs via deficit spending create powerful interests who become dependent upon its continuance.

A country simply cannot attain things without paying for it. Inflation is a form of taxation that hurts most those who cannot pay for it, and dictates individual and business activities by distorting markets. Inflation is a tax on the individual’s spending, his savings and life insurance. It is a flat tax in which the poor pays a higher percentage of personal wealth and income as the rich man.

Eventually, super-inflation, as the value of the monetary unit decreases at a faster rate than the quantity of money either is or can be increased, causes a disaster as the nation goes bankrupt.

“It discourages all prudence and thrift,” writes Hazlitt. “It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.”

In short, inflation is an increase in money supply. Printing money doesn’t create more goods nor services, so there is too much money chasing too few goods. Therefore, prices will rise. As F.A. Hayek wrote, inflation can be stopped by cutting down increases in the quantity of money. Hayek once said, “it would be one of the worst things which could ever befall us (but which John Maynard Keynes has unfortunately brought about) if the general public should ever again cease to believe in the elementary propositions of the quantity theory.”

Increases in the money supply is inflation and price increases are a consequence thereof as the money loses value. It leads to the misallocation of scarce resources and inefficiency. Money printing transfers wealth to somebody who has not produced. It has the same effect as going to a shop and paying with counterfeit notes.

In general, higher prices occur for various reasons. For instance, if there is a reduction in the supply of certain commodities, but not an increase in money supply, prices can also increase. Demand can increase due to circumstances, which can also lead to price increases.

Money velocity also dictates inflation, because it creates demand for goods and services, which can then create an increase in costs of goods. While new money in a bank account doesn’t necessarily impact inflation, spent money, and the velocity thereof, does.

Hayek views the quantity of money as a wide range of “substitutable things of varying degrees of liquidity.” The value of money is not dependent only on the total quantity of it being available, but, also on the demand for it. “[T]he harmful effects of an excessive supply of money consist not merely in the changes of the average price level but quite as much in the distortion of the whole structure of relative prices and the consequent misdirection of productive effort which it causes.”

Hayek believed that inflation is caused by a superfluous increase in the quantity of money and that the basic money supply by the central bank must be restricted. In his view, “the chief practical issue today is how fast inflation can be and ought to be stopped.”

The benefits of artificial stimulus only lasts so long as inflation accelerates, but inflation must end eventually. As soon as it slows, prices begin to fall, thus hurting unprofitable businesses and jobs disappear. “Every slowing down of inflation must there- fore produce temporary conditions of extensive failures and unemployment,” writes Hayek.

Along with the termination of inflation comes a “stabilization crisis.” Hayek called for a swift suspension of the practice of inflation. “If we want to stop inflation we must do it here and now,” he said. “It can be done, after the First World War the United States brought prices down by a third in six months (August 1920- February 1921).” At that time, “suffering was great,” but after six months of pain, a new boon began.

If governments did not put an end to inflation policies, then price controls, and ultimately a currency collapse, would follow. The act of stopping inflation is not easy, because we finance government expenditure by borrowing. “…At the moment we just do not know how to maintain the existing apparatus of government without continuing to inflate.”

In his book Human Action, Austrian economist Ludwig von Mises, in the chapter “The Inflationist View of History,” criticized the popular view that a policy of inflation, which leads to a general rise in prices of all goods and services, is good for economic development.

Mises notes that economics doesn’t neither support inflationary nor deflationary policy. “It does not urge the governments to tamper with the market’s choice of a medium of exchange,” he said. He alternatively outlines the following truths which economics establishes.

“By committing itself to an inflationary or deflationary policy a government does not promote the public welfare, the commonweal, or the interests of the whole nation,” Mises wrote. “It merely favors one or several groups of the population at the expense of other groups.”

Mises says it is impossible to know which group will be favored by an inflationary or deflationary policy. “These effects depend on the whole complex of the market data involved,” he said. “They also depend largely on the speed of the inflationary or deflationary movements and may be completely reversed with the progress of these movements.”

Mises argues that monetary expansion results in malinvestment of capital and overconsumption, for it leaves the nation as a whole poorer, not richer. “Continued inflation must finally end in the crack-up boom, the complete breakdown of the currency system,” writes Mises. “Deflationary policy is costly for the treasury and unpopular with the masses. But inflationary policy is a boon for the treasury and very popular with the ignorant.”

He adds: “Practically, the danger of deflation is but slight and the danger of inflation tremendous.”

Former Congressman Ron Paul opposes inflationary policies on constitutional grounds.


Cause = An increase in the supply of money.

Effect = Rising prices…Your money buys less.

Who increases the supply of money? … The Federal Reserve.

Is this Constitutional? … Of course not!”

Paul discusses inflation on his Liberty Report: “It’s an illusion to think that increasing monetary units is actually creating wealth. It has nothing to do with it. In fact, it distorts wealth creation because it distorts the economic picture.”

He argues inflation facilitates big government. “Whether they want wars or welfare, they can delay the spending and the penalties,” said Paul. “So, this is actually a threat.”

In Paul’s view, money creation is a type of tax. “If they can take a dollar and reduce the value by 50%, they have liquidated debt, which is always necessary,” he said. “But it’s also a tax because the people’s income gets lowered as well. But the big thing is, not everybody suffers the same consequences … The people who get the money first – the government, big banks, the big corporations, the military-industrial complex – benefit.”

He adds: “It’s not because of a free market. It’s caused by crony capitalism and our monetary system.”