Inflation Explained

By Patrick Brogan

Inflation is an often used word, but what is it and what does it do, exactly? Well, most of you will be aware that it is when the price of goods increases across an entire economy. When the price goes down, it is called deflation. This, in turn, affects the purchasing power of a currency, you get less while paying more and central banks are usually tasked with bringing down inflation for stability.

What’s the Point of it?

In short, it is a form of control. When the money system becomes unbalanced, it can lead to chaos, we will view some examples later. The money that is in the system at any one time must obey to the principles of supply and demand. If the Government gave everyone €1 million, the currency would become worthless, in theory anyway. I’m not sure what country you are reading this in, but any government giving away money to ordinary citizens is highly unlikely, so we don’t have to worry about that too much. So, a central bank may not create new money without somebody wanting it first. This is done through applying for mortgages and loans, etc.

Stability

Conventional wisdom tells us that a central bank’s main goals are creating stability, which in turn relates back to employment figures. Inflation is a big part of creating this stability as Investopedia (a great site for explaining economic terms) explains;  “The Fed’s monetary policy goals include moderate long-term interest rates, price stability and maximum employment, and each of these goals is intended to promote a stable financial environment. The Federal Reserve clearly communicates long-term inflation goals in order to keep a steady long-term rate of inflation, which in turn maintains price stability. Price stability, or a relatively constant level of inflation, allows businesses to plan for the future, since they know what to expect. It also allows the Fed to promote maximum employment, which is determined by nonmonetary factors that fluctuate over time and are therefore subject to change.” So, when there is an imbalance between supply and demand, inflation or deflation occurs.  If a Government or the public try to buy more than what businesses can produce the prices will rise. When the reverse happens; it’s deflation and this can be just as harmful to an economy.

The History of Inflation

If we look through England’s relationship with inflation it is interesting as it was the world’s biggest economy for a number of centuries. Plus looking at every countries’ inflation records is a book in itself. The Bank of England produced an excellent oversight video of England’s use of money and how this impacted the wider economy. After the Napoleonic Wars, Britain adopted the gold standard. This meant that all bank notes were receipts for a specific value of gold. Prices were stable because everybody knew what exactly the money was worth. No money could be added to an economy without adding gold first.

This all changed because of World War I. The country needed more money for weaponry. England ran up huge debts and prices more than doubled. Then deflation grew in the 20s as the economy tried to recover from crippling debts. Like the first major conflict of the 20th Century, World War II saw a huge increase in spending and loans. As America effectively won that war, they now had by far the world’s biggest economy. Britain joined the Bretton Woods agreement. This meant most major international currencies were pegged to the dollar and this was backed up by the American gold standard. This had the largest gold reserve at the time.

Again, it was a war that changed this system. The Vietnam War saw a huge amount of government spending and Bretton Woods was abandoned in 1971. The 70s also saw the price of oil tripling and enormous amounts of government borrowing meant inflation went through the roof in Britain.

In 1997, Gordon Brown gave the Bank of England its “independence”. He felt it should be free from short-term political goals. The BoE was now run by a board that meet every month to keep interest rates low, and until this day they have been very successful at that.

Negatives

A system of deflation and inflation is not immune from disaster. Earlier, I mentioned we would look at some examples. The most famous example of hyperinflation is Weimar Germany. The Germans were forced to pay reparations for the First World War. Many countries would not accept the German Mark. Foreign currency was demanded. The Weimar Republic paid for this by printing money without backing it up with any value. The result, the Mark became increasingly worthless. People were paid three times a day. In the end, they found more use for the Mark as wallpaper and for kindling than as a currency. Not surprisingly this caused mass unrest and many cite it as a major factor in Hitler’s rise to power.

Although, post-war Germany is the most famous example of hyperinflation, post-the other war Hungary was actually worse. There are a number of factors for this. Firstly, after World War I, it separated from the Austro-Hungarian Empire. It was a new country and had serious teething problems, especially financially. Then when the Second World War broke out, Hungary was caught between Russia and Germany. Destruction was widespread and the tax base was badly affected. What did the Hungarians do? The same as they had done every time they had a financial problem; print more money. This completely fucked up the economy. Indeed, there is a more recent example of hyperinflation that is worse than Germany. Zimbabwe. This happened because of the reasons as mentioned before, excessive money printing to deal with economic problems.

Central Banks and Fiat Currency

A repeated theory I often hear is that most central banks around the world are privately owned. So, when they create money from nothing, you back the loan and an interest on top of this. Their profit. Now, if we think of this logically, if this is the case, the world will constantly be in debt. If there is only a certain amount units in an economy, we’ll say 1,000,000 units for argument’s sake, and all of this has been issued by the bank at an interest rate of 4%. When all of the 1,000,000 units have been paid off, the bank is still owed its interest rate, but there is no money left in the economy. So, another loan is needed just to pay off the initial loan. The paying off these debts becomes perpetual as money is always issued as a debt. Central banks have many critics for this reason and I have never seen any evidence to disprove this theory and a lot to back it up.

So, if money is no longer backed up by gold, what gives it its worth? Well, a few different things. Firstly, with a Fiat system, from the Latin for ‘let it be’, the government essentially says what it is worth. Secondly, when you go for a loan, you are agreeing to the terms, including what the money is worth. All loans are backed by assets and it is often said that the asset backed against your loan is your promise to pay it. You promise to work until it is paid off. So, what ultimately gives Fiat currency its worth is your work, that’s what it’s pegged against. Now, if we go back to the theory that bankers create money out of nothing and then charge interest i.e. it is created without any physical backing like gold or silver, the bankers debts can never be repaid because money is created as debt, this also means there will never be enough work done to repay it, condemning the world to eternal slavery.

The work done will never cancel out the debt because each time money is created more work is needed than is available. Each time we catch up, more money/work is needed to pay off the increasing debt. If we look at this way; the country’s economy is worth 1,000,000 units. 1 unit = 1 working hour. 1,000,000 working hours are needed to pay off the debt, but when we get to that point the bank is still owed its interest.

Solutions

If you read this far you’ll hopefully agree this system needs to be changed. Luckily, there are a number of systems already being tried as an alternative. Bitcoin being one obvious example. Many hope to go back to a gold standard, but this can be corrupted and is very limiting as it depends on gold and what if no more gold enters the economy? Indeed, all systems can be corrupted if they are not properly democratised and decentralised. This is the core of an economy. Nothing happens without money, so we all must have a say and see how it is created. Here is cryptosigma on the importance and significance of Blockchain, a peer-to-peer form of transaction. Also, James Corbett of The Corbett Report on potential substitutes for a central bank system;

 

Conclusion

As it operates now, the central banking system is too costly, not just in a monetary sense, but the human cost. It is far too volatile and needs constant monitoring. It has long outserved its uses, which it did effectively in the short term. Under the gold standard, space exploration and other costly beneficial research would not have been possible, but as things stand, they won’t be possible again under a crippling financial system, like we have now. I don’t think it’s too much of a stretch to say that human advancement depends on shaking off the shackles of the current financial system. When we consider an economy, it is just a manmade system to streamline the cross-pollination of goods and ideas. There is no equivalent in nature. Therefore, it can be changed to best serve humanity’s needs.

 

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