Number 306, February 13, 2005

Happy Anniversary!

Inflation is Alive and Well
by Lex Concord

Exclusive to TLE

According to The Government's own Consumer Price Index (CPI), inflation in the United States has been fairly mild in recent years. Not since 1990 has the official CPI number exceeded 4%. With a few notable exceptions like gasoline, medical care, and college tuition, consumers have seen only modest price increases for most purchases in the past decade. At first glance, it might appear that the Federal Reserve has been doing a good job managing the money supply, and resisting the temptation to inflate their currency. But perhaps we should take a closer look.

The CPI measures nominal increases in the price of a "basket" of various goods. If those nominal prices are rising only slowly, does that tell us that the supply of Federal Reserve Notes is also rising slowly? It might, but not if the true costs to produce those goods are falling precipitously at the same time. Yet that is exactly the case today, with two powerful trends reducing the true costs to produce nearly everything we buy.

The first trend working to reduce costs is technological progress. Factories become increasingly automated, computers grow exponentially more powerful, software allows ever more efficient management of resources, and the rise of the World Wide Web connects everyone more seamlessly, reducing transaction costs and eliminating communications barriers.

The second trend is the ongoing worldwide division of labor, usually referred to as outsourcing. Furniture production moves from North Carolina to Vietnam. Software production moves from California to India. Manufacturing moves from Japan to China. While this process is immensely beneficial to the average consumer, workers in the outsourced industries tend to suffer, of course. (Their suffering could be reduced if governments would reduce the impediments to new business formation, allowing a quicker transfer of worker skills to meeting other areas in the unlimited array of human wants.)

With both technological progress and the worldwide division of labor working in our favor, prices should be dropping dramatically. The fact they are instead rising slowly is testament to the degree to which the Federal Reserve is actually inflating the money supply. True inflation isn't simply the percent change in nominal prices in Federal Reserve Notes—it's the change in nominal prices over what prices would have been if we used a currency with real value, such as gold or silver.

Why does The Government want inflation? Partly this is due to The Government's economists clinging to archaic economic theories, fearful that falling nominal prices would discourage present consumption, thereby causing an economic slowdown. Yet computer prices have been falling for twenty years, and we don't postpone our computer purchases forever. And a shift away from present consumption might be just what many people need, to encourage lower debt levels and higher savings.

Another reason for The Government to create inflation is political pressure. Even round-heeled American voters won't stand for overt tax increases, making it easier to grow The Government by borrowing more, rather than taxing more. Inflation makes it easier to repay the loans, since the Federal Reserve Notes used for repayment several years later are worth significantly less. Suggesting an increase in tax rates might cost even a Republican her seat in office, but allowing inflation to push us all into higher tax brackets, or toward the looming AMT (Alternative Minimum Tax), is accepted as if it were inevitable.

A conspiracy theorist might postulate that the Banking Interests controlling The Government prefer inflation over deflation, because deflation discourages borrowing and increases the likelihood of default on loans. If we know the currency unit is going to be worth more in the future in real terms, we are less apt to borrow money, and paying loans back becomes more painful. The Banking Interests can tolerate being repaid in inflated currency, however, because there are more loans to go around, and the interest rates charged already include an inflation component. But who believes the conspiracy theorists about Banking Interests controlling The Government, anyway?

You may have noticed that I haven't yet used the word "dollar" anywhere in this article. Federal Reserve Notes are denominated in "dollars," but the term no longer means what it once did. A "dollar" was once a coin containing 23.22 grains of gold, or 371.25 grains of silver. (There are 480 grains in one troy ounce.) Once upon a time, paper currency contained phrases such as "Twenty dollars in gold coin payable to the bearer on demand," or "One silver dollar payable to bearer on demand." Today's Federal Reserve Notes simply say "Twenty dollars," with no reference to any redeemable value, because they have none.

Even after Frank Roosevelt took America off the gold standard and outlawed the private possession of gold in the 1930s, American currency was somewhat pegged to gold once again by the Bretton Woods agreements in 1946. Americans still couldn't own gold, but foreign governments and central banks could exchange US currency at a rate of 35 US "dollars" per ounce of gold. Richard Nixon removed this last check on the Federal Reserve's ability to inflate their currency in 1971.

If you believe The Government's CPI numbers, 35 US "dollars" in 1971 had the equivalent purchasing power of 163.25 US "dollars" in 2004, meaning that inflation over that time amounted to 366 percent. Yet an ounce of gold, then worth 35 US "dollars", was recently trading for 413.50 US "dollars", an increase of 1,081 percent, or about three times the official government rate of inflation over that time period.

Given the current pace of technological innovation and an increasingly global economy, prices should be falling dramatically. Instead, prices continue to rise, stealing value from our savings and pushing our nominal incomes into tax brackets once passed off as being intended for "the rich." The people of any country who let The Government control the money supply shouldn't be surprised by the result.


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