When I read that “Canada’s inflation rate hits a 56-year low” in the August 19 online edition of the Financial Post I was intrigued by this supposedly welcome news. A careful reading of the short news item, which includes quotes from 3 professional economists, reveals that confusion about economic inflation is prevalent among journalists and economists. It is not just the rest of us who don’t understand inflation. 

In the article, no effort is made to explain inflation in any terms other than the relative changes in the prices of various categories of goods. One of the economists consulted for the article was reported to have said that prices were expected to continue easing in the coming months. The Financial Post writer, Alia McMullen, noted that: “This would allow the Bank of Canada to continue to stimulate the economy with record low interest rates….” And, the same economist reportedly observed, “…Canada doesn’t have a problem with either inflation or deflation”. (Emphasis added.)

 “Inflation” is a bad thing, but so too apparently is “deflation” in the context of economics. It is abundantly clear to most of us that “inflation” or “deflation” is either clearly good or clearly bad if it relates to say, the amount of air pressure in our car tires or the air mattress laid out for the visit of the new mother-in-law.

It is always prudent to define and understand your terms when trying to analyze an issue or a problem. So how does the Canadian government through the Bank of Canada, about which the aforementioned article is focused, define the inflation rate for its purposes? From the government’s list of economic indicators the following appears under “inflation rate”:

“The average rate of increase in prices. When economists speak of inflation as an economic problem, they generally mean a persistent increase in the general price level over a period of time, resulting in a decline in a currency’s purchasing power. Inflation is often measured as a percentage increase in the consumer price index (CPI). Canada’s inflation policy, as set out by the federal government and the Bank of Canada, aims to keep inflation within a target range of 1 to 3 per cent.”

This slightly ambiguous description indicates on the one hand that the government defines inflation as “The average rate of increase in prices,” while simultaneously indicating that “…economists…mean a persistent increase…over…time….” Note also that inflation is apparently considered a problem if it results “…in a decline in…purchasing power” for the currency.

Are you confused yet? Do you think that “inflation” means the price of everything just keeps going up? Conversely, do you think that “deflation” means the price of everything just keeps going down? Is either situation “good” or “bad” and when is it so? As a producer or consumer, lower prices for goods and services sounds like a good thing, and if your revenues, wages or salaries are going up that too sounds like a good thing. But, if the price of everything either keeps going up or down, you are bound to get caught on the wrong side of the deal. Either you’ll be unable to take advantage of lower prices because you have less income, or you’ll have more income but won’t be able to catch up with rising prices.

So, do we really understand “inflation” if it is described to us as “the average rate of increase in prices”? And, why do prices seem to trend upward or why are there concerns about them sometimes going down for that matter? Let’s try to understand what inflation represents in economic terms, and in the process discover that rising prices are an indicator of some sort, and not the source or cause of “inflation” itself.

There is a clue to be found in the nod to economists in the government description of inflation. Economists, according to the government’s description, regard inflation as an economic problem when a persistent increase in the general price level occurs over a period of time, resulting in a decline in a currency’s purchasing power.

With respect, this is an upside down representation of the immutable law of cause and effect. The underlying cause of an increase in the general level of prices in an economy is an excess supply of money and credit. It is called “monetary inflation,” to be more specific.

When there is too much money and credit the economy can be characterized by the description, “too much money chasing too few goods”. A rising price level doesn’t result in a decline in a currency’s purchasing power. It is exactly the reverse situation. Too much money lowers the purchasing power of money and causes prices to rise generally.

Think about it. If you instantly have more cash (created from nothing) to spread around, you would be able to outbid others for goods. If certain favored groups get more of the newly created government money, they can buy up certain goods they could not have afforded previously, leaving fewer goods available to others. Economics 101 tells you that when demand for goods increases, the price is bid higher to give producers the incentive to deliver more of those goods.

Trouble is, if the higher prices are the result of being bid up by unsound money in the first place, the producers may be uncertain about making the necessary investment, or if lured by artificially low interest rates they may make an investment in new production which could easily prove to be a mistake, resulting in unsold goods. That is because not everyone in the economy is privileged with the infusion of fiat money and many will be left worse off, even if they have prepared themselves with savings. The depreciated currency reduces the value of the savings while the price of goods and services just keeps going up. Thus, we have an “economic problem”.

So who is responsible for creating all the excess money and credit leading to this problem? None other than the government, through its central bank policies of “stimulus,” “record low interest rates” and a “target range of 1 to 3 per cent” for an inflation rate, is behind it.

If the general level of prices increases at 1 to 3 per cent annually that sounds awfully much like a “…persistent…increase…over a period of time….” So, if inflation of the money supply is the cause of the general increase in the level of prices in the economy, then monetary inflation is official government policy. This is true of all modern “controlled” economies (where elites are presumed to “know” what is good for the rest of us). One writer has made the observation that monetary inflation is like sin. All governments denounce it and all governments practice it.

Why do governments (or more specifically, the representatives of government in the form of politicians and bureaucrats) perpetuate such policies? Why would it not make sense for the prices of all goods and services, including money and credit, to be established by the voluntary trade of individual market participants? After all, money certainly was not invented by the institution of government. One of this institution’s most devastating “contributions” to economics has been the seizure of sound money and its replacement with fiat currency. Honest money was created by traders over centuries when they realized over time that a medium of exchange was needed to facilitate trade over relatively great distances and for convenience in making transactions. Sound money is difficult to produce, portable and conveniently stored. What government has done, using its monopoly on the use of force, is to make fiat paper currency the only legal tender for trade, and then take the difficulty out of producing it. Governments simply print the stuff. The great economist Ludwig Von Mises noted that “government is the only institution that can take a valuable commodity like paper and make it worthless by adding ink”.

Again, why do governments continue to inflate money and credit? I believe the answer lies in politics. The intoxicating power of political office seems to yield an ever-expanding elitist culture, one that many of its beneficiaries and practitioners will defend and promote mightily, with little regard for unintended consequences. There is no shortage, unfortunately, of influence peddlers and special interest groups which stand to benefit from government largesse. Certain groups argue that they need special favors from government—and, they vote. In order to achieve and retain political power some of these groups are catered to by political aspirants. There is an understandable reluctance on the part of promise-making politicians to raise taxes to cover the spending that is required to meet the demands of influential groups. The easy alternative has been the “magic” of deficit spending. Think now of a compulsive shopper high on crack cocaine, holding a credit card with no limit, to get an idea of what deficit spending offers by way of temptation for politicians.

Canadian governments have done relatively well in balancing budgets and avoiding deficits over the last dozen or so years. However, the fallout from the great deficit spenders in the United States to the south has had an impact. One of the worst moves, in my view, was the auto industry bailouts, in which the Canadian government has participated, helping lead to a projected current fiscal year budget deficit of $50.2 billion, as reported by The Canadian Press. Canada’s finance minister Jim Flaherty has recently indicated that deficit reduction is a priority for Canada. In the US one of the world’s richest and most successful equity investors, Warren Buffet, has warned in a New York Times Op-Ed about the need to get deficit spending under control in that country. Why is that? The US fiscal 2009 budget deficit is forecast at anywhere from $1.6 to $1.8 trillion or more in US dollars. That’s roughly 30 to 40 times larger than that expected for Canada’s. The risk of “inflation” looms large.

When it comes time to repay the debt accumulated by deficit spending, government has only one moral set of alternatives: drastically slash spending or raise taxes to cover its obligations. We already know how unpalatable that is to politicians seeking to stay in power, but there is another stealthy form of taxation that most people do not understand. It is called monetary inflation.

Remember that government has seized control over money by force and simplified its production. So, it has the means to increase supply in an instant. And, it does. Typically, the business of central banking involves the introduction and withdrawal of money and credit into and out of the economic system. This type of intervention, including the latest central planning fad of “quantitative easing,” where government prints money to buy back its own debt instruments, is supposed to create just the right conditions of “stimulus” to economic growth. All of these “tricks” are inflationary. We know that general price levels trend up over time because of monetary inflation being official government policy. So, what is the benefit to the government?

The key to answering that question is in understanding the declining purchase power of the currency. Debtors, who repay in contractual, nominal amounts over time actually benefit from currency inflation. If you make a contract to pay X amount over time in exchange for obtaining a current value Y, and if X is worth less over time, you benefit because you obtain Y for a reduced amount. This is called wealth transfer. Debtors are better off, creditors are worse off. Who is the biggest debtor of all? By repaying debt in cheaper currency, the deficit spending profligates in government are effectively taxing away wealth from taxpayers, without their knowing it, to cover the bills for past promises made and forced on us all.

Why should we be concerned about government control over money and credit? Why should we try to understand it? Aside from the fundamental immorality of initiating force against individuals with respect to economic activity, the particular case of money and credit represents the link that collectivists need to take complete control of your life and even to destroy it in the end. The great, influential, and seriously flawed economist John Maynard Keynes, upon whose ideas modern economics rests, observed in The Economic Consequences of the Peace (1920) that:

“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

With that, Keynes can join Lenin, Marx and others in being credited with fathering the modern socialist movement as far as I’m concerned. His ideas about government deficit spending lead to inflation and destruction. I also think he can join as contributor to or promoter of the kind of ideas that led, for example, to the failed economic and bloody social “experiment” that was the Union of Soviet Socialist Republics.

There are indeed consequences to monetary inflation that should concern you, if the loss of personal and political freedom is not a sufficient reason for concern. Monetary inflation makes you poor, unless you are among the immoral and favored elite.

In the extreme case of rapid hyperinflation, millions of people can be quickly impoverished. The hyperinflation of Weimar Germany is the most famous of devastating cases, though current examples can be observed in Zimbabwe, where the inflation rates have been measured in millions of per cent. The difference between single digit target rates and hyperinflation is really only one of magnitude and time. Inflation must stop eventually, because it cannot be sustained without destroying the society.

If your country is at the mercy of whatever gang of thugs has the opportunity to seize office, and this is increasingly the case in many western nations as societies become more fractious and group-identified, then the individual is ultimately at the mercy of that gang. The United States, once the icon of individualism in name if not in deed, has begun to succumb to the collectivists. No one can predict how long it will take for total destruction, but no one in the nineteenth century could have imagined how far that culture has declined from the perspective of protecting individual rights. Today, the US is just another dangerous place for the individual, dominated as it is by group politics and increasing class struggle as competing political interests vie for more and more state control over individual lives.

The US however has grown to such a size, thanks to its heritage of relative economic and political freedom, that its economy is larger than the next four largest combined. Thanks to bulging deficits, absolutely wild and continuing plans for spending, and a heated printing press, it may be poised to enter into a period of prolonged subnormal economic performance, willingly promoted by an administration ready to replicate many of the grave political and economic errors of history. This would have unintended consequences for the rest of the world, including you.

If you’ve read this far, perhaps you’ve gained some additional understanding of the problems associated with monetary inflation. However, you possibly don’t see how a single person can do anything about it in the face of formidable obstacles. These obstacles include the established policies and loud demands for increasing government control of economic matters. But, the only way change toward greater political and economic freedom can come about is if enough people understand what is involved. A sufficient number of such informed persons, and sufficient is not necessarily a large number, can bring clarity and uncommon sense to bear on those currently abusing the power of political and bureaucratic office.

©Copyright 2009 Edward Podritske