The Biggest Misconception About Inflation
Ask 100 people on the street to define inflation, and 99 of them will tell you it’s when prices increase.
Of course the Federal Government’s Bureau of Labor and Statistics will tell you the same thing:
“Inflation can be defined as the overall general upward price movement of goods and services in an economy.”
Notice that the BLS doesn’t say that inflation IS defined as such and such. They say it can be defined as such and such.
As an ardent student of the English language and turn of phrase, it speaks volumes about the Federal Government and the BLS and how they really view inflation when they use such imprecise language on their official website.
Inflation certainly CAN BE defined as a general rise in the price of goods and services – but it shouldn’t be!
A general rise in prices is a symptom of inflation – not inflation itself.
It would be like saying that the definition of drinking too much booze is when you have a headache. It’s a frequent symptom, but you can get a headache for a variety of other reasons, and you won’t always get a headache from drinking too much.
Similarly, we know that prices frequently rise for reasons that have nothing to do with inflation – such as a supply crunch or growing demand.
But as my good friend and Austrian economist Chris Wood tells me, “You can’t have a rise in across the board prices WITHOUT an increase in the money supply.”
And as we know, prices don’t always rise immediately as a direct effect of inflationary policy.
So why does the BLS use this other, weaker, misleading definition of inflation? It’s simple: the BLS can very easily jigger with how they measure prices. So in that way, they can control inflation as they define it.
So what is the real definition of inflation?
Inflation is simply an increase in the supply of money.
Money supply, like the amount of empty beer bottles in the recycling bin, is an easily quantifiable number. I might be able to convince my wife that I don’t have a hangover, but she can easily count the number of empties and determine if I drank too much last night.
(Honey, for the record I had three beers yesterday, one with lunch and two with dinner.)
So, while the BLS folks can easily re-jigger price numbers, they can’t do the same for money supply.
There are two main “counts” of money supply: Money supply 1 (M1) or Money Supply 2 (M2).
M1 accounts for all cash and checking account deposits.
M2 accounts for M1 plus all savings deposits, government bonds, and non-institutional money market funds.
So when M2 and M1 increase, that’s inflation – full-stop.
Prices don’t have to increase – though they’re likely to.
And as we can see, M2 is skyrocketing:
Eventually, increased money supply finds its way into commodity prices, and then consumer prices, and then wages – generally in that order.
So wages almost always lag price increases. You can see the most obvious example of this lag by looking at the price of a gallon of gasoline alongside rises in minimum wage.
You can see that wages have to play “catch up” with commodity prices.
It’s exactly this kind of disparity between wages and other prices that the BLS is constantly trying to fuss with.
Never mind that the Federal Government, specifically the Federal Reserve and US Treasury are wholly responsible for inflating the money supply. As the late great Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.”
In simple terms, that means that inflation comes from the policies of the Federal Government, their printing presses, their bond issuances and their magical money computers.
And when prices eventually rise as a direct result of their monetary efforts, the Feds are forced by popular demand to raise wages to get everyone back to even.
So the next time you hear some Senator complaining about the plight of the minimum wage earner, remember that it’s the policies of the Federal Government that cause the wage-earner’s loss of purchasing power.
The sad fact of course is that there aren’t more than a handful of people in Washington DC who even understand the consequences of their policies, let alone do they understand how they might fix those consequences.
Good investing,
Kevin McElroy
Editor
Resource Prospector
