In one sense, inflations (and hyperinflations) must be complex, not only because so many nations have suffered from them and not known what to do, but because so many events can cause inflations.
But in another sense, many nations have figured out how to prevent and cure inflations, and the causes can be boiled down to just two. This post reveals the two causes of, and the two best cures for, inflation.
Inflation does not exist in a vacuum. It is a change in the relationship between the value of a currency and the average value of goods and services. In short, the value of the currency declines relative to the value of the goods and services.
Popular wisdom holds that government deficit spending or “money creation” causes inflation. Many examples of inflation, particularly hyperinflation (an extreme form of inflation) do seem to correspond with money creation.
Weimar Republic (Germany) and Zimbabwe are perhaps the most cited examples.
Yet, in the U.S., the money supply has increased markedly with only moderate inflation.
The following graph shows indexes of three money measures, M1 (green), M2 (red), and M3 (blue), along with the consumer price index measure of inflation (purple). All indexes are based on January 1980 = 100.
While all three money measures have risen substantially, inflation has been comparatively modest, and within the Fed’s target of 2.5% annually. Why?
Here is another graph comparing the rise of federal debt (total of T-security accounts) with the consumer price index:
Again, there seems to be scant relationship between federal debt growth and inflation.
It would be difficult to look at these data and conclude that federal deficit spending (i.e. money creation) causes inflation. In fact, money creation seems to be a government’s response to inflation, not the cause.
Where does that leave us?
Inflation is based on the value of goods and service vs. the value of a currency. The value of goods and services is based on Demand/Supply. The value of a currency also is based on Demand/Supply.
The formula for the value of goods and services (Demand/Supply) is driven mostly by changes in the Supply side of the fraction. When food or energy are in short supply, inflation is inevitable. The Demand for food and oil (today’s stand-in for energy) is far less variable.
In the formula for the value of dollars, Demand/Supply, both Demand and Supply can be quite variable. The Demand for currency is based on Reward/Risk. The Reward for owning dollars is interest. The Risk would be the reduced “full faith and credit” of the issuer.
Because the full faith and credit of the U.S. essentially is perfect, Risk is not an important variable here.
This means that inflation comes when the Reward for owning dollars (interest) declines and/or the Supply of food and/or energy declines.
A larger economy has more money than does a smaller economy. For instance, California has a larger economy and more money than does Los Angeles. Therefore, to grow an economy requires growing the money Supply.
That indicates that trying to fight inflation by limiting the money supply (aka austerity), via reduced deficit spending and/or increased taxation, will lead to recession or depression.
As for surpluses (i.e. extreme deficit reductions), they lead to depressions (i.e. extreme recessions):
1804-1812: U. S. Federal Debt reduced by 48%. Depression began in 1807.
1817-1821: U. S. Federal Debt reduced by 29%. Depression began in 1819.
1823-1836: U. S. Federal Debt reduced by 99%. Depression began in 1837.
1852-1857: U. S. Federal Debt reduced by 59%. Depression began in 1857.
1867-1873: U. S. Federal Debt reduced by 27%. Depression began in 1873.
1880-1893: U. S. Federal Debt reduced by 57%. Depression began in 1893.
1920-1930: U. S. Federal Debt reduced by 36%. Depression began in 1929.
1997-2001: U. S. Federal Debt reduced by 15%. A recession began in 2001.
Bottom line: Inflation devolves to two variables: The supply of food and/or energy and interest rates.
The prevention and cure for inflation is to make sure the Supply of goods and services (usually food or energy ) is adequate, and the Reward for owning dollars (interest), remains adequate.
Example: Zimbabwe’s hyperinflation began when its leader, Robert Mugabe stole farm land from white farmers and gave it to black people who had no experience farming.
The resultant food shortage caused inflation. Then, Mugabe’s response was to print currency, which did nothing to solve the fundamental shortage problem. And as the inflation worsened, more and more useless currency printing followed, and it was the currency printing that wrongly was blamed for the inflation.
It was as though someone prescribed wine to cure a cancer. As the cancer progressed, more and more wine was prescribed until the patient died, and the wine was blamed as the cause of the cancer.
In short, to prevent inflation don’t cut federal deficit spending. Rather, make sure the economy has plenty of food and energy and high enough interest rates.
And so, to cure an existing inflation, you must increase your supply of food and energy, and/or increase interest rates.
Printing more currency is an ineffective inflation cure, as is cutting deficit spending (aka “austerity.) Both exacerbate inflation and lead to recessions and depressions. Instituting austerity to grow an economy is like applying leeches to cure anemia.
What should a Monetarily Sovereign country do about inflation? Here are the best steps to take:
- Increase interest rates to make the currency more valuable. This is the method the Fed uses to control inflation.
- Support farmers by cutting farm taxes, passing farm support bills, support farm research to increase crop yields.
- Support energy creation: Oil drilling, renewable energy.
- Do not blame federal deficit spending for causing future inflations
- Do not begin austerity (reduced deficit spending, increased taxation)
- Do not print additional currency.
- Do not borrow a foreign currency
What about monetarily non-sovereign nations like the euro countries, which do not have a sovereign currency?
If the EU cannot be convinced to prevent and cure inflations, while supporting economic growth, euro nations must re-establish their own currencies, and become Monetarily Sovereign, again.
Rodger Malcolm Mitchell
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The most important problems in economics involve the excessive income/wealth/power Gaps between the richer and the poorer.
Wide Gaps negatively affect poverty, health and longevity, education, housing, law and crime, war, leadership, ownership, bigotry, supply and demand, taxation, GDP, international relations, scientific advancement, the environment, human motivation and well-being, and virtually every other issue in economics.
Implementation of The Ten Steps To Prosperity can narrow the Gaps:
Ten Steps To Prosperity:
3. Provide a monthly economic bonus to every man, woman and child in America (similar to social security for all)
The Ten Steps will grow the economy, and narrow the income/wealth/power Gaps between the rich and you.