Lately, we’ve been hearing and reading a great deal about inflation, and how it’s either nothing to worry about or it’s the end of the world, depending on the motive of the author.
Currently, the Republicans are all atwitter about inflation, because they ascribe it to federal benefits for the not-rich, which they loathe — both the not-rich and the benefits for them.
The Democrats pooh-pooh inflation as nothing-to-worry-about because they want to put more dollars into the pockets of the poor while buying votes.
But what exactly is “inflation”? Surely, the science of economics can provide the answer to so basic a question.
For your confusion, I turn you to “The Definition of Inflation” by Ludwig von Mises.
No, not really.
It’s nonsense. I mention it, not as a reference, but as a reference to the confused nature of economics.
“Inflation,” as most people (except von Mises) think of it, is a general increase in prices. That might seem simple enough on its face, but dig below and it becomes rather muddled.
PCE Price Index (PCEPI) vs. Consumer Price Index (CPI)
The CPI is the most well-known economic indicator and usually gets a lot more attention from the media. But the Federal Reserve prefers to use the PCE Price Index when gauging inflation and the overall economic stability of the United States.
There are other indicators that are used to measure inflation, including the Producer Price Index and the GDP Price Index.
So why does the Fed prefer the PCE Price Index? That’s because this metric is composed of a broad range of expenditures.
The PCE Price Index is also weighted by data acquired through business surveys, which tend to be more reliable than the consumer surveys used by the CPI.
The CPI, on the other hand, provides more granular transparency in its monthly reporting. As such, economists can more clearly see categories like cereal, fruit, apparel, and vehicles.
Another difference between the PCE Price Index and CPI is that the PCE Price Index uses a formula that allows for changes in consumer behavior and changes that occur in the short term. These adjustments are not made in the CPI formula.
These factors result in a more comprehensive metric for measuring inflation. The Federal Reserve depends on the nuances that the PCE Price Index reveals because even minimal inflation can be considered an indicator of a growing and healthy economy.
In reading the above you might conclude that each measures inflation in a slightly different way, but overall, the results should be similar, differing only in detail. Right?
Well, here they are:
The above graph shows each measure on the index: November, 1970 = 100.
Hmmm . . . Three of the four are similar, but the blue line, Personal Consumption Expenditures (PCE), the one the “Federal Reserve prefers to use,” shows massively different inflation.
So, how much has been the “general increase in prices”? Has there been a lot of inflation? A little? Economists can’t tell you.
Let’s look at exactly the same basic data, but instead show Annual Percentage Change from the Year Ago:
The prior graph indicated that inflation at some unknown level, has existed for many years, though measurements differ significantly.
The second graph shows that year-to-year inflation changes generally have trended down. The outlier continues to be the Fed’s preference, PCE, while GDP Price Index and Consumer Price Index move in lockstep, as would be expected.
Now, we’ll include federal deficit spending, the great bugaboo of the right-wing (except when the deficits favor the rich):
We find no relationship between deficits and any commonly-used measure of inflation.
Look closely, and you will see that the maroon line (Federal Debt Held By The Public), the measure of federal deficit spending, does not move in concert with any measure of inflation.
There simply is no evidence to support the commonly held notion that inflation is caused by federal deficit spending. The belief in the monetary cause of inflation simply is wrong, though that belief is a primary source of federal debt fear.
Here is the “logic,” as expressed by Investopedia:
Financing a Deficit
All deficits need to be financed. This is initially done through the sale of government securities, such as Treasury bonds (T-bonds).
Wrong. Treasury securities do not finance anything.
They merely are deposits into T-security accounts, the money in which is not touched by the federal government.
Like the money in safe deposit boxes, the dollars just sit in the T-security accounts, gathering interest until maturity, at which time the contents of those accounts are returned to the owners.
Federal deficit spending is financed by federal money creation, not by borrowing.
Individuals, businesses, and other governments purchase Treasury bonds and lend money to the government with the promise of future payment.
No “lending” is involved. The federal government has no need for, nor use of, the dollars residing in Treasury Security accounts.
To pay for its deficit spending, the federal government sends instructions (not dollars) to each creditor’s bank, instructing the bank to increase the balance in the creditor’s checking account.
The instant the bank does as instructed, new dollars are created and added to the money measure known as M1.
The bank then clears the transaction through the Federal Reserve, a federal government agency, and the circle is closed. The government simply creates its own laws and approves its own money creation.
The clear, initial impact of government borrowing is that it reduces the pool of available funds to be lent to or invested in other businesses.
As noted earlier, the U.S. federal government, being Monetarily Sovereign, has the unlimited ability to create U.S. dollars. So it does not borrow dollars.
The so-called “borrowing” (i.e. deposits into T-security accounts) would “reduce the pool of available funds to be lent to or invested in other businesses,” but for three facts:
- Federal deficit spending adds dollars to the economy, which increases the pool of available funds
- The deposits earn interest dollars created ad hoc, by the federal government, which also increases the pool of available funds.
- Upon maturity, the dollars in the T-security accounts are returned to M1, which again adds to the pool of available funds.
This is necessarily true: an individual who lends $5,000 to the government cannot use that same $5,000 to purchase the stocks or bonds of a private company.
But some other individual, the individual who sold the $5,000 worth of goods and services to the federal government, has received newly-created $5,000 that can be used “to purchase the stocks or bonds of a private company.”
Thus, all deficits have the effect of reducing the potential capital stock in the economy.
Wrong. All federal deficits have the effect of increasing the potential capital stock in the economy, which why, as federal debt has increased, there is more capital stock in the economy today than there was in prior years.
This would differ if the Federal Reserve monetized the debt entirely; the danger would be inflation rather than capital reduction.
The so-called federal debt already is monetized by the money-creation involved in the federal government paying for goods and services.
Additionally, the sale of government securities used to finance the deficit has a direct impact on interest rates.
It isn’t the sale of T-securities that impacts interest rates. It’s the existence of T-securities that gives the Fed a platform for controlling interest rates.
Accepting an extra billion or trillion dollars in T-security deposits doesn’t change that fact.
Federal Limits on Deficits
Even though deficits seem to grow with abandon and the total debt liabilities on the federal ledger have risen to astronomical proportions, there are practical, legal, theoretical and political limitations on just how far into the red the government’s balance sheet can run, even if those limits aren’t nearly as low as many would like.
As a practical matter, the U.S. government cannot fund its deficits without attracting borrowers.
False. They probably mean, without attracting lenders, but that too would be false.
Deficits are the difference between tax collections and federal spending, which already is funded by federal money creation.
Deficits are not funded. It is the spending that is funded. And there are no financial limits to federal spending.
Backed only by the full faith and credit of the federal government, U.S. bonds and Treasury bills (T-bills) are purchased by individuals, businesses, and other governments on the market, all of whom are agreeing to lend money to the government.
True that U.S. Treasury securities are backed only by the full faith and credit of the U.S. government.
But the federal government does not borrow U.S. dollars. Even if the U.S. government didn’t offer a single T-bill, T-note, or T-bond, it could continue deficit spending forever.
No one lends money to a government that has, via its own laws, given itself the unlimited ability to create its own sovereign currency.
The U.S. federal government never unwillingly can run short of laws, and it never unwillingly can run short of dollars.
The Federal Reserve also purchases bonds as part of its monetary policy procedures. Should the government ever run out of willing borrowers, there is a genuine sense that deficits would be limited and default would become a possibility.
That may be the “general sense,” but it is wrong. The debt-worriers have been making the same “default” claim for more than 80 years, while the federal debt has risen 5,500%.
If interest payments on the debt ever become untenable through normal tax-and-borrow revenue streams, the government faces three options.
They can cut spending and sell assets to make payments, they can print money to cover the shortfall, or the country can default on loan obligations.
The second of these options, an overly aggressive expansion of the money supply, could lead to high levels of inflation, effectively (though inexactly) capping the use of this strategy.
The author has no understanding of the financial differences between monetary non-sovereignty (you, me, cities, counties, states, businesses) vs. Monetary Sovereignty (the federal government).
Neither taxing nor borrowing supplies dollars to the federal government. Tax dollars are destroyed upon receipt. And the federal government (unlike state and local governments) does not borrow.
The purpose of federal taxes (unlike state/local taxes) is not to provide spending money to the government. The purpose of federal taxes is to:
- Help the government control the economy by taxing what it wishes to discourage and by giving tax-breaks to what it wishes to encourage, and
- To make the populace believe that benefits are limited, a myth promulgated by the very rich in order to widen the Gap between the rich and the rest.
The federal government always creates new dollars to pay for interest, and this never leads to inflation.
The Bottom Line
Deficits are seen in a largely negative light.
By those who do not understand the differences between Monetary Sovereignty and monetary non-sovereignty.
While macroeconomic proposals under the Keynesian school argue that deficits are sometimes necessary to stimulate aggregate demand, other economists argue that deficits crowd out private borrowing and distort the marketplace.
Deficits always are necessary to stimulate demand. When deficits are lacking, or even too small, the economy falls into recession or depression.
A growing economy requires a growing supply of money, and this is created via federal deficit spending.
U.S. depressions tend to come on the heels of federal surpluses.
1804-1812: U. S. Federal Debt reduced 48%. Depression began 1807.
1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.
1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.
1997-2001: U. S. Federal Debt reduced 15%. Recession began 2001.
Since deficit spending adds dollars to the economy, it is senseless to claim that deficits crowd out private borrowing. Deficits have grown massively over the years, and there has been no “crowding out” of private borrowing.
Still, other economists suggest that borrowing money today necessitates higher taxes in the future, which unfairly punishes future generations of taxpayers to service the needs of (or purchase the votes of) current beneficiaries.
If it becomes politically unprofitable to run higher deficits, there is a sense that the democratic process might enforce a limit on current account deficits.
And yet, there has been no relationship between tax levels and federal deficits. No future generations have been punished. And the democratic process has not enforced a limit on federal deficits.
All of the above demonstrates the “science” of economics’s uncanny ability to ignore the facts in plain sight, and instead promulgate unproven and unprovable hypotheses.
Many people expect the Federal Reserve to control inflation. But inflation is not a financial problem. Inflation is a scarcity problem that only Congress and the President can fix.
Money is neutral. Deficit spending is not an inflation issue. The amount of deficit spending is not an inflation issue. The issue is how the money is spent.
Deficit spending that causes shortages is inflationary. Deficit spending the cures shortages is anti-inflationary.
Rodger Malcolm Mitchell
Monetary Sovereignty Twitter: @rodgermitchell Search #monetarysovereignty Facebook: Rodger Malcolm Mitchell ………………………………………………………………………………………………………………………………
THE SOLE PURPOSE OF GOVERNMENT IS TO IMPROVE AND PROTECT THE LIVES OF THE PEOPLE.
The most important problems in economics involve:
- Monetary Sovereignty describes money creation and destruction.
- Gap Psychology describes the common desire to distance oneself from those “below” in any socio-economic ranking, and to come nearer those “above.” The socio-economic distance is referred to as “The Gap.”
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 Monetary Sovereignty and The Ten Steps To Prosperity can grow the economy and narrow the Gaps:
Ten Steps To Prosperity:
- Eliminate FICA
- Federally funded Medicare — parts A, B & D, plus long-term care — for everyone
- Social Security for all
- Free education (including post-grad) for everyone
- Salary for attending school
- Eliminate federal taxes on business
- Increase the standard income tax deduction, annually.
- Tax the very rich (the “.1%”) more, with higher progressive tax rates on all forms of income.
- Federal ownership of all banks
- Increase federal spending on the myriad initiatives that benefit America’s 99.9%
The Ten Steps will grow the economy and narrow the income/wealth/power Gap between the rich and the rest.
8 thoughts on “What is “inflation”? Not what you might think. How to ignore the facts in plain sight.”
Good morning, Rodger. Here are some details to back up your analysis.
Investopedia is simply parroting the theories of mainstream economists who have, as you have long demonstrated, no understanding of the reality of how our sovereign monetary system works or how regular folks think.
“The clear, initial impact of government borrowing is that it reduces the pool of available funds to be lent to or invested in other businesses.”
This is the thoroughly debunked theory of “loanable funds”, which states that there is a limited amount of money available for investing and it is dependent on the amount of savings. As Keynes showed, the truth is that savings depends on investment. Thus, investment is required to produce the surplus value that becomes savings.
Investment funding is always available for capital projects as the banks will lend to any credit-worthy borrower regardless of the amount of savings (or reserves). This also injects new money into the economy. The difference is that federal government money creation is without debt, while bank money creation is debt that has to be repaid. Bank (debt) money will be used, supposedly, to produce goods and services with a higher value than the loan plus interest, which is how profits are realized and surplus value is created to be allocated to savings.
I say supposedly because too much lending in the past few decades has been for financial finagling and not for producing goods and services. This is a misallocation of money that only increases the wealth of the top few percent and increases the Gap.
“The Federal Reserve also purchases bonds as part of its monetary policy procedures. Should the government ever run out of willing borrowers, there is a genuine sense that deficits would be limited and default would become a possibility.”
The government cannot “run out of willing borrowers”. The Primary Agents who bid at Treasury auctions are required to make a bid. There is always at least two to three times as many bids as there are securities available for sale. In any event, as Investopedia notes, the Fed can “buy” any unsold securities. The Bank of Japan has been buying, for several decades, some 90% of government bonds issued and there is no inflation or chance of default.
“Still, other economists suggest that borrowing money today necessitates higher taxes in the future, which unfairly punishes future generations of taxpayers to service the needs of (or purchase the votes of) current beneficiaries.”
This is Ricardian equivalence which posits that consumers will perceive a future need to raise taxes to “pay back” today’s debt and will reduce current consumption in order to save for the future tax increase. Thus, the increase in current government spending will be offset by reduced consumer spending with the result that it is ineffective and perhaps inflationary.
IMNSHO, Ricardian equivalence is a complete misunderstanding of how regular folks think. Absolutely no one other than politicians and mainstream economists thinks this way. People make current consumption decisions based on their current financial resources, they never think about potential future tax increases (which aren’t necessary, anyway).
Well, it was morning when I started writing this comment. 🙂
Good comments, John.
With the vast majority of economic writers having no clue about reality, we never will run short of material about which to comment.
Hello Rodger, what do you think of the proposal to create a central bank digital currency (CBDC)? Isn’t it just another payment system administered by central bank itself bypassing the private commercial banks?
Long term it’s inevitable, but short term, the private banks have a lot of political clout. I think we soon will see the end of paper dollar bills, and then the end of credit cards, with all transactions taking place electronically first via iphones and then via voice (Siri, Alexa, et al).
I suspect blockchain will prove to be hackable, with something based on RNA or DNA taking its place.
Thank you. What are your thoughts on the viability of bitcoin and its potential as a replacement for the dollar system?
I don’t know about bitcoin specifically. The long-term acceptance of any currency is based on full faith and credit (See: https://mythfighter.com/2010/02/23/understanding-federal-debt/) and so far, bitcoin comes closer to being a commodity than to a form of money. Today, it is more similar to gold than to the dollar.
I do not see it replacing the dollar UNLESS the federal government supports it. It lacks the 8 features of full faith and credit.
Wouldn’t this mark the end of counterfeiting and make drug deals difficult?
There are problems with all forms of money:
As for drug deals, I should imagine the non-trace aspect of bitcoin makes them ideal for drug deals. It has a built-in money-laundering feature.