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Inflacionario, El American

Misconceptions About Inflation

All central banks have damaged the monetary sign, so we need to think about how to get out of the morass

[Leer en español]

There are still those who maintain that inflation is a multi-causal process without realizing that it comes only from a monetary phenomenon exogenous to the market, i.e., for political reasons. All else being equal, the more currency issued, the lower its value.

This does not mean that currency cannot change its value for reasons endogenous to the market. To illustrate the point, let’s suppose that we go back in monetary history and that we are still in the beginnings of indirect exchange after having abandoned direct exchange (barter) with the use of salt and iron (as it was originally in Africa), with silks (as it was in Persia), copper (in Egypt), cocoa (in Central America), cattle (in Greece), tobacco (in colonial Virginia) or after realizing the greater advantages of gold and silver due to their fractionality, homogeneity, and durability.

Let’s assume this situation, which to a certain extent means that people keep their valuation of the monetary unit unalterable, and which does not mean that there is inflation or deflation depending on whether it is valued less or more. This naturally translates into changes in the demand for money, reiterating that there are modifications in people’s endogenous appreciations that have nothing to do with inflation.

Even if there is a devastating earthquake that destroys a good part of the goods in a community or if there are abrupt decreases in the rainfall regime, prices will rise. This only shows what is happening due to natural or endogenous causes, but it is not inflation. On the contrary, inflation is always due to artificial or exogenous causes, that is to say, to political manipulations, foreign to the market.

On the other hand, as a footnote, we underline that deflation consists of the inverse phenomenon, i.e. exogenous contraction in the monetary base with all the problems mentioned above due to monetary manipulation.

In order to understand this phenomenon, we should dig into the roots of inflation. It is often said that it is “the general increase in prices”, which is a major mistake for two reasons. First, if all prices were to rise, there would be no problem with this phenomenon since there would be no distortions between income and prices since wages are prices. There would be no problem with prices and wages increasing at 50 % per year, per month, or per day. Eventually, money would have to be transported in wheelbarrows, and the columns in the accounting books or the digits in the calculators would have to be modified, but as we say, there would be no imbalance between prices and income.

Secondly, inflation does not refer to the movement of prices. It is the monetary expansion due to exogenous events its cause, and its effect is the distortion in relative prices, which causes tremendous distress due to imbalances between prices and wages. Monetary expansion (or contraction) due to exogenous causes touches different sectors at different times which alters relative prices and, as it is well known, prices are the only indicators to know how to operate in the market. Their distortion inevitably leads to capital consumption and as capitalization rates are in turn the cause of the increase in wages and income in real terms, these inevitably contract. In other words, inflation leads to poverty.

It is also common in conventional conversations to affirm that inflation is generated by expectations, by cost increases, or by the increase in the price of some strategic good. None of these three conclusions are accurate. If there are those who raise prices due to inflation expectations but which are not validated by exogenous expansions of money, they will have to lower those prices if they want to avoid a contraction in sales. If the costs of certain goods rise, this cannot be passed on to prices without reducing sales.

The merchant will always sell at the highest price he can (just as those who earn wages will ask as much as circumstances permit), which does not mean that it is possible to charge the price he wants, but rather what the market allows. Finally, if the price of a good rises (even if it is considered strategic) there will be two possibilities: if people want to consume the same amount of the good in question, the prices of other goods will have to fall; otherwise, if they prefer to consume the same amount of the other goods, the sale of the product that raised its price will decrease.

It is of enormous importance to bear in mind that in an open money market, as we will see below, the quantity of currency is not constant. The quantity will depend on the marginal utility of the monetary unit, as with other goods and services. And when people value money more and consequently its supply increases, it has nothing to do with inflation, since it is an endogenous expansion. It is not an alteration of the system but an expression of people’s tastes and preferences.

Now let’s get down to the basic issue. In view of the fact that all the so-called monetary authorities have damaged the monetary sign, we must think about how to get out of the morass. It is not a matter of having good regulators and manipulators, it is a matter of getting rid of them, as suggested by Nobel Prize winners in economics such as Friedrich Hayek, Milton Friedman, Gary Becker, James Buchanan, George Stigler, and Vernon Smith.

The point is to realize that every central banker is caught between three possibilities: at what rate to issue, at what rate to contract, or to leave the monetary base unchanged. For through any of the three channels chosen, relative prices will be distorted with respect to the situation in which people would have been able to choose. And if we assume that in the central bank there is a crystal ball and consequently proceeds according to what people would have preferred, there is no reason to justify meddling with savings in administrative expenses, but on the other hand, the only way to know what people would have preferred with respect to monetary assets is to let it act.

Perhaps the greatest fetishism of the moment is the supposed need for monetary manipulators, including the nonsense of referring to monetary sovereignty which is no different from a supposed “carrot sovereignty”. Everything is set up for state apparatuses to suck the fruits of other people’s labor along with tax pressure and government indebtedness. The conservative spirit in the worst sense of the expression does not allow us to clear mental cobwebs and get out of the prison of the status quo.

Asking how much currency there should be is the same as asking how many potatoes there should be. The choice of currency will not be from a good whose existence is too abundant, since it is not convenient to pay for the means of transportation of a thousand millions of something, and neither will it be a good whose scarcity is very marked, since it is not expeditious to pay with several zeroes before the dot that places the respective decimals.

As it has been said, monetary history finally preferred gold and silver. It cannot anticipate what the currency of the future will be, nor is it necessary to do so. We do not know if it will be a basket of currencies, if it will be this or that commodity or if it will be digital (despite the controversy of the latter due to its incompatibility with the monetary regression theorem). What we can anticipate is that the elimination of central banking will allow choices that tend to protect savings and that systematic looting will not take place.

Let’s keep in mind that the tendency to index as a measure that supposedly corrects the evils of inflation is not relevant because it raises prices uniformly according to an index as if prices were affected in the same way, which causes them to be located at higher levels in absolute values even though the distortion naturally remains.

It has been frequently prescribed to issue at a constant rate according to the growth of the economy “so that operators know what to expect and that the expansion gets based on the rate revealed by the gross domestic product”. This assessment is wrong for two reasons. First, traders will not know where they stand because, as we have reiterated, prices do not move at the same rate. Secondly, if the expansion is based on the output indicator, this will, for example, cause export growth to cancel out because of the decline in prices due to higher growth, imports to contract, and a series of other changes that will not happen because the expansion has cancelled them out.

This last recipe was applied with the Genoa and Brussels Agreements of the 1920’s, which decided de facto to replace the gold standard with an entelechy called “gold exchange standard” which meant replacing the gold metal with the dollar and the pound (this last monetary sign was later eliminated) which allowed the United States to expand its currency (also with erratic contractions), a reserve for other countries that also expanded their respective monetary signs, which led to the crisis of ’29 that was prolonged due to the policies of F. D. Roosevelt that were reluctantly cancelled by Truman, which allowed the correction of deviations in the real economy such as the liberation of prices and the hindrances in the labor market that led to unemployment while the capitalization rate fell.

In 1971, Nixon gave the final blow to monetary discipline by imposing what he called “the most important agreement in history”, which consisted of eliminating de jure gold from the monetary scheme and establishing fixed exchange rates that lasted until the resounding run of 1973, when this last policy, which severely restricted international trade, had to be abandoned.

This article is not the opportunity to deal with another debate that has been dragging on for a century and promises to do the same: the banking system. What can be concluded is that the fractional system will disappear as manifestly harmful, to be replaced by the total reserve or so-called free banking, with which the secondary production of money of exogenous origin will be without effect and the banks, finance companies, and equivalents will have to face all the responsibility of their management in relation to their clients without the embarrassing support of central bankers and the consequent absurd regulations.

To close this text we underline that in the traditional economic literature “convertibility” means an exchange between a commodity and a recipient called a bank bill but does not refer to the exchange of a paper of one color for another paper of another color, in any case, the latter – when a monetary sign is anchored in terms of another- is a fixed exchange rate with a passive monetary policy. In a free market, in monetary matters, there is a free exchange rate without such a thing as monetary policy (as opposed to what has been happening in most cases where a controlled exchange rate with active monetary policy prevails).

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