How Does a Fiat Money System Transfer Wealth from the Poor to Rich?

A colleague of mine asked this question.  Specifically he asked "doesn't inflation equally devalue $1,000 and $1,000,000?  So how does inflation transfer value to the rich?"  Could someone help me understand this or point me to some reading materials to figure this out.  I'm relatively new to Austrian Economics.  Thanks. 

The reason is easy, inflation does not affect all goods in the same way. Oil and gold are increasing in price faster than computers and realestate. The poor typically purchase more petroleum as a percentage of their income than rich people do. Furthermore, the crash in realestate where poor people have significantly more of their assets in has really made the pain felt by the poor more substantial. Also there are hidden costs of mortage late fees, defaults and bankruptcies that affect the poor worse than the rich. Finally, the government hates poor people and excludes the two most volitile products purchased by the poor in much higher percentages of their incomes: energy and food. So the government sez that there is a 2.5% annual rate of increases in general prices but they failed to include the 40%increase in petroleum and 60% increase in food prices.

Would it be appropriate to say, then, that inflation does not so much transfer wealth, as it disproportionately affects the poor?

The answer to your question is that increases in money circulation is a non-netural event.
To illustrate a netrual event is if an Angel (as in David Hume's famous illustration) came down and increased the money in everyones pockets by the same multiple, the prices of all goods should (if cosumer preference doesn't change) go up by the same multiple. What is netrual about it is that no one is potentially gaining at the expense of another.
Yet, we don't live in a world where Angels' are giving out money. In fact, money is printed by the central bank and sold to government debt holders. These are the people who get the money before everyone else. They, in turn, have the advantage of being able to spend it (driving up prices of the goods that they prefer). For instance it affects old age pension holders - who are on a fixed income.
I don't know if it necessarily adversely effects all of the poor - but tends to weigh on the poorest of citizens in the greatest way.

That's very helpful, thank you.  Another question: I thought that the Federal Reserve printed money when the government borrowed it and in exchange the Fed received government debt securities.  Are you saying that the government sells debt to others (e.g. international bankers) and then the Fed prints money on behalf of those who bought the debt? 

reidbump:

  Specifically he asked "doesn't inflation equally devalue $1,000 and $1,000,000?  

 

Its not the devaluation of currency already existent that causes the redistribution, its the new money itself. The new money does not enter the economy at every point at one once. It enters the economy unevenly, so  prices rise unevenly. That is how we get tech bubbles and housing bubbles.

That the Fed is committing theft by printing money should be obvious enough at face value. If a counterfeiter is criminal, why isn't the Fed?

But explaining how the Fed's easy credit, achievable only through the expansion of the money supply, redistributes wealth is easy enough.

If the Fed prints the dollars to double the money supply do prices change? No, inflation will not happen until the fed SPENDS that money and puts into circulation.  The first time those dollars are spent they are accepted at full value, because they are not yet in the economy so have not effected price levels. The banks spend pre-inflation dollars but its through that transaction that those dollars enter the economy and begins to influence price levels so the recipient receives a post-inflation dollar. This is how people high on the food chain(Banks and financial institutions et al.) spend dollars worth more than people lower on the food chain(the rest of us)

Another example is mortgages. Why do houses cost so much? Because people are willing to pay so much, obviously. But how are people able to pay so much? They borrow. If credit became harder to get(if there wasn't a central bank printing money eg) prices for homes would fall. But what effect would it have? People who own homes would have to sell their houses for less, but it wouldn't matter because their next house would similarly cost less. If a person did get a (sound) loan to buy a house it would be for a much lower amount, meaning a much lower mortgage. By expanding the money supply the Fed has driven up the costs of homes, thus the cost of mortgages.

Fractional reserve banks are rent seekers. They lend out newly printed dollars that do not represent real savings, but receive in return dollars that represent real wealth, people's labor. Fractional reserve banking does not only add money into the economy, it extracts real wealth out of it.

 

 

reidbump:

I thought that the Federal Reserve printed money when the government borrowed it and in exchange the Fed received government debt securities.  Are you saying that the government sells debt to others (e.g. international bankers) and then the Fed prints money on behalf of those who bought the debt? 

The Fed (used to) exclusively buy government debt to increase the money supply and regulate interest rates. They would either buy T-bills directly from the government (monetizing debt) or buy them off the market from a select group of banks (open market operations). 

Its a crazy complicated system and I'm not really clear on the intricate details but that's the basics. Either way creates new money out of thin air or from their stock of magic beans depending on who you ask.

Oh, and I say 'used to' because now they'll take any scrap of worthless paper as collateral if it serves to either bail out the banks or prop up the stock market through their involvement in the Plunge Protection Team.

 The simplest answer is this: New money being lent to banks first benefits the banks, then the companies that borrow from the banks (including the shareholders of those companies). If you don't own stock, if you are on a fixed income, if your salary raises only come once a year, then you are one of the last to get the new money, and whenever it comes, prices have already been higher for a while.

An increase in the supply of money means a decrease of scarcity of the existing supply. The people who most rely on money assets for their wealth, assets such as savings accounts and social security, tend to be poor. Rich people invest in higher risk assets which are inflation-proof.

 

As the other user notes, both are true (although I have never heard of the Plunge Protection Team). The Fed can effectively buy securities from those who hold them (which are the sort of inflationary scenario I was alluding to) or they can buy them direct from the treasury. Now, in the second case it may appear that my contention does not hold - but realize that this printing of money is being SPENT in the economy at the time it is borrowed (otherwise the government wouldn’t be issuing debt). Therefore, it would be the CONTRACTORS of government who are the first purveyors of money rather than the investment bankers. The inflation first appears where the preferences of those who get the money first are highest. Then there is a continuing ripple effect throughout the economy as each individual exercise their preference and they are factored in. As we can see – those who have the money first and spend it WIN out on the relative price break.

There are two parts:

1) debasement - this effects savings.  who is most likely to have their complete savings in dollar denominated assets, such as bank accounts or cash?  the poor.  thus, the money creation process's debasement of its value is paid regressively.  if money is created for the government to spend, we'd call it a tax - this is a clear transfer of wealth.  Furthermore, interest on the government debt issued is paid by the tax-payers.  In this manner, both the poor and middle class are heavily taxed.  of course, the FED and its member banks win too, in that every new dollar the government spends, the FED can issue about 9 times as much credit.  Even though their outstanding loans are debased, the interest on their new loans more than makes up for this.

2) privilege - if anyone could create money, we'd find chaos, with a barter system between a bunch of crappy "currencies".  but if only one group can do it, they are privileged.  this is the who gets the money first argument, as monetary inflation can always "stay ahead" of price inflation, until hyperinflation disallows the currency from being used as money.