There is almost complete unanimity among economists and various commentators that inflation is about general increases in the prices of goods and services. From this it is concluded that anything that contributes to price increases constitutes inflation. However, inflation is not a general increase in prices but embezzlement through artificial increases in money supply.
In an unhampered market economy, with a market-selected money such as gold, a producer of goods exchanges his production for money and then employs the money to make further exchanges for the goods of other producers. Production is exchanged for production by means of money.
In the present monetary system however, an inflationary increase in money supply produces an exchange of nothing for something. Money is generated out of “thin air” and exchanged for produced goods or services. Thereby producers are defrauded. Goods are channeled from wealth-producers to non-wealth-producers. Alternatively, inflation of money supply facilitates consumption without preceding production—a counterfeiter effect.
The Counterfeiter Effect and Monetary Growth
Consider the case of a counterfeiter who generates fake money that masquerades as real money. The counterfeiter uses the forged money to fraudulently exchange it for goods and services. The forger has produced nothing useful (except to him), but exchange of fake money for goods facilitates an exchange of nothing for something.
Whenever the central bank—through its expansionary monetary policy—enables an increase in the money supply, this has the same principle effects at the counterfeiter, but on a much larger scale. Expansionary monetary policy provides the base for the counterfeiter effect. The early receivers of the newly-inflated money and credit are in a similar position as the counterfeiter. The early receivers of money become wealthier since they now have more money than before the increase in money took place.
The early receivers can now acquire a greater amount of goods while the prices of goods remain unchanged. The later receivers and the non-receivers of the inflated money and credit endure the burden of price increases, monetary devaluation, distortions in the price and production structure, boom-bust cycles, and a decline in their living standards. According to Rothbard,
And inflation is, in effect, a race—to see who can get the new money earliest. The latecomer—the ones stuck with the loss—are often called the “fixed-income groups.” Ministers, teachers, people on salaries, lag notoriously behind other groups in acquiring the new money.
Does Every Increase in Money Supply Lead to Embezzlement?
When money is gold or another market-chosen commodity, and there is an increase in the supply of money as a result of an increase in the quantity of gold in the economy (through production and/or exchange), this is not an act of embezzlement (i.e., the counterfeiter effect). When money is gold, it must be produced and exchanged on the market (unlike paper or digital entries). As Cantillon demonstrated, prices will change unevenly throughout the economy, but that is not the same as artificial expansion of money and credit.
Furthermore, we can also infer that an increase in the supply of gold will not cause a boom-bust cycle. This is not so in the present monetary system where inflationary increases in the money supply undermine wealth-generators and benefits non-wealth-generating activities. These activities are also called bubbles.
History of Embezzlement by Means of Money
Historically, the act of embezzlement via tampering with money can be traced to when kings would force his citizens to give them their gold coins under the pretext that a new gold coin would replace the old one. In the process, the kings would falsify the content of the gold coins, mixing it with some other metal and return the diluted gold coins to the citizens. This would allow them to expropriate the purchasing power of of the money to themselves as a source of revenue.
Because of the dilution of the gold, a king could now mint a greater number of coins and pocket the rest for himself. What now passed as a pure gold coin was, in fact, a diluted gold coin. According to Rothbard,
More characteristically, the mint melted and recoined all the coins of the realm, giving the subjects back the same number of “pounds” or “marks,” but of a lighter weight. The leftover ounces of gold or silver were pocketed by the king and used to pay his expenses.
Because of the increase in the quantity of coins that masquerade as pure gold coins, prices in terms of coins increase (more coins are being exchanged for the same goods). What we have here is an inflation of coins (i.e., an expansion of coins), which is only partially backed by gold. As a result of the inflation of coins, the king can also engage in an exchange of nothing for something, but at a much larger scale than the individual counterfeiter.
In the modern world, money is no longer gold but coins, notes, and digital entries, which are much easier to inflate. As Austrians, we do not say, as the monetarists maintain, that the increase in the money supply causes inflation, but rather than the artificial increase of the money supply is inflation. In fact, this has always been the historical definition of the word.
Money and Prices
It is extraordinary that, in attempting to explain movements in prices, various commentators have nothing to say about the role of money in forming the prices. After all, monetary price is the amount of money for which goods will be exchanged. Once new money enters a particular market, it alters decisions and behavior. Demand often increases for existing goods which leads to price increases.
When money is injected it enters a particular market, it has an uneven effect on prices and production. These price increases also beget other changes in the price and production structure, moving into other markets. The shift of money from one market to another is not instantaneous; there is a time lag from increases in money and its effect on the average price increases. This heightens the unequal effect that inflation has on different members within an economy.
Conclusion
Inflation is not about general price increases but about increases in the money supply. A general increase in prices, as a rule, emerges from inflationary increases in the money supply. Such artificial increases in money supply weaken the wealth-generation process, not price increases, which are a result of inflation. Policies that are aimed at countering inflation without identifying what it is only make things much worse.
When inflation is understood as a general increase in prices, then anything that contributes to price increases is called inflationary. It is no longer the central bank and the fractional-reserve banking that are the sources of inflation, but rather various other causes. Ironically, central banks are not known for causing inflation and economic instability, but as inflation fighters who provide structural stability. Mises wrote,
To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call “inflation” the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase.
They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying “catch the thief.” The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices.
