Inflation: It’s a Wealth Redistribution Scheme
Many central banks around the world aim to achieve some “inflation target” either as a single explicit policy goal — as in the case of the South African Reserve Bank — or part of a set of policy goals as pursued by the US Federal Reserve. But far from maintaining economic stability and fostering prosperity, consumer price inflation targeting practically guarantees a pernicious wealth transfer year in and year out, a perpetual duping of unsuspecting employees and companies, and a permanent blind spot to hidden inflation.
What Is Inflation?
Most economists define inflation as what happens when the prices of things like bread and haircuts and rent go up in money terms and consumers generally experience an overall loss of purchasing power of their money. This is known as consumer price inflation represented by the consumer price index or CPI. This definition of inflation is reasonable at describing the outcome of a larger general process, but it unhelpfully leaves more gaps than it fills. By looking at broad averages it doesn’t tell us if everyone or only some are getting poorer. It also fails to see hidden price inflation. Hidden price inflation occurs when prices remain roughly stable when they would have fallen as a result of technological progress and greater productivity. Finally, this definition of inflation doesn’t really tell us why prices are generally rising. Is it from printing more money or a loss of confidence in the currency or a large drop in production, say, during a war?
A further problem arises in measurement. The “official” CPI inflation rate is determined by measuring prices of thousands of consumer goods and services. While CPI is an important economic statistic, a myopic focus on it risks blindness to other important areas where price inflation might manifest, such as in real estate, stock markets, or foreign currency. CPI is also a broad average which doesn’t tell us whether a narrow or broad range of prices are rising.
The Monetary Cause of Inflation
These problems in definition and measurement can partly be resolved by defining inflation as an inflation or expansion of the money supply rather than as a general loss of consumer purchasing power. For one, it is easier to measure money supply in a system of national currency overseen by a central bank (though that's not without its challenges). Furthermore, being the primary cause of general and persistent price inflation, measuring the money supply offers a more fundamental perspective on the overall inflation phenomenon. For example, focus on money supply can diminish our blind spot to hidden inflation. If prices should have fallen say 10 percent due to technological progress, but instead remain flat due to say a countervailing 15 percent expansion of the money supply, we are still able to spot inflation despite prices not rising.
Looking at the money supply can also point us to an important aspect of inflation: where the new money enters the economy. In the modern monetary system, new money enters the economy as debt through the banking and financial system and goes first to the already wealthy and creditworthy borrowers — wealthy households, large businesses, and the government. This class of people get to invest the money first before it has filtered through the entire system and raised prices. A very significant wealth transfer takes place from late-to-early receivers of new money. This is sometimes referred to as the Cantillon Effect.
Inflation as a Process of Wealth Transfer
It is better to think of inflation as a process rather than a particular rate. The process starts with a particular type of monetary system, emerges in an expansion of the money supply by central bank printing and bank loans flowing into various areas of the economy, manifests itself in prices rising generally — though unevenly — higher than they otherwise would have been, finally leaving a wake of winners and losers.
This approach allows us to see inflation as not some inevitable force, but a deliberate process of wealth transfer enshrined in state policy.
How is wealth transferred by inflation? Money represents purchasing power. Creating money out of thin air, which is what central banks and commercial banks are licensed to do, confers purchasing power on those who are able to use the money first. For this new money to obtain purchasing power, it must rob little bits of purchasing power from all the other money in the economy. Purchasing power is transferred from those who hold money to those who create new money at close to zero marginal cost.
This explains how and why wealthy, creditworthy asset owners get richer while many poor people tend to resort to overconsumption and ultimately get poorer. Economist John Maynard Keynes, ironically a proponent of inflationary policies, famously noted that “by a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
Inflation as Trickery
Yet, mainstream economists believe that some degree of rising prices is “optimal.” Thus, central banks actually try to ensure consumer prices keep going up. But their reasons for this chiefly revolve around the trickery of inflation on unsuspecting people. For example, many inflation proponents argue that the best way to lower people’s wages to restore company profits is not to actually give them a pay cut, but to rather create inflation so they won’t fully notice their real wages falling.
These economists also favor tricking companies into thinking prices of their products are rising due to higher demand, when in fact it may be due to monetary inflation and therefore a misleading, temporary boost. Companies invest in new capacity only to have it made redundant when all prices rise and they realize demand for their product had not really increased. What follows the initial boom in hiring and production is layoffs and liquidations. In other words, support for inflation tends to revolve around short term, narrow considerations. But, as Henry Hazlitt has taught us, economic policies must be judged by their effect over the longer term and for society as a whole. On this basis, the process of inflation is pernicious.
Solving the Problem
Inflation can and should be abolished to rid ourselves of insidious and unjust wealth confiscation. Society can move toward this goal by the following means:
- Adopting a broader perspective on price inflation than just CPI to include producer prices, asset prices like stocks and houses, and even foreign exchange prices. This will allow the public to better identify the inflationary process.
- Recognizing central banks and commercial banks as the source of inflation and including changes in the money supply (appropriately measured) as a key measure of inflation. This will start to place emphasis on understanding who are the winners and losers of the inflationary process.
- Reforming the financial system to end special money creation privileges, abolishing legal tender laws that drive people toward using manipulated currencies, and allowing any private entity to issue currency in competitive markets.
Only in this holistic way can societies begin to address the gnawing pestilence of inflation foisted upon them perennially by the financial and political elites.
Russell Lamberti is co-founder of the Mises Institute South Africa and Chief Strategist at investment advisory firm ETM Analytics. He is co-author of When Money Destroys Nations. He lives in Johannesburg, South Africa. Contact: email; Twitter