The Theodore Newsletter

September 1, 2022

Inflation! You have been hearing a lot about it since President Biden took office. Here is my take on this controversial issue.

Let’s start with what Webster has to say on inflation: “increase in the amount of money in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices.” The opposite is deflation, which is defined as “a lessening of the amount of money in circulation resulting in a relatively sharp and sudden rise in its value and fall in prices.” Thus, inflation and deflation are terms used to describe a decline or an increase, respectively, in the value of money and in relation to the goods and services it will buy.

Since inflation is the continuous rise in prices in goods and services, these price increases erode the purchasing power of money and other financial assets with fixed values, creating serious economic concerns. Repeated price increases were historically unique and often directly linked to wars, poor harvests, political upheavals, etc.

Effects? Inflation initially increases  business profits, as wages and other costs lag behind price increases, leading to more capital investment and payments of dividends and interest. Despite this temporary gain, however, inflation eventually disrupts normal economic activities, particularly if the pace fluctuates. Interest rates typically include the anticipated pace of inflation that increases business costs, discourages consumer spending, and depresses the value of stocks and bonds Higher mortgage interest rates and rapidly escalating prices for homes discourage housing construction. As noted above, inflation also erodes the real purchasing power of current incomes and accumulated financial assets, resulting in reduced consumption, particularly if consumers are unwilling to draw on their savings and increase personal debts. Business investment suffers as overall economic activity declines, and profits are restricted as employees will demand immediate relief through some form of automatic cost-of-living escalator clauses. It is fair to say that inflation is a major element in the prevailing pattern of booms and recessions that cause unwanted price and employment distortions and widespread economic uncertainty.

Impact? The impact of inflation on individuals depends on many variables. People with relatively fixed incomes, particularly those in the low-income groups, suffer during accelerating inflation, while those with flexible bargaining power may keep pace with or even benefit from inflation. Those dependent on assets with fixed nominal values, such as savings accounts and pensions, suffer erosion of real wealth. Borrowers usually benefit while lenders suffer, because all forms of loans are paid with money that loses purchasing power over time and interest rates tend to lag behind the average rate of price increases.

Stabilization measures? I have no answer since I am not an economist. However, it seems to me that any serious anti-inflation effort will be difficult.

I close with these thoughts:

1. Politicians like to spend money because it gets them votes and power. They spend more than what is raised by taxes so they have to seek money elsewhere. They turn to printing money and / or borrowing money. Money is borrowed from government trust funds such as Social Security and Medicare and from the open market via Treasury Bonds. This assumes that the government can always borrow money without consequences. It also assumes that interest payments can also be borrowed. Elected officials know they must be right because this scheme has worked out pretty well since 1964 with the start of the Great Society and the War on Poverty. But now,  it appears that a day of reckoning may be fast approaching.
2. The question of money always arises in inflation discussions. A nation can only create money of value when there are businesses creating useful goods at a profit. With these conditions, it is then a function of government to print money to facilitate commerce. As businesses prosper and trade increases, then governments, of necessity, print more money, However, if government prints money faster than the increase in business activity, then excess money will begin to chase the supply of goods available and prices will rise. Enter inflation.
3. Our nation is blessed with an economic system which is very productive and efficient. It is able to take materials of low cost and make them into very valuable products. (The productivity of workers today is orders of magnitude higher than in those days of handcrafting.) As a result, workers are paid salaries that allow them to save money. These savings are a result of goods that have been made. If businesses borrow savings, it is usually to create more production and more money of value, and that is good. However, government spending rarely creates useful goods at a profit which would result in new money creation. In fact, the opposite happens. Most government spending destroys the value of money since government spending can result in the earlier statement of too much money chasing after a limited supply of goods. Once again, enter inflation.
4. Treasury debt now exceeds 30 billion dollars and is still rising rapidly. Ouch!!

Note: Thanks are due to fellow Cooperite, colleague and friend Dick Graven for providing some of his thoughts on this controversial topic.

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