Inflation: In-Depth
Now that the basic concept of inflation is understood, we can begin to examine its truly nefarious effects. As stated in the previous section, inflation is the means by which wealth is transferred from the poor and middle class to the wealthiest among us. How does this happen?
The Declining Purchasing Power of the Dollar
Crouching Dollar, Hidden Printing Press
Congratulations! In this scenario, you are the recipient of an amazing device which will profoundly change your life forever: your very own printing press. This machine will spit out as many paper dollars as you like, completely indistinguishable from those that come from the US Mint. What’s more, you get to use this device with total immunity from counterfeiting laws. Sound good or what?!
What would you spend this new money on first? How about a new car? You go down to a dealership, and plop down $25,000 cold on a new vehicle of your choice, then roll off the lot in your new wheels. Everything seems pretty great. And everything is great–for you. But what about all the rest of us, who don’t have printing presses of our own?
The newly created money that you spent on the car has gone out into the system, inflating the total money supply. And as we discussed in the previous section, when the money supply increases, prices must inevitably rise, in order to compensate for all those extra new dollars floating around.
You get home and park your new pride and joy in your driveway, where your neighbor enviously eyes it up and down. It just so happens that he has been saving to buy the exact same car. As bad as he wants it, he knows he still needs to save for 6 more months before he can buy his very own.
Six months passes and your neighbor has met his savings goal, and rushes off to the dealership to buy his very own dream car. As it happens, there is an identical car in the showroom–well, nearly identical. It has the same paint job, the same tires, the same engine and transmission, all identical except for one thing: the price. The car dealer is now offering the car for $26,000. Demand for the car has not spiked–it’s actually even somewhat diminished, as some people are starting to wait until the new year’s model comes out before they buy. Why has the price of an identical car risen, even though there has been no appreciable change in supply and demand? You guessed it. It is you and your printing press hijinks that have brought inflation down upon everyone else.
For in the mean time you have gone on to buy the same car as a gift to a friend. You easily print up $26,000 and buy the vehicle. What do you care if the price has gone up or not? You’ll wind up with the car in any case. But for your neighbor or anyone else that goes to buy another car, by that time the same car will probably cost $27,000.
The lesson here ought to be clear: even though inflation acts as a hidden tax on us all by draining the purchasing power of our currency, the effects of inflation are NOT felt equally. If you are one who gets to spend the newly created money first, you get the benefit of buying things at their pre-inflated prices. But those who have to wait to make their purchases until after the inflation has set in are disproportionately hurt by the increase of prices. Identical goods cost more than they did before all that freshly-printed money was injected into the system.
Inflation: Real-Life Winners and Losers
Now that we know that those who get to spend the new money first are the beneficiaries of an inflationary system, let’s look at who the real-life winners and losers are.
Winners:
- Banks: Banks make money by lending out money at interest. The more dollars there are in the system, the more vehicles that exist through which they can make loans and charge interest (*Note: The Federal Reserve Bank is in a class by itself here, as it is the real-life entity that controls the printing press, but more will be devoted to the Fed and the fractional reserve banking system in their own respective sections).
- Investors (including investment banks): Those who borrow money cheaply and use it to make investments which provide a much higher return than their interest payments get a great boon through inflation.
- Long-term, fixed-rate debtors: Anyone who is able to pay off their debts over a long period of time, with a fixed interest rate, will feel the benefit of inflation, as the regular amount owed can slowly be paid off with cheaper and cheaper money.
- The US government: The most prodigious long-term debtor in world history. Much has been discussed recently regarding the debt limit, but the simple truth is that the US will never FORMALLY default on its debt obligations, as long as it can pay off its debts with the consistently depreciating currency that an inflationary monetary policy can provide.
Losers:
- Savers: Those who try to provide for a better future by saving for it will have a very difficult time indeed. Even if their money can earn 1% interest in the bank (which is high by today’s standards), they will have a nearly impossible time improving their quality of life. With inflation even at a modest 3%, that means the real interest rate they are receiving on their dollars is -2%.
- Workers and retirees on fixed-incomes: Those who get the same amount of income, month in and month out, while prices consistently rise see their purchasing power reduced, leading directly to a diminished quality of life.
- Long-term, fixed-rate creditors: Anyone who holds long term US savings bonds or other long-term, fixed-rate debt obligations will see the amount being paid to them reduced in purchasing power as inflation increases over time.
Recap
Inflation is a hidden tax on everyone in a given monetary system, but the reality is the effects of inflation are not shared equally. Those who get to put the new money to work for them first wind up as the winners in an inflationary system. Savers, workers and retirees on fixed incomes are the losers. The winners who can access the new money first will use it over time to buy up all the assets in the system for themselves, leaving the losers broke and destitute. This is the insidious way in which inflation is the means by which wealth is transferred from the poor and middle class to the wealthiest among us.
The following quotation is attributed to Thomas Jefferson, who understood all too well the ravages of inflation due to the Colonies’ experiences with it during the Revolution.
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
In the section that follows, you’ll be able to utilize the resources included therein to take a very personal look at the destructive effects of inflation upon your own economic well being.
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