Good and Bad InflationInflation has and will always be a monetary phenomenon. This is to say that inflation is the direct consequence of government policies. Spending more than it takes in, governments often resort to policies of inflating the currency. What a government can’t politically extract in the form of taxes it extracts through inflating the money supply. This, in effect, is another form of taxation. The government is taking what is not lawfully its own by expanding the supply of dollars in the economy. Unlike citizens who have to work for wages or investors who earn returns from their investments, the government contributes nothing for the dollars it creates. It is simply adding dollars to its account through fiat means, which depreciates the value of the national currency.
The consequences of these actions are that the value of the currency declines and in this case, the value of the U.S. dollar. When a government or central bank creates additional money through fiat means, it creates inflation.
The real definition of inflation is an increase in the supply of money beyond any increase in specie. 1 By its very definition, it attributes the real cause of inflation to its root source which is expansion of the supply of money and credit through artificial means. Its real cause is an act of fraudulent intervention into the financial and economic system distorting values, investments, and in the process, the distribution pattern of wealth and income within the economy.
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Prices are rising, but why?By focusing more on the symptoms of inflation (rising prices) rather than its root cause (expanding money supply and credit) shifts attention away from government. Government decisions or central bank decisions to expand the supply of money and credit is what causes inflation in the first place. The fact that prices are rising is simply the way that expanding money and credit surfaces in the economy.
By creating more money and credit than can be produced or gained from productive resources or through savings, the government has interjected an artificial source of demand in the economy. There is now more money and credit floating around the economic system than there is the capacity to produce goods or services. Since the additional money did not result from producing additional goods or increased savings, its source is artificial. The additional dollars created through fiat means creates additional demand in the economy beyond its ability to produce, so the prices of goods or services rise as a result.
And Bubbles EverywhereAs repeatedly annunciated through press releases following FOMC meetings and Fed research papers, the Fed was concerned over the possibility of asset deflation or the bursting of bubbles it had artificially created through its own polices. Money supply growth expanded at double-digit rates as the Fed expanded liquidity in the financial system in an effort to keep asset prices from deflating.
We now had multiple bubbles taking place in not only bonds, mortgages, and real estate, but another mini-bubble was developing again in the stock market as the price of profitable and unprofitable companies rose sharply. In the most recent rally it was the shares of unprofitable companies with balance sheet problems that rose the sharpest. Rather than looking at the various asset bubbles and their cause, attention was directed at the rise in asset prices. The inflation that was occurring in real estate was viewed more in terms of a bull market than its inflationary cause. This once again stems from the distorted definition of inflation as rising prices without examining its cause. This definition doesn’t apply to assets. Rising asset prices are always viewed as favorable regardless of their cause. In this case rising real estate prices, rising debt levels as a result of refinancing, and above-normal consumption financed through debt was viewed favorably as a sign of economic recovery rather than the distortion created through excess money and credit.
When John Q Wakes Up