Inflation is another word that has become completely confused in everyday conversation. Inflation used to mean an undue expansion of the money supply. By undue, one would refer to an increase in the money supply over the supply of gold. Today, on the other hand, our parents refer to a general increase in consumer prices when they speak of inflation. In reality, it is simply an increase in an arbitrary compiled index. The change of the very meaning of the word inflation is of immense importance, because the conclusions and policy implications that will be resorted to under the two different definitions can be diametrically opposites.
If inflation is defined as an undue expansion of the money supply, then it is easy to know when the banking system inflates. By comparing outstanding money notes with gold in reserves one can immediately determine if there has been inflation or not. Under the second definition things becomes far more obscure because there will be a considerable lag between the change in the money supply and its effects on prices. Inflation with our parent’s definition does not occur before the retailer changes his prices announced to his customer. In other words, the causal connection between inflation and money expansion appears broken, and replaced by a new causality between the whims of a store clerk and his idea of what prices should be. Please observe; the reason and hence blame for increasing prices can no longer be put on the government, but the evil capitalist. For whom, other than the capitalist, does the actual act of increasing prices?
With our parent’s definition of inflation also follows a depraved definition of deflation. Nowadays deflation is defined as falling consumer prices. Deflation through modern history has often been highly correlated with economic depressions, and today’s economists believe falling prices causes depressions. Think about that for a minute. Can falling prices actually be the reason for lower economic activity? Say we were on strict commodity based money standard with outstanding notes 100 per cent backed by said commodity. In this world, we could reasonably assume economic output of consumer goods to exceed output of commodity money. In that case consumer goods prices will most surely fall. However, there is no depression in this economic constellation as prosperity increases through higher purchasing power for everyone. The policy response when equating falling prices with hardship and poverty would be to damage this healthy development through inflating the money supply. Such is the world created by our parents, where good is bad and bad is good. No wonder we tend to be confused.
Still, the most important reason they decided to change the definition is even more opportunistic. In order to maintain a 100-year trend toward fiat money it was necessary to change the definition of inflation. Before WWI most western countries were on some sort of gold standard, which worked relatively well. Prices were falling in the 1870s and 80s but prosperity rose all over. With the end of WWI the global economy adopted a gold-exchange standard, which in reality was a pound/dollar standard controlled by the Anglo-Saxons in London and New York. After WWII New York managed to push the Brits out and were able to run the global monetary system solely to their own advantage. However, there were still an official link between gold and dollar so foreign central banks could in theory keep the dollar inflation in check. That said, as soon as the French tried to exchange dollars for physical gold the dollar exchange standard collapsed. Since 1971 we have been on a pure fiat standard.
Up until 1971 policymakers had constantly reduced the original intent of a gold standard as proposed by David Hume through meddling with the automatic price specie flow. For every action follows a reaction. But the reactions were often painful to bear, so instead of dealing with the pain head on, previous generations rather turned the going monetary system into a watered down monstrous Frankenstein of it old self. After 1971 the obvious question of what to replace the pure fiat with arose. There was no natural next step when the bust came and global central banks were forced to hike interest rates to unprecedented levels in the early 1980s. This was too much to bear, so instead of accepting reality one defined the problem away: First in the 1960s by getting rid of the old definition of inflation, and then in the 1980s and 90s by changing the definition of the consumer price index itself. The reason consumer prices fell so steadily during the “Great Moderation” was much more due to changes in the index than to competent monetary policy makers. Today we hear once again about the wonders a new consumer price index will have; it will cut future state liabilities through lower pension payments, it will reduce growth in wage indexations and hopefully clear the labour market and so on.
Under a pure fiat standard one has to resort to measures like changing the consumer price index in order to justify increasingly higher monetary inflation to keep a rotten system going.
And this is exactly what our parents have been doing. They have had to increase money inflation at an exponentially rate to maintain their ever increasing debt levels. This of course consumes and misallocates capital and reduces future productivity. When deflation comes, which it inevitably will, the end game is near. Then our parents panic and starts to print money like never before in a desperate hope to push the problems over to our generation!
One of the most visible effects of this policy was the dramatic shift in house prices. Our parents bought their houses in the 1960 and 1970s just when monetary inflation started in earnest. Now, that we have moved out, our parents will move into smaller apartments while we have to buy their houses with inflated prices, which amounts to nothing less than a gigantic wealth transfer! No generation through history has ever taken more out of society without going through some sort of social revolution.