It's important to understand that inflation is not rising prices. It's so important that I'll say it again: inflation is not rising prices. In the normal course of events, prices rise and fall according to supply and demand, and it is important for the smooth functioning of the economy that these price signals are left unmolested.
Rising prices right across the board however are more accurately the symptom of inflation. Inflation itself is the injection of currency or credit into an economy by government, ahead of productivity and production. It is the inflation of the money supply. On the back of this injection of paper into the purchase of production, producers charge higher prices for their products in response to the extra “demand,” other producers raise their prices to compensate, the labour force seeks to do likewise, and the spiral has begun. Those who raise their prices at the beginning of the spiral come out ahead (as do those who get first use of each new tranche of paper), but when the spiral is really underway one raises prices simply to keep up, and those on fixed incomes are left behind.
In that it is deliberately reducing the purchasing power of money by this means to cover its own profligacy, governments that inflate the currency are engaging in hidden taxation. In a recent 'Free Radical,' Larry Sechrest draws the obvious conclusion from all the evidence :
Mark this well. Central banks are the source of both inflation and business cycles. Tragically, many people seem to believe that both inflation and boom-bust cycles are somehow an intrinsic part of a market economy. They thus turn to the central bank to solve the problems that the central bank itself created. I might add that the very existence of a central bank introduces into all markets pervasive “regulatory risk” that would not otherwise exist. That is, market participants expend real resources in an attempt to forecast---and then cope with---the manipulations of money, credit, prices, and interest rates undertaken by the central bank. It all sounds frighteningly familiar.This is a tax that can only be applied once governments gain control of the banking system, and in particular of the money supply. In the normal course of events, with banks free to produce their own banknotes based on some recognised store of value (often either gold or silver), it is neither possible nor advantageous for the currency to be inflated, and prices are able to rise and fall at the behest of supply and demand. It is only once governments wrest control of currency supply that the motivation exists to indulge in this insidious form of hidden taxation.
It is a temptation few governments are able to resist.
The most famous historic example of an unchecked inflationary spiral and of its dreadful consequences was post-WW1 Germany. Between 1914 and 1923, the money supply increased several millionfold; prices rose even more. It was said that at the beginning of this period one might have taken money in one’s wallet to buy goods to take home in the shopping basket; by the end of it, one took money in one’s shopping basket to buy goods to take home in one’s wallet!
In New Zealand inflation was triggered by the deficit spending embarked upon by the Kirk/Rowling and Muldoon governments, and with the introduction of the Reserve Bank Act in 1989 and the explicit pursuit of price stability since then, it is often thought that it has been tamed. This is an erroneous conclusion, since in order to hold the prices of a nominal "basket of goods" stable, the local currency has been inflated by between ten and twenty percent annually, leading to serious problems with the exchange rate, and problems for producers, exporters, home-owners and prosperity overall, and the rampant rise of malinvestment.
The fact is, that in pursuing this illusion of price stability while ignoring (and in fact exacerbating real inflation), our wealth is still being stolen, destructive illusions come to be peddled as common wisdom (the nonsensical idea for example that "too fast growth" is bad, and tax cuts will be destructive) and we are being set up for some serious future problems as the whole price system unravels. MA Abrams explains:
"In an economically progressive community (that is, one where the real costs of production per unit are falling and output per head is increasing), any additions to the supply of money in order to prevent falling prices will be hidden inflation; and in a retrogressive community, (that is, one where output per head is diminishing and real costs of production are rising), any contraction of the supply of money in order to prevent rising prices will be hidden deflation. Inflation and deflation can occur just as well behind a stable price level as when the price level is rising and falling..."It is essential that a separation of state and money supply be effected, one as effective as the historic separation of church and state. It is most likely that in a free money/free banking scenario, citizens will repair to a currency whose everyday form will be backed by and redeemable in some other less perishable commodity (such as gold), whose existence will act as a discipline on the amount of the everyday form in circulation, and will undergird a genuine prosperity.
This is part of a continuing series explaining the concepts and terms used by NZ libertarians, originally published in The Free Radical in 1993. The 'Introduction' to the series is here. The series itself is accumulating down on the right-hand sidebar, and in the archives here and here.