Friday, May 8, 2009

Inflation

First of all lets get on the same page with a definition of inflation. My informal definition of inflation is that money (or I suppose another medium of exchange) will purchase less then it would previously. I have heard people refer to inflation as stealing our wealth. For a long time I did not understand what they were talking about, maybe I am slow on the uptake. In any case I recently figured it out.

We get inflation when the supply of money increases so it is more common and thus worth less. How does that money get out there? It gets out there because our government prints it. Our government does not print huge amounts of money just to have it in circulation, that would be madness. THEY PRINT IT SO THEY CAN SPEND IT. More specifically they print money so they can spend money THEY DON'T HAVE.

This is sort of a backdoor tax. Why is it a backdoor tax you ask? Imagine that you have $100 in your pocket, $1,000 in checking and $10,000 in savings. The government prints a whole bunch of money and spends it. Now we have 15% inflation.

Your hundred dollars will now purchase $85 in goods. Your $1,000 in checking will purchase $850 in goods and that $10,000 in savings is now really worth $8,500.

This is a backdoor tax because a tax was not passed. You did not have money stolen out of your paycheck and didn't write them a check but they in effect reached into your wallet and bank accounts and via a loss purchasing power you were essentially taxed.

12 comments:

flea said...

Good way to explain it TOR and with the spending we are doing nevermind inflation...try HYPER inflation.

It doesn't have to happen but if we keep spending money we don't have like drunken sailors...it will.

Adam said...

the funny part is that it's only possible for the govt to do this because of the federal reserve. Since in our modern fractional reserve system debt is money, as long as people/nations keep buying/holding american debt this plan works.

But the minute the tide shifts to not buying/selling american debt, then we're all screwed.

The Hermit said...

Inflation is a huge concern for people on a fixed income, since they have no way to compensate for the decreased buying power of their monthly income. In the case of people like me, who work for companies having financially tough times, it hurts as well. We won't be getting our annual raise, so my actual buying power will drop considerably in the coming year, but I'll be doing more work for what amounts to less money.

Anonymous said...

you left a zero off the last number i think...

here's another way of putting it...how many dollars does it take to buy the same out of goods

http://www.infoplease.com/ipa/A0001519.html

the true inflation is actually worse since this link is for gov't generated CPI numbers which are changed at will :)

Anonymous said...

For a long time I did not understand what they were talking about, maybe I am slow on the uptake. In any case I recently figured it out.You're EXACTLY right, TSLR, and the difficulty in comprehending what inflation really is, is precisely the reason Americans aren't more outraged.

They don't understand that a rise in stock market is MEANINGLESS if the dollars in their pockets lose their purchasing power.

I hear economic "experts" every day saying that interest rates are low so there's no inflation. They don't understand that high interest rates and higher prices are not inflation, but rather the RESULT of inflation. Inflation is an increase in the money supply, which 'dilutes' the purchasing power of currency.

The wheels are going to come off once the world realizes it's mathematically impossible for the U.S. to repay it's debts, and everybody cashes in their dollar-denominated chips at the same time.

Buy silver.

Snoop-Diggity-DANG-Dawg

Adam said...

that's the thing anon, will the masses ever really "realize" what's going on? I don't think so.

theotherryan said...

Flea, Thanks. We are not at HYPER inflation at this time. It is any ones guess if we will find ourselves there.

Adam, It is pretty darn hard to inflate copper, silver and gold.

Hermit, Pensioners will have it the worst for sure. I think lots of people are in that same position.

Anon, Yeah I did. Thanks.

Anon, Yeah. Once you factor in inflation a 5% gain is often a loss.

Snoop, I buy as much as I can afford to.

Adam, They will realize it. The question is if they will realize it while things can be fixed without serious pain.

Bitmap said...

I think of it this way: If you had 10 oz of gold and you issued 10 certificates, each certificate would be worth 1 oz of gold. If you then issued 10 more certificates while you held the same 10 oz of gold, then each certificate would now be worth 0.5 oz of gold. You just inflated the "currency". If you agreed to pay someone 20 certificates and used this method to pay then you just stole 10 oz of gold from them. In fact, you just stole half of the value from everyone that held a certificate.

theotherryan said...

Bitmap, There is no gold anywhere in this equation.

Steve said...

I may be mistaken, but I think that, contrary to a prior comment, an inflation of the money supply leads to a decrease in interest rates. The reason is that, since the interest rate is the "price" of money, the more money there is, the lower the "price", or interest rate.

Another insidious effect of monetary inflation is that by lowering interest rates, it provides a disincentive to savings, which has a negative effect on capital accumulation.

theotherryan said...

Steve, I believe you are mistaken. It works like this. The bank lends you dollars and expects to make their profit in interest. Once inflation gets going high they are getting paid back with weaker dollars. If they are making 5% interest and inflation is 7% they actually LOOSE 2%.

They factor in inflation and include that into the interest so it actually goes up significantly.

In the late 70's and early 80's when inflation here was high I believe 20% home loans were not uncommon. Don't remember the exact date but Hermit mentioned it a couple times.

flea said...

TOR, you are correct. During periods of inflation interest rates usually go UP not down.

They make up for that dollar you are giving them being worth less ANY way they can.

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