Monday, January 25, 2010

What is inflation?

EXCERPTS: The True Meaning Of Inflation John Tamny

The Federal Reserve is empowered by Congress to keep inflation in check, but its definition is even more wanting than the monetarist view. According to the Fed's leading lights--including Chairman Ben Bernanke--inflation is a function of too much economic growth. This impoverishing definition is even easier to discredit than the monetarist description. . .

So what is true inflation? It seems the answer resides in the price of gold. Used as a money measure for thousands of years, gold achieved its purely monetary role precisely because its role in the productive economy is so minuscule. As a result, nearly every ounce of gold ever mined is still with us, which means gold's real price is hard to alter thanks to a great deal of gold stock in existence relative to new discoveries.

When the price of gold moves, gold's price isn't moving; rather it is the value of the currencies in which it's priced that is changing. Gold is the objective indicator of inflation: When its price in any currency rises substantially, that means the unit of account is weakening and that we're inflating.

What does this mean for the economy? Broadly it means that when the dollar weakens such that the price of gold spikes, what is limited capital seeks safe-haven in hard, unproductive assets like gold, oil, art and property. Physical assets least vulnerable to monetary debasement win out over less tangible investments of the innovative or knowledge variety. In that sense it's no surprise that technology investments thrived in the '80s and '90s when the dollar was strong.

Getting back to inflation, rather than a measure of prices that change for various reasons that have nothing to do with currency policy, inflation is at its core the painful process by which capital flows to the hard assets of the earth and away from innovative, wage-creating industries. As individuals we don't so much hate inflation for the rising prices as much as we balk at it because our chances to capture good jobs and good wages are compromised for capital essentially hiding.

As the rising price of gold has revealed throughout the decade we've been inflating, no matter what the more quiescent government measures of consumer prices have been telling us. A weak dollar explains our economic unhappiness because a weak dollar is what has made capital disappear. . .

In short, inflation is about capital going on strike. And the political party that catches on to inflation's true meaning will thrive. The problem, however, at least for now, is that politicians and economists on both sides of the aisle are captive to false inflation definitions that have blinded them to the true inflation that is very much with us, and that weighs on the economy more than any other policy today.


  1. Where did the side list of leading economists/philosophers go? It was a great list.

    Another factor related to inflation is the policy of the Federal Reserve with regard to interest rates. Artificially low interest rates help increase the amount of money in circulation.

    Also involved in the inflation business is the practice of fractional reserve banking.

  2. "Inflation is always and everywhere a monetary phenomenon."

    With that catchy zinger, I always wonder how Milton Friedman can justify being the Monetarist giant he was.

  3. I got rid of the list...thought it was fluff but will re-think having the list. Anyone who reads this blog can figure out the great minds.

    The theme of the last 5 or so posts leads one to some frightful insights.