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The insidious effects of monetary inflation

By: Steve Saville, The Speculative Investor

 -- Published: Tuesday, 9 May 2017 | Print  | Disqus 

Most people with a basic grounding in economics know that increasing the supply of money leads to a fall in the purchasing power of money. However, this is usually as far as their understanding goes and explains why monetary inflation is generally not unpopular unless the cost of living happens to be rising rapidly. Monetary inflation would be far more unpopular if its other effects were widely understood.

Here are some of these other effects:

1. A greater wealth gap between rich and poor. For example, monetary inflation is probably a large part of the reason that the percentage of US household wealth owned by the richest 0.1% of Americans has risen from 7% to 23% since the mid-1970s and is now, for the first time since the late-1930s, greater than the percentage US household wealth owned by the bottom 90%. Inflation works this way because asset prices usually respond more quickly than the price of labour to increases in the money supply, and because the richer you are the better-positioned you will generally be to protect yourself from, or profit from, rising prices.

2. Large multi-year swings in the economy (a boom/bust cycle), with the net result over the entire cycle being sub-par economic progress due to the wealth that ends up being consumed during the boom phase.

3. Reduced competitiveness of industry within economies with relatively high monetary inflation rates, due to the combination of rising material costs and distorted price signals. The distortion of price signals caused by monetary inflation is very important because these signals tell the market what/how-much to produce and what to invest in, meaning that there will be a lot of misdirected investment and inefficient use of resources if the signals are misleading.

4. Higher unemployment (an eventual knock-on effect of the misdirection of investment mentioned above).

5. A decline or stagnation in real wages over the course of the inflation-generated boom/bust cycle. I point out, for example, that real median household income in the US was about the same in 2015 as it was in 1998 and that the median weekly real earnings level in the US was about the same in Q3-2016 as it was in Q1-2002.

Real earnings decline or stagnate because during the boom phase of the cycle wages will usually be near the end of the line when it comes to responding to the additional money, whereas during the bust phase the higher unemployment rate (the excess supply of labour) will put downward pressure on wages.

Note that while a lower average real wage will partially offset the decline in industrial competitiveness resulting from distorted price signals, it won’t result in a net competitive advantage. It should be intuitively obvious — although to the Keynesians it apparently isn’t — that an economy could never achieve a net competitive advantage from what amounts to counterfeiting on a grand scale. In any case, what sort of economist would advocate a course of action that firstly made the economy less efficient and secondly tried to make up for the loss of efficiency by reducing living standards (a reduction in real wages equals a reduction in living standards).

6. More speculating and less saving. The greater the monetary inflation, the less sense it will make to save in the traditional way and the more sense it will make to speculate. This is problematic for two main reasons. First, saving is the foundation of long-term economic progress. Second, most people aren’t adept at financial speculation.

7. Weaker balance sheets, because during the initial stages of monetary inflation — the stages that occur before the cost of living and interest rates begin to surge — people will usually be rewarded for using debt-based leverage.

8. Financial crises. Rampant mal-investment, speculation and debt accumulation are the ingredients of a financial crisis such as the one that occurred during 2007-2009.

The above is a sampling of what happens when central bankers try to ‘help’ the economy by creating money out of nothing.


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E-mail: Steve Saville


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