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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 as far as
most people's 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. We list, herewith, 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 national income captured
by the richest 1% of Americans has risen from 9% to 25% since 1980. 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 inflation
rates, due to the combination of rising material costs and distorted price
signals. The distortion of price signals caused by the 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. In
relation to this point it is appropriate to contrast the performances over
the past decade of the manufacturing sector's
of Germany and the US. Germany is far from being a bastion of economic
freedom (its economy is hampered by a heavy regulatory burden) and German labour costs are high, and yet Germany's manufacturing
sector has handily outperformed its US counterpart over the past decade. The
only advantage that Germany appears to have had is the absence of an
inflation-fueled boom. But what an advantage it turned out to be!
4. Higher
unemployment (an eventual knock-on effect of the misdirection of investment
mentioned above).
5. A decline
in real wages over the course of the inflation-generated boom/bust cycle.
Even 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. During the
bust phase, the higher unemployment rate (the excess supply of labour) will exacerbate the tendency of wages to be
slower to rise than most other prices in response to inflation.
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 that an economy could never achieve a net competitive advantage from
what amounts to counterfeiting on a grand scale.
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 eventually happens when central bankers try to 'help' the
economy by creating money out of nothing.
Steve Saville
www.speculative-investor.com
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