The View From 1776

Understanding The Nature of Inflation

Inflation is a monetary phenomenon.  Too few people understand its true nature and its devastating impact on their lifetimes.

When our money supply growth exceeds the rate of increased production of real goods and services, the dollar is being debased.  Citizens pay for this with a cumulatively huge decrease in purchasing power of their earnings and savings.  This monetary inflation is an invisible tax increase imposed by the Federal government’s deficit spending to finance the ever-growing socialistic welfare state.

As recently as the 1950s, $35 would have bought an ounce of gold.  Since then the worth of the dollar has fallen so abysmally that, at yesterday’s closing, an ounce of gold would have required a buyer to pay $1,598.  In other words, the purchasing power of a dollar has depreciated 98% over the past 50 years.

When I got my first Wall Street job in 1958, my salary of $5,700 was well above national averages.  Most people earned less than $100 per week.  I could afford to pay Manhattan apartment rents, go to Broadway theatre performances or concerts, and otherwise have an active social life.  Today the same standard of living in New York City would require income well north of $100,000 for a single person.

That change was fueled by the Federal Reserve’s excessive fiat money creation.  One measure of this recklessness is the M3 money stock statistics, which the Fed discontinued in 2006.  The M3 money stock increased from approximately $300 billion in 1958 to approximately $10.2 trillion in 2006, an increase of 3,300%.  Quite obviously our real economic production of goods and service expanded at nowhere near that level.

The sixty-six years since the end of World War II started with the Bretton Woods pseudo gold standard (the so-called gold-exchange standard).  The money supply, lacking stabilization by a true gold standard, was continually increased at rates far above increases in real goods output, particularly to support the Treasury’s deficit financing of President Johnson’s Great Society.  With the flood of easy money in 1970 came PennCentral Railroad’s bankruptcy and the resulting collapse of the commercial paper market along with the commercial real estate boom and bust of the 1970s.  In 1971 President Nixon abandoned the gold-exchange standard and imposed price controls.  We were well on our way to the era of stagflation, with both the prime interest rate and the Consumer Price Index hitting 18% per annum.

In the first couple of years of the 1980s, Fed chairman Paul Volcker stopped the surge of inflation by sharply reducing the money supply.  His successors Alan Greenspan and Ben Bernanke, however, reverted to Keynesian easy money policy, which created the 1987 stock market crash, the 1990s implosion, and the residential real estate boom and collapse in 2007. 

Still believing that higher volumes of increasingly worthless dollars solves all economic problems, Bernanke’s Fed has massively increased the money supply.  The Consumer Price Index, which measures only a small slice of costs of living, is back up to a 3.5% rate of increase, roughly the same rate that inaugurated the 1970s stagflation.

For more regarding the nature and uneven effects of monetary inflation, read Krugman attacks Ron Paul, Austrian Economics.