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What Causes Inflation?

by Dr. Doug Cardell

People think of inflation as akin to a pandemic or a hurricane, a disaster that just happens, a fact of nature. However, only government action can create inflation. It is a result of government policy. In fact, in most cases, it is the policy. If inflation continues for a long time, the result is an economic and societal disaster. Inflation happens when a government's actions cause its currency to lose value. It occurs when a government puts more money into circulation without any corresponding increase in the value of its economy. Governments do this in several ways, including printing more money, borrowing more money, changing interest rates, and using regulations and taxes. This monetary expansion causes a rise in prices and wages. Wages are just another price, the price of labor. Here's what happens: every economy has a precise value; you might think of it as Gross Domestic Product or GDP. The GDP is the value of all the goods and services produced in the economy. The whole economy's worth is no different in principle than a single item's worth. That value is or should be comparable to the amount of money in circulation. When the government increases the amount of money in circulation, this higher amount of money now equals the original value. So one dollar of value should equal one dollar of money. Doubling the amount of money means that the same value equals twice as much money. Looking at it another way, this means everything costs twice as much. It's like a stock split in the market. Let's say XYZ Inc. has stock selling for $1000 per share. The company's officers may decide the price is too high to encourage investing. So, they split the stock two for one. They give every stock owner an extra share for every share they have and reduce the value of each share to $500. So, if you owned 100 shares at $1000 each, you would now have 200 at $500 each. Either way, you have $10000 worth of stock. Doubling the number of stock shares cuts each share's value in half. It works the same with the money supply; if you double it, each dollar is worth half of what it was. Advocates of increasing the money supply believe that having more money in circulation makes everyone richer. However, purchasing power is the only accurate measure of consumer wealth. Inflation increases dollars in circulation while decreasing those dollars' purchasing power. The consumer loses. Inflation is an increase in the quantity of money without a corresponding increase in the value held in the system. However, it is reasonable for the money supply to increase in an amount equal to the increasing wealth held in the economy, but only due to an increase in wealth. Furthermore, once the government creates inflation, it is extremely difficult or impossible to reverse. Inflation is self-sustaining because rising prices lead to a demand for higher wages, which increases prices, leading to a demand for still higher wages. The truth is that no increase in the welfare of the members of society can result from the availability of an additional quantity of money. Consumers have more money, but everything costs disproportionately more. The only beneficiary is the government because, due to the rise in incomes, people are now in a higher tax bracket and must pay a higher percentage of their income to the government. Value is what it is, and no change in the dollars in circulation can raise the value of an economy. A recent example should make the point clear. I'd like you to try a little math experiment. First, add all the money you received in COVID relief funds. Next, calculate the effect of the resulting inflation on your earnings. In 2021, the rate was 7%; in 2022, it was 8.3%; in the first half of 2023, it was 4.6%. Since inflation compounds, the calculation is 1.07 times 1.083 times 1.046, which equals 1.219 or 22%. Prices are 16% higher than they were two years ago. 22% inflation lowers your purchasing power to 1/1.22 = .826 = 82% of what it was before the inflation. So, inflation effectively reduced your income to 82% of what it was two years ago. Therefore, you lost 18% of your income. So, if you multiply the amount of money you earned in the past two years by .18, you find the purchasing power you lost to inflation. Now, you can compare what the government gave you in COVID relief funds to the amount the inflation it caused cost you. Let's use a specific example. The median individual income in the US is $44225, and 18% of 44225 is $8051. The COVID payments were $3200 per person. So, the government, by expanding the money supply to give everyone $3200, created price increases that cost the average earner $8051, more than two and a half as much as they handed out. Only a government bureaucrat could think this was a good deal. Worse yet, workers don't get back that 18% yearly loss even if inflation stops now. Eventually, income may increase enough to return to even, but that could take a decade or more. The only way anyone will ever get back to the purchasing power they would have had is if their employer gives them a 22% raise to match inflation; how likely do you think that is to happen? Worse yet, you will keep losing that 18% yearly even if inflation stops now. Eventually, your income will increase enough to prevent you from losing more. But, the loss will continue until that happens or if inflation continues.

Looking at the graph, you can see the effect of the Biden Inflation over the next decade. Average wage growth is about 2% per year, and you can see that in the upward slope of the line. The plunge in 2021-2023 is the effect of the Biden Inflation. While those in the upper incomes lose more in dollar amount, those in the lower income group are most affected. Those with higher incomes may have to curtail their spending, but those with lower incomes barely get by as it is. An 18% cut is devastating when you're already budgeting as tightly as possible. For all incomes, it may take a decade to return to the purchasing power of 2020. Why does the government keep doing this? The simple answer is that they want to spend more money than they have. Money is power, so the government has a strong incentive to spend as much money as possible. During the last two years, the administration spent about seven trillion dollars a year and took in 4 trillion. To cover the 3 trillion dollar shortfall, the government would have to raise taxes by 75% or expand the money supply. The administration knows that the citizens would never stand for a 75% tax increase, so they expand the money supply. To put this in perspective, Spending 7 trillion dollars at a rate of one dollar per second would take two hundred twenty thousand years. Increasing the money supply allows the government to take over larger segments of the economy, which increases its control over the populace. Additionally, inflation enables the government to reduce consumers' purchasing power and increase the need for government services and the corresponding government control. This increase in control limits consumer choice and democratic freedom since consumer choice is a fundamental right. Therefore, the populace must see inflation as the threat that it is. The only solution is to stop inflation with a stable money supply and a balanced government budget.

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