How is inflation created
by Tom Rose
Cease, my son, to hear the
instruction that causeth to err
from the words of knowledge.
Since the stock market crash of 1987 the official word issued by both the Federal Reserve Board and our national government in Washington, D.C. is that there has been little or no inflation.
Nothing could be further from the truth! In fact, the official statements about "inflation" by Federal Reserve Chairman Alan Greenspan and the U.S. Department of Commerce are simply part of a grandiose deception designed to mislead the large mass of citizens so they won't think clearly. The reason for the grand deception is that people who have trouble thinking clearly about economic and monetary issues can thereby be more easily manipulated and controlled. Manipulated by whom? and for whose benefit? Manipulated by and for statist-minded presidential administrations; by and for their hired bureaucrats; and by and for globalist-minded special-interest entities who always stand ready to sacrifice the welfare of their own country and countrymen for monetary gain. How true when the apostle Paul warned that "the love of money is the root of all evil!" (I Tim. 6:10).
Now, I realize that my words are harsh and that they smack of collusion and conspiracy in high places. Therefore, let us go back a bit in history.
The classical definition for inflation was very simple and straightforward. Economists once correctly defined inflation simply as an increase in the money supply. Understanding this easy-to-grasp definition, when people noted a persistent rise in the general level of prices they were able to readily perceive that a prior increase in currency and credit (money) was the underlying cause of the rise in prices. And, even more importantly, they therefore knew what must be done to correct the problem: Civil rulers must be made to rein in their voracious tendency to spend more money than citizens were willing to pay in taxes; and private bankers had to reduce their creation of bank credit. It is important to note that when banks extend loans to customers, the bankers actually create the money they lend to borrowers. The economic effect is exactly the same as if the bankers were counterfeiters who illicitly print the unearned money they spend! In short, when counterfeiters spend money that they print, they inject new, unearned purchasing media into the economy. A similar increase of unearned purchasing media occurs when bankers lend printed bank notes or computer-generated checkbook credit to borrowers.
Early banks were established on reserves of specie (gold and silver coins), but they also had legal authority granted to them to have their own unique bank notes printed for them by private engravers. The bank notes were thus nothing more than privately-issued "IOUs" (i.e. credit slips) which were partially backed up by specie reserves held in each bank's vault. Around 1850 the use of checkbook money in America grew to be as popular as bank notes. Thus people had their choice of credit when applying for a loan. They could opt for an issue of credit either in bank notes or a bank check. In either case, the extension of a loan to a customer by the bank resulted in an immediate injection of newly created money into the economy. This new increase of credit-money into the economy, relative to the fixed supply of existing goods and services, thus served to fuel a subsequent rise in the general price level. The monetary inflating process works exactly the same today as it did in the 1800s before the Federal Reserve Bank was created and befo re modern computers were used to obfuscate the money-creation process.
In short, monetary inflation occurs when banks extend loans (the supply of circulating money goes up); and monetary deflation occurs when borrowers repay loans (the supply of circulating money goes down). My point in explaining how early banks systematically created and destroyed money in their normal course of extending loans and later accepting repayments is this: The insidious process of monetary inflation and deflation used to be much easier for ordinary people to understand; but now the existence of the Federal Reserve System and computer-generated credit make the entire process much more difficult to grasp. For over three decades I would carefully share this maxim with my students in my Money and Banking classes:
The process of money and banking of the creation and destruction of purchasing media is very simple to understand. It just appears to be complicated and difficult to understand; and this is not by chance! For, man cannot control what he is unable to understand. Let me warn you that your economic and political freedom depend on your clear understanding of money and how it can be systematically created (monetary inflation) and destroyed (monetary deflation) by the banking system in collusion with government-created central banks (like the Federal Reserve Bank).
Let me give a simple example: Picture me with a toy balloon in my hand. I put the balloon up to my lips and blow air into it. Result: the balloon expands. I have inflated the balloon! Assume that the air I expel from my lungs into the balloon is money, and assume that the circumference of the balloon represents the general price level. With each huff and puff more air (money) is injected into the balloon (the economy), and the result is that the circumference (price level) rises. This is what monetary inflation (injected air into the balloon) and subsequently rising prices (the growing circumference of the balloon) is all about.
CONFUSION OF THE LANGUAGE
The problem facing us today is that the clear language of yesteryear has been quietly changed. The former easy-to-understand thought process that excessive money creation (i.e. inflation) today will subsequently lead to rising prices tomorrow has been insidiously changed. And when new meaning is attributed to once easy-to-understand words, the people are easily confused; and with the confusion of words, there is an accompanying confusion of thought! Has this happened by chance? Not by a long shot!
Today, the federal government, the Federal Reserve Bank, every major financial publication, the controlled news media, and the vast majority of textbooks all refer to inflation as a general rise in prices. Why and how did the change occur from a correct and easily understood definition of inflation an increase in the money supply to one that is incorrect. Is it a question of widespread planned collusion and deception. Or is it simply a matter of stating, "That's just the way it happened. It was simply the result of a chance occurrence!"
Different observers will come up with differing opinions and explanations. But a pertinent saying comes to mind: "Follow the money!" People with similar interests are naturally drawn together, like birds of a feather that flock together. My answer to the above question is this: The correct definition of inflation leads people naturally from the cause (injection of newly- created money) to the result (a subsequent rise in price levels); while the incorrect definition of inflation (a rise in the general price level) leaves people to wonder what the underlying cause is! A quick review of some historical points will help shed some light.
During the Great Depression of the 1930s John Maynard Keynes came up with an idea for solving the problem of widespread high unemployment. His idea was especially enticing to civil rulers in Great Britain and these United States of America. It was this: The high level of unemployment could be solved if civil governments would expand their spending, not through increased tax levels, but rather by creating additional purchasing media (monetary inflation) and then spending it on various government "make work" projects. He argued that a general rise in price levels would not occur because the economy was suffering from deflation. He further argued that a general rise in price levels would not occur unless the civil authorities carelessly boomed the economy beyond what he called the "full-employment level."
Keynes' idea of government spending without increasing taxes was just too attractive for politicians and their hired bureaucrats to pass up. The Roosevelt Administration anxiously took the bait but got immersed in the longest and worst depression in our history. It was really the massive WWII spending that finally revived the U.S. economy; but continued deficit spending by the federal government, and the resultant expansion of credit through the Federal Reserve Bank and the banking system (monetary inflation), largely explain the long lasting post-WWII inflationary spiral of wages and prices.
Today we are propagandized by the Federal Reserve Board that rising wage levels and/or rising prices for gasoline at service stations will cause inflation. Frankly, this is gobbledygook! It is a grossly false statement that is purposely designed to mislead people in their thinking! How can rising prices (a result) be the cause of rising prices? The plain answer is that rising prices cannot cause a general rise in the price level unless it is accompanied with further injections of new money and credit into the economy. Remember my example of blowing air into the balloon! Rising wages do not cause inflation; nor do higher prices at gasoline pumps cause inflation. Rather, wages paid to workers and gasoline prices at the pump are simply market prices. Like all other market prices, they simply reflect the prior injections of new money into the economy.
These monetary injections are brought about by a quiet collusion between various special interest groups:
1) the federal government, which aggrandizes its political and economic power over citizens by continually engaging in deficit spending;
2) the Federal Reserve Bank, which is the inflationary tool used by the federal government to monetize the IOUs (bonds) that are created by deficit spending;
3) the banking system, which relies on the Federal Reserve as an inflationary "lender of last resort;" and
various large corporate business and labor union interests.
All of these entities, except the labor unions, have a special interest in shifting the blame of continually rising price levels onto workers, who are only interested in preserving the purchasing power of the money they receive in wages. But labor union leaders have been in the foreground of fostering inflationary policies to be followed by the civil authorities. In matter of fact, Keynes' idea of fostering government spending via deficit spending rather than through increased levels of taxation was a sick scheme designed specifically to fool working men into accepting lower "real wages" as rising price levels served to undermine the purchasing power of workers' paychecks. Government leaders, some labor union leaders, and big business firms in Britain accepted Keynes' scheme as an insidious way of fooling labor union members into working for lower wages. They thought that working men would be too ignorant to recognize the fact that their paychecks would dwindle in purchasing power as the government, the central bank, and the banking industry quietly, but steadily, inflated the money supply.
The idea was for industrial leaders and government leaders to acquiesce to union members' militant demands for higher wages, but then to purposely erode the purchasing power of the higher nominal wages that were granted by inflating the money supply via government deficit spending. This was the unsavory economic scheme that was so readily adopted, first by the government and business leaders in Britain, and then also by the Roosevelt Administration when Keynes paid a visit to FDR and explained his scheme in 1935.
The result was a 60-year-plus wage-price spiral in these United States of America, from WWII to the present; and this explains why the purchasing power of a Dollar in 1940 is now worth less than eight cents! Actually, if we look at the value of the dollar before the establishment of the Federal Reserve System, which began operation in 1914, we find that the 1913 dollar has been so depreciated in real purchasing power that it is now worth about one cent!
In short, the point I am making is that, since the establishment of the Federal Reserve System in 1913, a planned collusion of long-term monetary inflation has quietly bilked Americans of multi-billions of dollars of their hard-earned savings. This has especially served to impoverish elderly people who rely mainly on fixed-income retirement money from insurance and pensions. And this same inflation that has produced the long-term wage-price spiral has made it increasingly necessary for mothers to leave the home and enter the work force. In addition, this same monetary inflation has encouraged once-freedom-minded Americans, not only to acquiesce in, but even to seek various socialist/fascist government programs that have quietly eroded historic American economic and political freedoms.
Americans would be much, much richer today if this planned monetary inflation deception had not occurred; and we would also be enjoying much, much greater degrees of political and economic freedom too, which is even more important than the lost economic riches. This systematic long-term monetary inflation and the resulting long-term wage-price spiral just could not have happened without the knowing acquiescence of leaders in civil government, central banking, private banks, big business, and big labor unions. To claim otherwise is to suggest that such leaders in our country are ignorant of the working of economic cause and effect; and these entities are anything but ignorant! I strongly disagree with many coercive labor union tactics as well as deceptive practices by civil rulers, central bankers, and some business leaders. But one thing I can assure you of is this: The wages people receive in the market place are not the cause of what today is wrongly called "inflation" (i.e. rising prices); but rising wage levels are, rather, the later effect of prior monetary inflation surreptitiously brought about by conniving of the special interest groups mentioned above.
Since the market crash of 1987, the Federal Reserve Bank in cooperation (perhaps collusion would be a better word to use!) with past and current presidential administrations and hidden special interest groups has freely pumped multi-billions of new money annually into both our domestic and world economies. And with the recent potential threat of bank runs induced by fear of Y2K (which did not occur), the Federal Reserve pumped additional billions into the banking system, which nefarious practice it is now attempting to offset without inducing another deflationary spiral as the Federal Reserve did in 1929-39 and again in 1973-74.
Question: Why did the massive monetary inflation engineered since 1987 fail to generate subsequent rises in the general price level? To make a complicated answer short, it did. But, the impact of the prior money creation has been somewhat softened and diverted. Let me explain: First, economic observers are increasingly making the claim that government statistics do not accurately reflect the true level of rising prices. Any homemaker can readily substantiate this claim. Statistics can easily be "groomed" by excluding some prices and giving different weights to others. Next, civil governments and central bankers can create and inject as much money as they wish into the economy, but they cannot control where the money goes once it is injected. Over the last decade trillions of dollars have been created. Domestically, much newly-created money has been funneled into the stock market. Thus, we now have the greatest credit bubble in history! Lately, it has shown signs of bursting. It is impossible to predict when or how the inflationary bubble might burst and when the feared downturn in economic activity might occur.
Another part of the diversionary aspect of engaging in monetary inflation is that recent presidential administrations, the Federal Reserve Bank and various foreign central banks, and international banks and businesses have worked hand-in-hand (collusion?) to decapitalize much of America's basic industry even to the point of shipping entire manufacturing plants overseas. The result of this collusion, much of it accomplished at taxpayers' expense, has been to generate an artificial industrial boom in less-developed countries with low wages (especially Red China, who regards America as her primary enemy) and a great influx of cheaply-made, shoddy goods that has put many American workers out of work. This is why we have not seen rising prices for many consumer goods in our country; and this helps explain why the officially promulgated statistics don't show the expected effects of the prior monetary inflation that has been taking place since at least 1987.
A LESSON TO LEARN
Is there a lesson to be learned? Yes! There is a double-sided lesson to be learned: First, a freedom-loving people must carefully guard their common vocabulary so that the historic meaning of words will not be insidiously changed. Failure to take this precaution will lead to certain confusion of terms and thence to confused thinking by the general populace. Secondly, a freedom-loving people must constantly ponder the following question regarding civil government and keep the answer foremost in their mind: What is the proper role of civil government in society? Is its proper role to manipulate and control the business cycle in an attempt to foster economic security for citizens? Or is its proper role simply to maintain law and order with the goal of maximizing each individual's freedom and self-responsibility before God? The biblical answer to this question is very clear, but it won't be readily accepted by the majority of Americans because they have been spoon-fed the unbiblical idea that it is the proper role of civil government to attempt to ensure their economic security with the hope of full employment, rather than simply allowing people to stand free and responsible for self before their Creator. "It's the economy, Stupid!" has become the cry, and its acceptance by a populace unfamiliar with economic history will lead to certain enslavement.
This truth is so important that it bears repeating: There is one all-important question that freedom-minded Americans should be asking: "What is the proper role of civil government in society?" How Americans answer this question will determine whether they are to live as self-responsible individuals in a peaceful environment of God-given freedom, or (as they are living today) under an inherently brutal regime of government-imposed fascism, not only at the national level, but ultimately on a global scale. The preservation of God-given freedom requires a people who can think clearly and be guided by biblically oriented principles. A true understanding of what inflation really is, and the subsequent price effects produced by government-induced monetary inflation, will certainly equip people to think more clearly. But to do so, we must protect the integrity of our vocabulary.
by Tom Rose
June 3, 2000
Tom Rose is retired professor of economics, Grove City College, Pennsylvania. He is author of seven books and hundreds of articles dealing with economic and political issues. His articles have regularly appeared in The Christian Statesman, published by the National Reform Association, Pittsburgh, Pennsylvania; The Chalcedon Report, published by the Chalcedon Foundation, Vallecito, CA; The Freeman, published by the Foundation for Economic Education, Irvington-on-Hudson, NY; Christian Economics, published by the Christian Freedom Foundation, Buena Park, CA; and in many other publications. For ten years he wrote a weekly syndicated column published by newspapers such as: The Santa Ana Register (CA), The Indianapolis Morning News (IN), The Manchester Union Leader (NH), The Gazette-Telegraph (CO), The Odessa American (TX), and others. He and his wife, Ruth, raise registered Barzona cattle on a farm near Mercer, Pennsylvania, where they also write and publish economic textbooks for use by Christian colleges, high schools and home educators. Rose's latest book is Reclaiming the American Dream by Reconstructing the American Republic. published by American Enterprise Publications, 177 N. Spring Road. Mercer, PA 16137. Phone: 724-748-3726; Fax:724-748-5373.
Copyright © 2000 by Tom Rose. All Rights Reserved.
Reprinted by USAGOLD with permission of Tom Rose. No further reproduction without permission.
Return to the The Gilded Opinion Index PageSource: www.usagold.com