I guess my real question is, exactly how does inflation work? Why does a dollar’s value decrease over time? Is it really related to the amount of actual paper/metal currency out there? If so, can I slow inflation by burning a big pile of money? Is this why it’s illegal to deface or destroy US currency? And is inflation now different from the way it worked before we went off the gold standard?
I tried using the search to see if this had been asked before, and I found some tangential references, but nothing really comprehensive. If any of my assumptions are really lame, I apologize in advance.
Inflation happens when people’s spending power increases. This can be the result of several things: increasing wages, lowering interest rates, skyrocketing stock markets, or the availability of new currency, for example. If I have more spending power, merchants realize they can get away with charging me more, thus the value of the currency decreases.
Friedo, that seems to make sense on the face of it, but I’m having trouble wrapping my mind around it. I guess my problem is, if merchants start charging more, why does that mean the value of a dollar decreases? I mean, shouldn’t that mean that in times of recession, when a lot of people lose their jobs, the value of a dollar should actually go up? But as far as I can tell, inflation has only ever gone up.
I wish they wouldn’t simplify extremely complex subjects just to be able to cover them in grade school. In like 6th grade social studies or whatever, there was maybe a sentence about inflation: “Inflation happens when more money is printed and the value of a dollar decreases.” Gee, thanks.
…Inflation is simply when prices go up. If ALL merchants charge more, each dollar buys less-- remember, a dollar has NO intrinsic value. Its ONLY value is measured by what it can purchase. It helps (me, anyway) to think of it in terms of the economy as a whole. The Fed indirectly controls the money supply (per Uncle Cecil, et al). If the economy does not grow and the Fed inceases money supply by 5%, prices have to rise by an average of 5% - there’s simply 5% more money per good. A few notes: 1) Currency only makes up about 7-8% of the entire US money supply, and the US Fed generally does not increase the money supply by running the mints, though many governments have (including the Confederate government during the Civil War), with consistently disasterous results. 2) Deflation has certainly happened in the US, as recently as the 1930s. 3) Friedo is on the right track, but do not misterpret his assertion that inflation is associated with higher purchasing power. If the Fed cleaned doubled the money supply overnight, everyone’s wages and all prices would double, and theoretically everyone would have the same purchasing power, even in the face of 100% overnight inflation.
Short answer: unquestionably yes, burning money would slow inflation.
MONEY <> CURRENCY. (The little <> means ‘does not equal’.)
Most money is just records in (increasingly electronic) ledgerbooks. The currency (a physical representation of the concept of money) only represents a very small percentage of all the money out there earning interest. Having to have physical counters is a throwback to when we bartered gold for supplies way back a long time ago. We could go completely cashless economy suddenly and it would not affect how most businesses do most of their business one bit.
OK. There are two reasons for inflation; they might actually be called “good inflation” and “bad inflation”. “Good” inflation takes place when there’s growth in the economy, consumers have more money, and prices increase. This tends to be quite moderate. It’s also not especially harmful because it’s accompanied by real growth in production and employment.
The other kind, paper inflation, is caused by artificially decreasing the value of money by non-productive exercises such as stock speculation, land speculation, or the arms trade. This kind is the more harmful because it’s not accompanied by real growth. Things cost more not because of greater production, but because money is worth less.
I realize this is controversial and am prepared to defend it on request. (A good primer is “Armaments,” “Land Speculation,” and “Inflation” from Saul’s Doubter’s Companion.)
The problem with governments fighting inflation is that they do it by increasing interest rates, which reduces the money available for investment in new growth initiatives and therefore strangles the productivity which leads to “good” inflation. This is instead of trying to restrict paper inflation (speculation, arms trades, and whatnot). It’s like saying dieting means eating less, and then cutting all the meat and vegetables out of your diet and leaving only chocolate bars.
