Controlling Inflation

Contents

What is inflation?
What causes inflation?
Debt and inflation
What are the effects of inflation?
Government Investment
Can we cure inflation?
Price Controls
Deflation
Conclusion

What is Inflation?

Inflation is a continuing,  general rise in prices.

As all prices go up, a currency loses its value as money.

Usually, inflation is measured over a year unless it is hyper-inflation.

Inflation of 2%, means that over a year, there is a general, mean average price increase of 2% on goods and services. Thus, someone with a fixed income will find their income worth 2% less by the end of the year.

2% is the government maximum target of inflation given to the Bank of England which attempts to control inflation by controlling the money supply.

The current inflation level is above 5%.

The highest rate of inflation since WW2 was around 12% in the late 1970s and early 1980s  This was largely due to a very high increase in the world price of oil which had a knock-on effect on the price of all goods and services in most countries.

Inflation is a deeply political subject.  For instance, the UK media tried to blame UK inflation at that time on wage increases rather than the underlying cause. Wage increases never caught up with inflation. Despite inflation over the last 12 years wages have remained largely static.

Hyper-inflation is an extremely high rate of inflation. It may be characterised at that point where people want to buy things with their currency as soon as they get it because it is losing value so quickly. It ceases to retain a key feature of money: “a store of value.”

Some have suggested that 30% inflation per month is hyper-inflation.

The most infamous case of hyper-inflation is that of 1920s Germany, when the government deliberately printed massive amounts of money to pay off the WW1 compensation (reparations) demanded by the Allies. They made the mistake of denoting the compensation in German marks.

Once hyper-inflation sets in it is almost impossible to save the currency without a major re-valuation.

What causes inflation?

It is generally agreed that inflation is caused by too much money in the system in relation to the goods and services available. Conversely, of course, it can be seen as too few goods being produced as with the slump in production during Covid lockdowns.

It is easy to understand that if everyone had their wealth doubled, then general prices would inevitably rise, probably doubling unless people saved more.

Saving reduces the amount of currency circulating in the economy: it reduces the velocity of money circulation.  More saving, in the first instance, has the effect of reducing inflation.

So, if inflation increases, year on year since WW2, then we have to ask the question “Why?”   Academic economists and politicians seldom if ever address this question. This is because it has deep social/economic consequences that they do not wish to discuss.

We need to understand how the amount of currency in the economic system continually increases. We also need to understand the other side of the equation: why goods and services do not keep up with the supply of currency.

The underlying equation of our society is that money does not circulate as such. There is a huge daily cream-off in the form of net profits and rents. These profits and rents are often “invested” in funds: the most common being Mutual and Hedge funds.

The top ten US Mutual Funds all have over a Trillion US dollars under management, with Blackrock having a staggering $9Trillion.

UK funds are tiny by comparison, M&G, the largest, having a “mere” £20 Billion under management.

These funds “invest” in shares and bonds.  The former paying  dividends and the latter interest.  The money swirls around chasing these “assets” as the Wall Street and London City boys make a rake off with each transaction.  Those who have read the “Big Short” will know it is all a gigantic rip-off of those entrusting their savings to these sharks.

Thus over the years, there has been a huge rise in prices of the “Asset” market, the market for shares/stocks and bonds. Shares are issued by companies and Bonds are i.o.u’s issued by the government and companies and pay annual interest. They are paid off in full after a stated period of time. Government bonds are especially safe and known as “Gilts.”

Thus, with money being extracted from general circulation it means that the people who produce the goods and services do not have, over all, the necessary money to buy back these goods and services.

Nor do companies have the necessary cash to make essential investments in start-ups, renewal or in new technologies.

This led to the business cycle decades ago: the era of booms and slumps. Quite simply, producers would reach of point of production where the market was saturated, where consumers could no longer buy back what they had produced. 

We were faced with that absurd situation in capitalism where there was a crisis of over-production!

When companies can no longer sell all of their production they naturally cut back to a point where they think they can. The thing is, of course, so do other companies. It becomes a social economic phenomenon. As companies cut back on production then they cut the hours that their employees work and lay off those “extra to requirements.”

Thus, the employed workforce shrinks, which, of course, means those unemployed spend less and general demand drops.

We can see that this will lead to a vicious circle: as unemployment grows, demand drops and employers are forced to lay off even more workers causing an even greater drop in demand  and so on. 

But at some point, the larger companies will take over the smaller companies which have gone bankrupt and will also seize the opportunity to invest in new machinery and upgrade training of its workforce.   This will be at the bottom of the business cycle at which point, the new investment will cause employment to increase and demand to grow, causing a virtuous cycle of increased demand  and employment. The slump will end and the boom begin.