Inflation Is Theft

There has been a lot of chatter lately about inflation taking off - both in the UK and across the world. Prices have gone up particularly in the sectors of energy, transport, and clothing retail in the UK, and the overall rate of inflation is reportedly not shooting way up only because of a temporary hospitality VAT tax cut. In the US, a yearly 4.2% inflation in April was reported, spurring economists and commentators to share their worries and predictions. People have started to notice that prices seem to be steadily climbing now, at a rate which is a bit suspicious considering the still-low reported official numbers.

The inflation which is reported is price inflation. In other words, it’s how much prices rise - specifically, prices of everyday goods people often tend to consume and pay for. But the word ‘inflation’ did not always mean that. Around the last century’s interwar period, there was a shift in what people commonly meant when they used the term. Before that, ‘inflation’ used to mean monetary inflation - an increase in the total amount of money in circulation. While monetary inflation and price inflation do tend to go hand in hand, though not always perfectly, those two meanings are still very different.

For all the commotion around ‘inflation’ in the press now, it needs to be said that if the word was still being used in the monetary sense as opposed to that of price, what is happening would not be surprising. In fact, it would be obvious. Monetary inflation went through the roof during the pandemic. While the amount of money in the economy can be measured in multiple ways, virtually all of these indicators now show a rise of several tens percent over the last year across the world’s economies. For example, the growth of M2 money supply for the US dollar reached 27 percent year-on-year in February 2021. Alternatively, the same entry in terms of TMS money supply showed a growth rate upwards of 39%. When it comes to M2, this nice graph (best when set at 5Y) shows the enormous upwards jump in the first half of last year, when close to 15% of the entire money supply to date had been created in just four months (an annualised growth rate of 45%). M1 money supply for the US dollar grew by over 50% between February and August last year.

With the rest of the world, it’s a similar story. The details are not too interesting, but the trends are the same.

So what does this mean? When it comes to money creation, the shorthand usually applied is to say that the government or the central bank just prints more. Money printer goes brrr - you know the story. While that is indeed a neat summary, it’s also useful to look in more detail at how it is actually done. Money is usually created by commercial banks providing loans. They do so in practice by literally adding extra numbers to the account and the balance sheet involved. These loans are given out on top of mandatory reserve requirements - laws that codify what percentage of money banks lend out they need to hold themselves in reserves. At 100%, banks just provide warehousing to depositors. At 0%, banks can theoretically create any amount of money they wish at any time (though there are still some other constraints to this unlimited creation, of course).

In practice, the already low reserve requirements end up being only a loose constraint, if any, with extra reserves being readily obtainable at any time from the central bank - the lender of the last resort. The central bank is the boss here and the practical result comes down to the negotiation details of the lending terms.

The other major way money has been created ever since the last recession is by central banks directly. They inject the money they create into general circulation by buying up assets. This has come to be called ‘quantitative easing.’ While the central banks can buy whichever assets they like, most of this money-creation usually goes into buying government debt in the form of bonds. The government can engage in runaway debt spending financed by the central bank, which buys that debt with newly created money. It is also worth noting that to the extent that the central bank buys up other assets from the market, that effectively constitutes a form of nationalisation.

Since the beginning of the pandemic, incredible amounts of new money has been created this way. Specifically, quantitative easing was more widely used than ever before. When new money is created and added to the total stock, the value of all previously existing money is diluted. If the new money was created and then distributed proportionally to everyone, it would have no effects on people’s real wealth and the only thing to happen would be for prices to adjust upwards accordingly. But this is not what happens when new money is created. It is not distributed proportionally and, therefore, it has redistributive effects. Money creation takes wealth from all currency holders and transfers it to those who get their hands on the new money first.

This is called the Cantillon Effect and, in the context of the methods of money creation described above, it shows us that in our present day, those who benefit from the newly created money are either large borrowers (when money creation by commercial banks is predominant) or governments and firms whose bonds are bought by the central bank (when money creation by quantitative easing is predominant). Overall, it can be summarised thus: the financial and political class gets most of the value of newly created money, while this value is gathered from those to whom the new money gets last - the regular currency users with no connections to governmental or financial institutions.

Inflation is a form of proportional tax on all money holders, while it is the well connected who have first access to the newly created money and therefore to the total value sheared from all other people.

As the new money gradually starts to permeate through the economy, an increasing number of people get hold of it until it eventually reaches the general population. But money is not valuable on its own. It is only valuable for the things one can exchange it for. Money is just tokens for other, real goods and services. When there is no new underlying value actually being created, more of these tokens in total only means there are more tokens for each real good or service. The result is a question of simple supply and demand - prices rise. Other things being equal, monetary inflation will always eventually result in money losing its value, i.e. price inflation. 

While prices eventually rise across the board, they don’t all rise at the same time and to the same extent. As in any complex system, there is going to be a lot of variation. One can’t exactly predict which specific price is going to inflate, where bubbles might be created, and so on. Sometimes, it might be assets like stocks or housing where the prices inflate the most, while at other times, everyday consumer goods might be more affected.

States and central banks have an incentive to engage in inflation - besides the redistributive effects already mentioned. As most states nowadays are typically deeply indebted, inflation helps erode this burden of debt. At the same time, states and central banks also have an incentive to report low price inflation - mainly for financial reasons. With many contracts and obligations tied to official inflation figures, reporting these numbers to be high might get expensive. What states and central banks can do to lower this number is to strategically change the baskets of goods from which overall price inflation is calculated. As the economy evolves and products and services are continuously improved and replaced, it is always necessary to adjust the baskets to keep them representative of what people buy and spend their money on. This offers plenty of opportunities for moves done not with the best of intentions.

For these reasons, it needs to be remembered that reported inflation numbers are probably removed quite a bit from the real inflationary effects amid which we live. Suffice to say that with improving technology and increasing productivity, if the money supply was not being inflated, price deflation of hard-to-estimate magnitude would be the norm. One can guess a little better what the real effects of the present system are by looking at the monetary inflation numbers.

The percentage by which the money supply is yearly enlarged is the percentage of wealth stolen from you each year - in addition to other taxes - by the central banking monetary system designed to milk the tax-cattle as much as humanly possible, by any means necessary.