As an economic term, “inflation” is shorthand for “inflation of the money supply”.

The general public, however, usually takes it to mean “rising prices” which is not surprising since one of the common effects of an increase in the money supply is higher prices. However, supporters of government policy often say, “If quantitative easing (QE) and its terrible twin, fractional reserve banking, are so awful, why have we got no inflation?”

To address this conundrum, there are six related factors that are noteworthy:

First, we need to be clear about the terms we are using.

Instead of talking about “inflation” in the loose sense, as above, it is more accurate to speak of currency debasement, which is the real impact of fiat money creation by any means. We experience currency debasement as declining purchasing power. Two sides of the same coin: one reflects the other.

Secondly, the above question overlooks the fact that the measures used in this process are inherently unreliable. The decline in purchasing power is most evident when objectively measured by reference to an essential commodity such as oil – rather than against the Consumer Prices Index (CPI). The CPI purports to reflect the prices of ingredients selected by government statisticians in what they consider to be a typical, but notional, basket of “consumer goods and services”. This basket, whose contents are varied periodically, results in an index that cannot be trusted as an objective barometer. It supports the wizardry of non-independent Treasury statisticians, and relates to goods that scarcely feature in your shopping basket or mine.

Measuring the oil price in gold

Fifty years ago, in 1966, the price of a barrel of oil was 3.1 dollars. It is now just under 50 dollars – so it appears that the price of oil has risen. But that apparent increase is rather the measure of the decline in the dollar’s purchasing power over the same period – a decline of around 94 percent! What’s more, the apparent increase in the price of a barrel of oil disappears when measured against a stable commodity, such as gold, rather than against a volatile unit of fiat currency, such as the dollar.

Here’s why: Fifty years ago the price of that same barrel of oil equated to 2.75 grams of gold. Today it equates to 1.0 gram of gold – so the purchasing power of gold, measured in barrels of oil, has all but trebled.

The ability of gold to measure the ongoing debasement of virtually every fiat currency lies, of course, in its own relative stability in terms of quantity. Although there are new sources of supply – mainly mining – its extraction and production are costly and strictly controlled. And, most important, its worth cannot be debased by a central government printing press.

The example of oil also highlights the difference between sound money and fiat money, such as pounds, dollars, yen, yuan or euros. The monetary policies of virtually every central bank are likely to

aggravate this problem over the foreseeable future. Such is the prevailing level of ignorance wherever you look.

Blowing bubbles

The third point is that the newly created fiat money MUST go somewhere – and so it goes into the grasp of its first receivers, the banks, the financial institutions, government institutions, and city moneyed classes who least need it, gratuitously widening the gap between rich and poor, and thereby building asset bubbles in property, luxury cars, yachts and the myriad baubles that only the very rich can afford to acquire. So never say that “there is no price inflation” – it’s just that those asset prices don’t figure in the official CPI stats.

Fourth: The European Central Bank (ECB) is no slouch when it comes to money creation out of thin air, and banks within the Eurozone have therefore come to rely on it for survival. The solvency of Southern EU countries is dependent on the promise of limitless (‘whatever it takes, M. Draghi!’) fiat money bailouts from the ECB – but until it actually arrives they do their coercive best to prop up their insolvent banks by any means, fair or foul. In Italy, for example, the government has now ‘invited’ the country’s pension funds to invest 500 million euros in a bank fund called “Atlante”, which has been formally set up as a buyer of last resort to help Italian lenders (whose bad debts equate to a fifth of GDP) reduce their toxic burden! Invest? A joke? Having run out of other people’s money the Italian government is now trying to raid the nation’s pension funds.

Fifth: In the same refrain, you have no doubt heard reference to “helicopter money”. This is a variant of QE favoured by certain politicians who talk blithely about the need for “QE for the people”! The idea is to by-pass the treasury mandarins by dropping newly printed money directly on the people, so that they (rather than the already-rich classes) can benefit from the bonanza and aid the economy by spending their new-found wealth. Again, this notion commits the fundamental error of equating ‘money’ and ‘wealth’. If everyone suddenly finds that free handouts have swelled their bank accounts, how long will it be before prices follow? (And since even helicopter money originates at the central bank, you can be sure that the City will get its hands on it first anyway!)

The sixth point concerns the corrosive effect of the deliberate and utterly misguided suppression of interest rates which, if they were allowed to find their own market level, would represent the time-value of money, or what the private sector is prepared to pay for liquidity – either for spending now or saving for future spending.

The suppression of interest rates is yet another desperate attempt to stimulate demand, hoping that it will lead to productive economic activity. But it flies in the face of Say’s Law, which holds, correctly, that we produce in order to consume. Reversing these leads to the idiocy of “demand management” – as if stimulating demand will magically generate the production needed to satisfy that demand! If that were true, Venezuela and Zimbabwe would be vying right now for the title of the world’s most prosperous economy.

Suppressing interest rates destroys the natural measure of time preference.

Suppressing interest rates destroys the natural measure of time preference. It leaves many long-term infrastructure investment plans on hold, simply because no private sector producer of capital projects will commence a venture that cannot be reliably costed. After all, who knows when interest rates will rise? And at what economic cost to the project? Uncertainty stifles action.

The risk of misallocation of capital resources is simply too great for the private construction sector – just look at the many public sector cock-ups: there are Spanish airports at which no plane has landed, and Portuguese motorways on which there are no cars. And in this country? Just wait for HS2, new airport runways, Hinckley – and all the other mammoth ‘interest-free’ projects that get the go-ahead, having never been subjected to any reliable economic calculation.

So what do we finish up with in the productive sector? The near-zero interest rates favour short-term production schedules with minimal capital requirements, resulting in low-risk production lines of cheap goods. That’s why we have “pound- shops” and 99p shops and all the other shabby outlets that now litter every suburban high street – creating the illusion of zero inflation. Which is where we came in.

Emile Woolf

Emile Woolf

Emile Woolf is a Renegade Inc. correspondent.

Over 45 years, he has been a teacher, lecturer, best-selling author of professional texts, practising accountant, forensic expert witness and, throughout this period, one of the profession’s most widely read columnists and magazine journalists.

Emile's subject range includes the wider spectrum of economics, taxation and any related developments that have a financial dimension, always seeking to identify the principle that lies behind the dilemma.

Emile Woolf

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3 thoughts on “The Inflation Conundrum

  1. I am very interested in the theories presented on this site, but two things are missing. I would like to see much more detail to back up and reinforce the statements made. As it is I get the impression that these are no more than theories of the author. It is very easy to debunk the current practices, but without some proof to reinforce the statements they remain little more than theories and therefore lack substance. I do not believe that this is all that you are looking for.
    I also find the lack of comments puzzling. Do the readers not have strong enough opinions to get a good debate going? Or do you not want any comment? If the latter is the case I am not interested in following this website any longer

  2. Inflation.
    Given that about two trillion pounds of fiat money has been created since 1980, one would expect there to have been hyperinflation. Around half of that has been for housing mortgages and it seems to me that we have indeed had a kind of hyperinflation in that sector. Emile, when you talk about ‘the natural measure of time preference’ does that mean that the money was created for business investment? Surely that is not the case. The vast majority of business investment comes out of profits reinvested and frankly, the banks have very little interest in commercial investment unless it is ‘property’ based.

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