What REALLY is inflation?

in #economy5 years ago (edited)

There are two misconceptions that are commonly taken for inflation; the first, that inflation is the generalized increase in prices; the second, that inflation is only the increase of monetary issue. Both generated from a confusion between the cause and effect of inflation, but cannot be classified as such, since inflation is a major economic phenomenon, although not for that difficult to understand.

The popular myth in which it is stated that inflation is the general rise in prices, and consequently, the loss of purchasing power of the currency, is simply not true. First, because prices don't rise in a homogeneous way or uniformly, and although it may rise in a generalized manner, they don't do so at the same pace or at the same rate. Some prices go up faster and higher than others.

Second, the rise in prices, generalized or not, homogeneous or not, is only the manifestation of another event that precedes it, and which we can access through abstraction. That is, the rise in prices is not inflation itself, but thanks to that symptom, we can diagnose what the original problem is, that is, understand the inflationary phenomenon.

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What really causes the rise in prices is the increase in demand, that is, consumption. The reason why the price of a product rises is because it consumes all of its existence, exhausting the amount of available supply, which, in turn, generates an unmet demand, and when this happens, the opportunity arises that someone or something can satisfy it, but to do so, necessarily, prices must be increased, and in turn, this makes the price rise in a general way.

This raises a question, why should prices increase?

The fact that there is a unmet demand, presupposes that those who offer the product cannot, or don't want to, produce more at the same price that is stipulated in the market. That is to say, that the companies or the individual that offer a product do so because that is their will, or simply because their capacity does not allow them to produce more. In both cases, what will drive producers to increase supply is the increase in prices.

You will think, "If production increases, and the same price is maintained, the producer will earn more, why not increase it without raising the price?"

And yes, you would be right to think like that, of course he will earn more, and in fact, it is possible that that's what he will do, but as I said, at some point his production capacity will be exhausted, he simply cannot produce more with the amount of resource he have available.

In order for the producer to increase the supply, in turn, he must consume more resources, and the problem of that, generally, is that at a certain moment the production chain faces two concepts that are ultimately the generators of inflation, and which are known in economic terminology as the Production Possibility Frontier and the Opportunity Cost. Which basically tell us that to produce a certain product, it requires a certain amount of human capital, material resources and time, and that all these, in turn, are limited, so to produce more of something, unless that there are idle resources, necessarily requires that the production of something else be reduced.

For example, if the producers wanted to increase the supply of milk in the market, at some point they would have to be forced to reduce the production of the cheese industry, and in turn, the increase in the supply of beef would have to reduce both the production of cheese and milk, that, of course, as long as there are no idle cows.

When a consumer decides to buy milk, and not cheese, makes a decision in the market, the milk producer gets more capital than the cheese producer, and as a result, can buy more cows, and thus allocate a greater amount of resources to the production of milk that of cheese. After all, why not produce more milk than cheese, if people are consuming more than one of the other?

The problem occurs when the consumption of milk and cheese increases in similar proportions, then, there is a dispute between the producer of cheese and milk for trying to acquire the available cows, and as the farmer who owns the cows wants to get the greatest possible profit, he will sell it to the one who offers more money for them, which means that regardless of who gets the cows, the price of cheese and milk increases for consumers, one directly for shortage, and the other for costs.

On the other hand, if the producers simply did not have the will to increase the supply by their own means, or were legally incapacitated to do so, what would happen is that the unmet demand presented in the market would be satisfied through a resale mechanism, that is, those who have access in the first instance to the purchase and sale of a certain product, could resell the product in a secondary market, of course, what would motivate them to do this, again, is the increase in prices. Then, we would see a scenario in which the price increases while unmet demand persists.

From all this we can deduct a single thing, the rise in prices is generated when is consumed more than what was produced until then, that is, when the consumption capacity is exceeded, which is why it is required to produce more than what was previously produced. It is the increase in consumption that causes the increase in prices.

Why does consumption increase?

Consumption can increase basically for two reasons. The first is the increase in population, that is, the more mouths to feed, the more food is needed, however, the more people, the more human capital available, which also represents an increase in production capacity, so unless natural resources are scarce, there should not be inflation. The second, and that basically is our current problem, is the increase of the money supply, that is, the production and distribution of money, in the hands of people willing to use it, and who actually do it, increases consumption, and consequently, that generates the previously mentioned scenario.

Let's see a bit of history to understand better.

By the year 1453, still in the feudal Middle Ages, the Ottoman Turks would finally succeed in conquering the city of Constantinople (now Istanbul). The decadent Byzantine empire, the last link of the unrecognizable Roman Empire, would finally collapse, giving, in turn, control of Asia Minor to the powerful Ottoman empire, which, at its height, would achieve a united dominion with presence in the three old continents, and take control of the all-important silk road.

This milestone would be his blessing and, in turn, his curse, what gave them power would eventually take away in less than a century. The Ottomans, between their struggle with the West, and aware of the advance of Christians in the Iberian Peninsula, would end up disintegrating the last commercial connection between Europe and Asia, placing Europeans on the verge of a crisis.

In these circumstances, Europeans on the edge of the abyss and unable to face the Muslims, were given the task of circumventing the blockade, a question that would be dealt with by the mobile frontiers of the West; Spain and Portugal. We already know this history, the Portuguese would circumnavigate the gigantic African continent, beginning the Age of Discovery, for their part, the Castilians, with the help of Christopher Columbus, would arrive for the first time to the American continent, an event that would completely change the course of all human history.

The amount of precious metals that would enter the European continent because of colonization was so high that it is here where the flame is lit for a new revolution, an economic revolution.

The increase in the supply of gold and the presence of precious metals, would create for the first time an important state of inflation in what is known as the "Price Revolution", Europe would know levels of inflation never seen until then, approximately 1% annual. The Spaniards would be the first to notice this, realizing that the prices of basic products increased more in places where gold was abundant than where it was scarce, the same bread could cost more in Spain than in France.

The abundance of gold soon spread throughout the West, causing all products in international trade to increase in price, and making Spain richer, which caused a disaster in economies that had not increased their coffers, and that now they needed more metals to buy the same, and yes, we are talking about nations like the Ottoman Empire itself, which would enter a period of economic decline.

I have resorted to history, in order to find a moment where what we call fiat money did not exist, or was simply not used, to explain in this way that any inorganic increase in the amount of money, be it gold or paper money, will generate inflation.

If the amount of money remains static, to buy more cheese it would be necessary to reduce the consumption of milk, or another product, so that the rise in prices would not occur in a general way, but would focus only on those products with higher demand, however, when the amount of money increases inorganically, people have the possibility of increasing the consumption of the entire product matrix, and therefore, the natural thing is that everything rises in price, because everything is being demanded in greater quantity, that is, we see the effect of inflation; the general rise in prices.

So here we realize that if the increase in prices is relative to the increase in consumption, in the same way, the general rise in prices is the manifestation of the generalized increase in consumption.

When I speak of inorganic money, I speak of any monetary system that is disconnected from work. The problem is not that paper money has no value and that gold and silver do have value, the problem arises when money is produced faster and in greater quantity than the goods that will be bought with it are produced. Inflation will occur regardless of the monetary unit, it does not matter if it is digital money, if it is paper currency, if it is gold or silver, as long as there is more and more money and the amount of resources remains equal or less, it will occur, as a consequence of scarcity, a general rise in prices.

When money ceases to be an instrument used merely to exchange the goods produced, and becomes an element to consume without having previously worked, that is, it becomes credit, surely we will experience inflation.


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Nice resume of the thing XD

@vieira

Great post! I would have thought that you would include the quote about inflation which you used in a comment a few months ago... can't remember the exact words but it comes down to people are purposefully confused as to what the word inflation means hence the lack of conformity to define it. People are easier to bullshit if they are confused.

Maybe I should have, but this time I started the post from scratch. I had just had a discussion about inflation with another user, and I decided to write a post as complete as possible about inflation, removing the axioms that are generally not understood by many, and explain the dispute that arises when producers demand more resources.

People are easier to bullshit if they are confused.

Yes, I guess that's the way it is.

Thanks and regards!

Great explanation what inflation is about @vieira

he first, that inflation is the generalized increase in prices; the second, that inflation is only the increase of monetary issue.

This is indeed very common belief.

Second, the rise in prices, generalized or not, homogeneous or not, is only the manifestation of another event that precedes it, and which we can access through abstraction.

Wouldnt you agree that rises in prices are also caused by property market? After all if rentals are more expensive, then costs are growing and it may push prices forward as well. And it wont have anything to do with inflation.

Yours
Piotr

I think the opposite could happen, because if people are spending more money on rent, then they have less money to spend on other products.

The increase in rent could have an effect similar to that of taxes, with which most of the time it is sought to reduce inflation.

Again, thank you very much for stopping by, greetings!

hi @vieira

I think we didnt understand each other. What I ment is that since rental prices goes up, then manufacutring and many other services will be more expensive. So final price of goods and services is increasing.

Yours
Piotr

Really it is difficult that the increase of the rents causes by itself that result, unless in that hypothetical situation you describe the whole raw materials industry must pay a higher price for the rental of their property, which except for a situation in which the government raise taxes, it is very difficult to occur in a widespread. In that case, what is known as "cost-push inflation" would be generated.

Dear @vieira

Thank you for your comment.

So just to summarize: Let's say that you want to buy milk from your shop.

Not only it has to be manufactured (price of land / rental of property etc will already increase overall cost of manufacturing).

Then you have network of shops selling that milk. And rentals are also part of the cost.

You've shipping companies. They also rent offices etc.

At the end cost of rent is affecting everyone on the way.

If cost of land/properties/rent would increase heavily then it would push prices up of everything. Which cause inflation and it is still not related to printed money.

Am I right or is my thinking process wrong?

Yours
Piotr

In that hypothetical case, it could be said that yes, but then, as I said, we would have to ask ourselves, did all the rents go up in price? What happens to the owners of their own land who don't have to pay rent? Why does the price of rents rise?

Hopefully more highschool and college student will read this. Your article was much better than many I've seen on https://mises.org

I'm glad you liked it, and very thanks for that.

Gold coins were first used by the Lydians as currency because Croessus, or his forebears, minted worthless yellow alloy into coins, with which he paid his mercenary army. These coins were the only commodity accepted as the form of tax remittance, which gave it value. The only "value" of Lydian coins derived from Lydian tax system. It is much the same with the modern world. The much maligned fiat is no different from gold coins, as their value derives from taxation and central government.

The type of currency, or means of tax remittence, can have far-reaching consequences for sociopolitical development. The Incan empire's currency, much like that of feudal Christendom, was that of labor-time. As such, even though the Incan empire rivaled and even surpassed Europe in centralization and autocracy, their empire was characterized by frugal use of existing resources, specialized regional production, and sustainable expansion. Similar sociocultural characteristics can be observed in feudal Christendom. The transition from labor-time remittence to specie remittence in Europe allowed for the credit expansion and inflationary pressures outlined above. It may be that non-perishable commodity used as wealth measure/tax remittence lies at the foundation of inflation, credit bubbles, and market "cycle."

Excellent addition!

Interesting, I did not know about the system of the Inca empire. But I agree, I'm not surprised that this happened.

Indeed, I believe that what we must understand is that any monetary unit, no matter what it is, is susceptible to generating inflation if the work and the creation of new wealth is separated from the issuance of money. Regards!

Hardly anyone understands the money economy. Our schools and training companies do not teach this, although a manufacturing company could do it much better than a telecommunications company. The ignoring of circular thinking and the splitting of reality and virtuality has probably taken its course from the moment when manpower was paid with money. Perhaps even earlier. Perhaps from the moment man stopped living from hand to mouth. He began to hoard things, to store them and to own land.

In principle, the economy is always linked to ecological, biological and geological resources. But an artificial separation has taken place and that is why money has become a virtual affair, which unfortunately has very real consequences.

If money is drawn from nowhere, it can promote unchecked consumption, and that is exactly what is happening. I regularly wonder how my country is so smoothly serving the growing demand for electronic goods. I have come to the conclusion that this is why food is so cheap. We seem to have enough means of power to produce our food cheaply elsewhere in the world so that we can cope with rising rents and cheaply buying food.

Actually, I suspect this is one reason why I have never cashed out here at Steemit. My account, which has grown continuously through my mental commitment to literary products, has emerged from nowhere. A very strange thing comes into play here: to judge whether the use of energy is of quality. Many people complained that people simply earn their coins with very little or no use of energy. There is something to it.

I hope, my sons English is going to improve, so he can read your article one day :) - Or maybe I should make a German translation.

It is, in fact, as you say, the link between consumption, work and the scarcity of natural resources has been broken. In fact, I think that somewhere I read that currently the consumption of society has exceeded the amount of natural resources that the planet can replace in that same period of time, something truly regrettable.

Again, very thanks for that.

This post I have to take to my e-reader to digest slowly. Fine pictures you have chosen. Thanks.

Thanks to you for stopping by, greetings!

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