Thursday, June 6, 2013

The Intelligent Woman's Guide to Inflation

I suspend my study of Bastiat’s “The Law” not only because the material is quite difficult to handle, but also because my reading interest shifted to Christian economics. The present article is a summary and reflection of Chapter 2 of Gary North’s “Introduction to Christian Economics”. North gave a very interesting title to this chapter, “The Intelligent Woman’s Guide to Inflation”.

Chapter 2 is all about inflation. For North, this is a very important subject that every taxpayer has to understand. To him, inflation is “the most pressing economic question” (Gary North, An Introduction to Christian Economics, 1974, p. 20). In chapter 3, he also said among the dangers to free market economy, inflation is the greatest both historically and theoretically (p. 29).

In explaining inflation, North deals with 6 interrelated subjects, but I only want to focus on 4 of them – definition of inflation, basic properties of money, origin of modern banking and inflationary policies.

Meaning of Inflation

North started his essay with a working definition of inflation. He identified two basic definitions:

1. An increase of the money supply; and

2. An increase in the prices of goods and services

Number 2 is the definition known by the public, but North used the term in his essay using the first definition.

Money’s Properties

North then enumerated the basic properties of money. These are durability, transportability, divisibility and scarcity. Understanding the importance of the fourth property is critical to see the illusory foundation of existing monetary system, which violates this important basic property of money.

Origin of Modern Banking

Third, North narrated a brief history for the origin of modern banking. He started with ancient history and then proceeded to medieval period.

During ancient time, says North, the Roman Empire practiced inflation by counterfeiting the existing gold and silver coins. The Empire did this by “adding cheap metals into the molten gold or silver, yet calling the resulting coins pure” (p.21). Such deception resulted to the reduction of value of coins and the loss of their purchasing power.

In the Medieval Period, the role of the Roman Empire was replaced by goldsmiths and metalworkers who were later known as “bankers”. They are the ones who introduced the idea of storing precious metals. The people trusted them and so the silver and gold coins of the public were given to them for safekeeping. The people received IOUs as “money substitutes” for their coins in the vault. However, people became more interested with money substitutes than gold or silver coins. Bankers devised a scheme to maximize their profit. They issued more IOUs than what they actually possessed in their banks believing that people will not take their deposits simultaneously.

Such simultaneous withdrawal is described as “bank run”. Bankers fear such event. Such panic on the part of depositors is occasioned by the loss of confidence in the ability of the banks to meet their responsibilities. The 1930’s is usually referenced as a typical example of such panic where 9,000 banks collapsed (p.22).

Inflationary Policies

North then describes what he called as “the central flaw of all inflationary policies” particularly in relation to the development of paper money. He explains it as follows:
“…citizens decided to trade certain money metals for scarce consumer goods and services. They later consented to use paper claims to money metals as convenient substitutes. But paper and ink are in large supply, unlike gold and silver; it is far easier to print an IOU for a thousand silver dollars than it is to mine the silver, smelt it, and form it into the actual thousand coins.” (p. 22).

This development destroys the fourth basic property of money, which is scarcity. Such violation results to devaluation of existing monetary unit or the increase in the value of goods and services.

The sectors of society that suffer the most in inflating the money supply are those who depend on fixed salary while the groups that benefit from inflation are politicians, bankers and the suppliers of goods and services to the government.

To illustrate the economic destruction caused by inflation, North returned to Germany’s experience in the early 1920’s. Germany that time was operating “over 300 paper mills and 2,000 printing establishments” to print German marks, Germany’s money that time. We were told that the change in the value of Germany’s money that time was so fast that its original value in the morning was no longer the same in the evening. I think there is no worst case to illustrate how inflation destroyed Germany’s economy that time than the fact that a loaf of bread would cost 1.25 trillion marks. Unemployment became widespread, savings were wiped out and German marks turned worthless. Economic depression prepared the way for the rise of the Nazi dictator.

Personal Response

Do Americans learn from Germany’s experience? The existing economic situation of the US tells us that they did not learn from the past, but is actually heading towards similar path of economic destruction. When North wrote this essay, the price of gold was $41 per ounce and US national debt was $353 billion. After 44 years, gold now costs $1,598 per ounce and US national debt is closed to $17 trillion. I just wonder if Gary North’s analysis is correct, how come his predicted “economic collapse” is not yet taking place? Instead, we have been hearing from mainstream news that 2008 economic crisis has already been solved! Or maybe, “the day of reckoning” has just been extended due to Federal Reserve’s commitment to indefinite QEs.

Now, why am I interested in all of this? Why worry about American crisis whereas the Philippine economy is now experiencing a boom?

I am not an economist, but I am entitled to my own opinion. I suspect that our “economic boom” is not based on solid economic practices. It is a “spill out” of what’s happening both in the US and the EU. At least in their case, reality is setting in and I am hoping that economic illusion would gradually fade. But they are transporting such illusion into our shore and we welcome it with open arms.

I do not doubt that those at the top are ready to reap the financial rewards of living in economic illusion. But as all artificial “booms” end in “busts”, I think it is important that Filipinos should understand the role of “imported inflation” that drives the growth in our stock market for us not to be caught unprepared once this illusion starts to fade.

Note: Originally posted in Studies in Economics and mirrored in Acts of the New Commonwealth last April 2, 2013