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Diverting
the Blame for "Inflation"
By
Steve Saville The
Speculative Investor
March
9, 2010
Below is an excerpt from a
commentary originally posted at www.speculative-investor.com
on 7th March, 2010.
It
is said that the more things change, the more they stay the same.
This is certainly true when it comes to identifying the causes of
large increases in the cost of living. Although it can be logically
established that a large and sustained increase in the general price
level could not occur in the absence of a large increase in the
supply of money, and although the historical record confirms that
every great "inflation" was preceded by a large increase
in the money supply, leading figures in economics and central
banking have consistently come up with explanations for broad-based
price rises that have nothing to do with the money supply.
A recent example of citing a non-monetary reason for a large decline
in the purchasing power of money was the amusing claim by a senior
Reserve Bank of Australia (RBA) representative that mining booms
cause "inflation". Australia has experienced rapid
"price inflation" over the past several years, so the
central bankers of that country naturally perceive the need to come
up with reasons for price rises that have nothing to do with their
own actions. A convenient explanation is the mining boom, because it
can be shown that the large gains made by commodity prices are
linked in some way to China's rapidly-growing demand for
commodities. The idea is that if the mining boom CAUSED Australia's
"inflation" problem then the finger of blame for the
problem could legitimately be pointed at China!
It was a nice try by the RBA, but the reality is that China's
actions -- regardless of what they happen to be -- cannot possibly
bring about a substantial decline in the purchasing power of the
Australian Dollar. Prices within any economy are continually
fluctuating and large localised price rises will sometimes occur in
response to unanticipated shortages of, or increases in demand for,
some goods and services, but in the absence of a higher money supply
a price rise in one part of the economy will have to be offset by a
price decline elsewhere.
Not surprisingly, the true explanation for Australia's
"inflation" problem can be found in the money supply
statistics. During the 9-year period from January-2001 through to
January-2010, Australia's M3 money supply** rose 168%. This equates
to a compound annual growth rate of around 11.5% and is the sort of
money-supply growth that could bring about a doubling in the cost of
living.
The true explanation can always be found in the money supply
statistics, yet other factors will invariably be blamed. This was
certainly the case with regard to the great "inflation" of
the 1970s. According to many pundits, the troublesome broad-based
rise in prices of the 1970s was set in motion by a series of supply
shocks, the most important being the collapse of the Peruvian
anchovy harvest in 1972 (anchovies from Peru were processed into
fishmeal, a major source of feed for livestock and poultry
throughout the world at that time) and OPEC's restriction of oil
supply in 1973. Other factors to be cited as causes of
"inflation" during the 1970s were the increasingly
aggressive demands of labour unions and the Iran Hostage Crisis.
There have always been supply shocks and other disruptions, but
these supply shocks have only ever been accompanied by large and
sustained losses in money purchasing power when there was also a
large increase in money supply. In this respect, the 1970s was no
different to any other period of high "inflation". Those
who believe in fallacious neo-Keynesian concepts such as
"cost-push inflation" and "demand-pull
inflation" should explain why the currency never recovers its
purchasing power once 'costs stop pushing' or 'demand stops
pulling'. Why, for instance, did the US$ fail to recover ANY of the
purchasing power it lost during the 1970s after that decade's
commodity shortages went away?
Interestingly, even the most spectacular inflationary episode of the
past century was blamed on factors other than money-supply growth.
We are referring to the Weimar inflation of the early 1920s, the
cause of which was held -- by the central bankers at the centre of
it -- to be a combination of Germany's war reparations and the
activities of foreign speculators. The central bank's rampant
monetisation of government debt was, apparently, not relevant.
In conclusion, it's a fact of life in a free or semi-free economy
that relative prices will be continually adjusting in response to
changes in the supply of and the demand for different goods and
services. Therefore, when an "inflation" problem occurs it
will inevitably be accompanied by non-monetary events that cause
prices to rise sharply in some parts of the economy. These localised
price rises will, in turn, create an opening for the central bank
and/or the government to point the finger of blame at things that
are clearly outside the control of the monetary authorities;
however, the propaganda can't work if the populace understands that
only an increase in the money supply can bring about a large
economy-wide rise in prices.
*When we put quotation marks around inflation
it indicates that we are giving the word its popular meaning (a rise
in the general price level), as opposed to its correct meaning (a
rise in the money supply)
**We don't have TMS (True Money Supply) data for
Australia, so we will have to make do with M3.
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