Understanding Finance from scratch

Chapter 39 In the past, a house could be bought, but today it is only worth a bottle of wine—Finance to be concerned about inflation (2)
Economists have searched for a long time to understand the causes of inflation.Regarding the cause of inflation, the Austrian school first put forward a controversial point of view. They pointed the culprit of inflation to the government. Von Hayek once pointed out that the government controlled the history of currency and caused the instability of the monetary system.He severely criticized that the monetary policy controlled by the government is the main cause of inflation, and that depreciation of currency is the result of government actions no matter when and where.Why not rely on the spontaneous forces of the market to provide the medium of exchange that people need?
Immediately afterwards, Ludwig von Mises, the new leader of the Austrian School, pointed out more severely: "Only the government is an institution that can not only print blank paper as money for consumption, but also print paper money indiscriminately so that it becomes Worthless." He argued: "I don't think it's an exaggeration to say that history is mostly the history of inflation. Generally speaking, inflation is something that governments have crafted for their own benefit."

Here are some of the main reasons cited by economists:
(1) Inflation makes our national debt more manageable because we can pay it back in cheaper dollars.

(2) In a democratic country where the entire population is indebted, the government naturally chooses a monetary policy that favors the debtors in order to win elections.

(3) Inflation helps to ease the government's financial pressure to achieve the social projects required by voters, thereby avoiding options that are not conducive to political elections, such as raising taxes.

(4) Inflation is easily confused with economic growth, and economic growth is easily confused with healthy economic development.Of course, theoretically speaking, GDP takes inflation into account, but whether the inflation figure is artificially manipulated is unknown.

(5) Inflation causes nominal asset prices to rise, such as stock and real estate prices, thereby creating an illusion of wealth creation for voters, even though the actual purchasing power of their assets has declined.

Therefore, out of consideration of its own interests, the government is creating inflation on the one hand, and covering up inflation on the other hand.Finally, let us remember Alan Greenspan's description of inflation in "Gold and Economic Freedom" written in 1966: "a scheme for the secret confiscation of wealth".There is nothing wrong with it. For example, Bernanke once gave a speech at the National Economist Club in Washington, DC.In this speech, he played a metaphor of dropping money from a helicopter, saying that the US economy can achieve high growth through government fiscal (lower taxes) and monetary policy (printing money).This is the famous "helicopter theory", which is basically advocating inflation.

Well, let's go back to the original question: What is the cause of inflation?
Cost-Push Inflation: This view holds that inflation is caused by an increase in production costs.If resource prices increase without a corresponding increase in productivity, it will eventually lead to higher product prices.For example, for an automobile manufacturer, the cost of steel is the price at which the steel manufacturer sells the steel, and when the price of steel rises, then the cost of automobile production increases, which brings about an increase in the overall price level.

Demand-Pull Inflation: This view holds that inflation is caused by excessive growth in aggregate demand as the price level rises due to excessive aggregate demand.The price level rises because too much money chases too few products, or because the demand for goods and services exceeds the possible supply at prevailing prices.

Monetarists believe that in a stable economy, the money supply and the quantity of goods and services are generally in a balanced relationship.Of course, within this framework, if the demand for a good or service changes, its price will also change.However, this change is offset by other changes within the system.That is, aggregate demand and aggregate price will remain unchanged.

The only thing that causes aggregate prices to rise is an expansion of the money supply, or a contraction in the supply of goods and services, which are essentially two sides of the same coin.By blaming demand for rising prices, the government is effectively explaining inflation as economic growth.That is, we become victims of our own success.But in fact, economic growth in the true sense will lead to lower consumer prices, because economic growth means an increase in productive output, that is, an increase in the quantity of goods and services.Thus, in the absence of any change in the money supply, consumer prices will naturally fall.

To make a simple analogy, when people explain why they get wet, they always say that it is because of rain, not because of the high pressure going south and meeting the cold air. Similarly, when people face inflation, they only know that the cost increases. Demand pull, people don't know the root cause of money growth.And everyone knows that in modern society, only the government has the right to print banknotes. Therefore, the cause of inflation is that the government has issued excessive banknotes.This is the cause of inflation, and the only cause of inflation.

Fighting Inflation
Zimbabwe's inflation rate in July 2008 was astronomical: 7 million percent. In January 2.31, the central bank issued 2009 trillion Zimbabwe dollar banknotes, with 1 zeros behind the 100, which is also a world record.In order to curb the runaway inflation, the Zimbabwean government officially abolished the national currency in April, announcing that the U.S. dollar and the South African rupee would be used as currency in circulation, but the old Zimbabwean dollar continued to circulate among the people.

In Zimbabwe, once you leave the metropolis, it is hard to find a strong currency.Bus drivers in the city have a small amount of US dollars or South African currency for change. Although there are no shops in the countryside, the mountains are not turning around. The shops will give customers candy, chocolate, or indicate on the receipt that they can enjoy a discount for the next purchase.In the capital city of Harrera, an aunt took a bus with banknotes worth 3 trillion Zimbabwean dollars, just to pay the fare once.What's more interesting is that the uncle driver didn't bother to count at all, just accept it.

Inflation is a problem that we have to face in our daily life, so how can we fight inflation?
Inflation is a worldwide problem. For many years, economists have been thinking hard about solving inflation, and of course they have made great contributions to clarifying this problem.

In the field of economics in the 20th century, there was a great economist who was as famous as Keynes, and he is also the most influential economist in the world since World War II.He was also a monetarist whose direct and indirect influence on modern monetary economic theory was immeasurable. His name was Friedman.

Although as famous as Keynes, Friedman's economic theory ran counter to Keynes's. In the economic circles at that time, Keynes' theory advocating government intervention in the economy was in full swing, while Friedman's theory was just the opposite. He opposed Government intervention in the economy, that government intervention often exacerbates economic fluctuations.

Friedman established the monetarist school of thought. He believed that regardless of expansion and contraction of monetary policy, not only would not stabilize employment and prices, but would worsen the situation. Prices and employment may fluctuate greatly. Therefore, by controlling the quantity of money Economic fluctuations can be smoothed out by stabilizing prices.In one sentence, inflation is only a monetary phenomenon, so how to fight inflation?
First, Friedman's prescription is that inflation will not occur only if the growth rate of money is consistent with the growth rate of production capacity.As much as the economy develops, the money will grow as much. As long as the money supply is controlled, there will be no inflation.Friedman even suggested that it would be better for the computer to replace the function of the central bank. It is only necessary to set the currency quantity on the computer to have a stable growth rate.He once mocked the Keynesian monetary policy like this: "We can replace the Federal Reserve authorities with a horse. On the first day of each year, this horse will stand at the gate of the Federal Reserve headquarters to answer questions about monetary policy." Reporter Will ask: "How will the money supply develop this year?" The horse stomps 4 times, and the next day the newspaper will print: "The Fed will increase the money supply by another 4%."

In 1973, after the Chilean military coup, Pinochet came to power. At that time, Chile was in chaos, with widespread unemployment and serious inflation coexisting. The Pinochet government invited Friedman to give advice on Chile's economic pain. Deman implemented shock therapy, slashing government spending and reducing monetary aggregates. Although such measures effectively suppressed inflation, Chile also experienced a severe recession, with national income falling by 13%.Discussions about reforms in Chile continue today, but in any case, Friedman is remembered throughout the world for his lifelong defense of his liberal ideas.

Well, now we know a way to fight inflation: control the money supply.What the government had to do in order to reduce inflation was to increase the money supply at a slower rate than the economy grew, which was the basis of Mrs Thatcher's economic policy, and this approach was eventually abandoned.It was abandoned because the government was never able to meet its money supply growth rate target.

Although this is a simple and easy way to curb inflation, few people dare to use it. This method is like blocking the fuel needed for the engine of inflation to slow down monetary growth.Unfortunately, because of the high demand for money associated with high inflation, an attempt to suddenly reduce the money supply would cause interest rates to rise sharply, triggering a severe economic contraction.

Second, adjust through monetary policy.For example, in order to slow down inflation, the central bank adopts the policy of raising interest rates to guide the rise of market interest rates, which increases the cost of financing for enterprises and bears more interest expenses, thereby reducing the demand for investment.On the other hand, more funds will flow into the banking system, which will help curb consumption and ease the transitional economy.During Greenspan's tenure, the realization of this goal relied too much on personal judgment rather than institutional guarantees.There is no doubt that Fed policy has real effects on output and employment, but these effects are temporary.

But things didn't work out that way. In 1979, Paul Volcker, then chairman of the Federal Reserve, began to thoroughly control inflation.For a while, interest rates in the United States were above 20%, and the country's economy fell into recession, although the specter of global inflation has since disappeared.But Walker, who later became a professor at Princeton University, still recalls that experience very painfully, and he seems never to want to mention that time again.

The high interest rates imposed by Volcker reduced real GDP by about 1982% in 2, while unemployment was nearly 10% that year.It is said that angry farmers sent sacks of rotten food to Volcker. The emotional crowd even brandished a machete in the Fed's conference room. A Republican candidate for the U.S. Senate even said that Volcker's "high interest rate policy is killing the U.S. economy and putting millions of Americans out of work," amid fears that this deepening recession will turn into a depression.Until 1983, the rate of money growth gradually started to improve, all slowly getting better, and while Volcker is ultimately credited today with eliminating double-digit inflation, the actions he took at the time were widely criticized attack.

In fact, many central banks around the world have adopted the strategy of inflation targeting in recent years.They choose a specific inflation target, say 2%, and then raise or lower interest rates as needed to keep inflation at or near the target.One of the many advantages of inflation targeting is that it prevents the economy from falling into an inflationary spiral.If the central bank has full credibility in beating off any tiny bit of above-target inflation, it needn't worry about fighting a bout of severe inflation at all, because such inflation will never occur.

Third, abolish the central bank system and allow private currency issuance.The Austrians, following in Friedman's mantle, were staunch defenders of traditional laissez-faire economic policies.They believe that due to the existence of the government's monetary monopoly, the conditions for the free activities of the private sector are restricted, thus hindering the effective operation of the market mechanism.Their representative, Hayek, believes that if the right to issue currency is conquered and monopolized, it will inevitably bring about market instability, unemployment and inflation.Therefore, the Austrian school was the first to explicitly propose a revolutionary solution to inflation: abolish the central bank system and allow private currency issuance.

(End of this chapter)