Inflation for Snots 2

by Richard Morris

In Part 1, we learned the high price of tickets to the rock rap massive metal band Snot Heat Ice Tooth concert in Reykjavik, Iceland did not cause inflation.

We also covered that economics is the study of the use of limited resources that have alternative uses. The fundamental question is simple: What system should we use to allocate resources? The basic choices are either orders from the government or the free market. There are blends of these two, but there is no other fundamental choice-even though some would like to pretend there is by applying price or government controls.

Then we examined inflation, which is a general increase in the prices of goods and services. Like the tide coming in and lifting all boats, inflation causes the price of everything to go up. What causes this?

Inflation has one cause - and only one

Inflation comes from printing legal tender - that is, printing money, or creating the modern digital equivalent. It has nothing to do with tickets to the Snot Heat Ice Tooth concert, and although it might be news to CNN and Paul Krugman (who self-identifies as Keynesian and liberal), real economists have known this for hundreds of years.

Even Krugman, for example, tweeted on February 7, 2021, "The constraint is political, not financial; what we need is a program that delivers tangible benefits to voters, showing them that govt can do good." He places votes above economics.

Economist Milton Friedman accurately said: "Inflation is always and everywhere a monetary phenomenon." He should have left this 1990 statement at that, but he didn't.

In 1994, he expanded the statement and committed an error. He said: "Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output." While that is true, it is misleading in the sense the statement implies (1) prices should remain the same forever and (2) it is possible to measure gross output in order to increase or decrease the money supply.

Monetarism posits that the government's job is to control the amount of money in circulation - that is, by issuing fiat money in amounts decided solely by the government. Monetarists assume monetary policy by the government is proper, then argue that the objectives are to control the money supply to keep prices the same as they are now - whatever "now" means. That is the fatal flaw.

Why are the prices now the "proper" prices? Why should they remain the same in the future? Why not lower prices later for the same goods and services?

Friedman and Krugman probably disagreed on everything else, but they both agreed the government should control the money supply. Where they differ is the how, when and why.

Friedman advocated the free market, or capitalism. He wisely said: "The great virtue of a free market system is that it does not care what color people are; it does not care what their religion is; it only cares whether they can produce something you want to buy." The free market is the only system where everyone is equal under the law. Equality of opportunity, but not of result.

He also said, again wisely: "When government in pursuit of good intentions tries to rearrange the economy, legislate morality, or help special interests, the cost come in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player." Why? Because anytime the government becomes an active player by picking winners and losers, it interferes with the market. That interference rewards friends and sends false signals to all others who participate, to the detriment of the general population. Friedman, again, is correct.

Even if one trusts government, governments do not have a good history of picking winners-but losers have a great history of picking governments. Witness the Solyndra fiasco. Obama praised this company for its innovative and extraordinary manufacturing of solar panels. It got a $535 million loan guarantee from the U.S. Department of Energy. Solyndra also got a $25.1 million tax break from California and a tax break from the DOE. The company started in 2005, and went bankrupt in 2011. DOE took a $528 million loss.

Beyond winners and losers, we can't trust the government. If we learned only one thing from the Covid pandemic, it should be that official government narratives are politically slanted and often untrue. Government should never be an active player in business or money.

Friedman was a champion of monetarism, if not the originator, which holds the government should be an active player in the market through monetary policy. Monetary policy says the government controls the amount of money in circulation. In practice, this process necessarily rewards friends and sends false signals to the market economy, to the detriment of the general population.

Friedman was a great economist, yet he advocated (1) the government not to be an active player in the economy and also (2) to be an active player in the economy. These are patently mutually exclusive positions, meaning that if either one is true, the other cannot be true. Both might be wrong, but at least one necessarily is wrong.

Why didn't he see he was holding mutually exclusive positions? He died in 2006, so we will never know, but we must not make the same error. Therefore, we will briefly examine Friedman's famous idea of  monetary policy.

"Monetary policy" is impossible

One of the main reasons socialist societies fail is that no one person, or council of super-intelligent people, can make the innumerable daily economic decisions made by the individuals within that society. Thomas Sowell, Ludwig von Mises, and many other economists noted that no single person or council can accurately decide which products and how much of any particular product a society should produce because this requires knowing the individual decisions of every person, collectively amounting to trillions of decisions made daily.

The Soviet Union, under central planning, was famous both for shortages of essential goods, as well as warehouses bulging with unneeded other goods in the wrong place, because central planners constantly made mistakes.

This truth applies just as much to fiat money.  How much fiat money should the monetary authority inject into the economy,  or how much should it extract? Tough question. But there is more: How to do the actual calculation for that number?

Consumer Price Index (CPI)

How do we measure inflation? Here's a shocker: we can't, at least not with any precision.

It's surely not the Consumer Price Index (CPI). We can calculate the ocean's tide because it does not involve anything other than the height of the water that we can measure using a standard, non-changing, ruler. But not so with inflation, because there is no such measuring stick.

Economist Murray Rothbard said it best: "Any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate. Even pounds of sugar and pounds of butter cannot be added together, because they are two different goods and their valuation is completely different."  

Trying to measure inflation by adding up product prices is not accurate, so the government "weights" them to compute the rate. To make matters worse, the government arbitrarily decides what goods to include and the weight given to each item in compiling the CPI. The con game is to make the government look good.

The CPI is a primitive tool, much like the first magnetic compass pointing to the magnetic north pole, not the true north pole. The needle was unstable, wiggled, oscillated, and dipped. The earth's magnetic field does not align with the lines of longitude we use for navigating. The compass is also subject to deviation and variation errors. Yet, it was their only tool, and better than nothing. Likewise, the CPI is the only tool we have to measure inflation. And, alas, as flawed as it is, it gives us a clue.

How much fiat money to print or burn?

For the same reasons as the inability to measure inflation, monetarists cannot measure how much fiat money to print or burn. This makes the application of their idea impossible.

And the problem gets worse. As soon as you introduce government into the market, you invite corruption. In this case, who decides how much fiat money to add or withdraw? How much does it cost to "buy" that person? I hope you are not surprised to learn that corruption is, and always has been, rampant. You might be surprised to learn politicians are cheap.

What about the market? Well, all items constantly change in relative value to other items-including money. There is no such thing as a "fair price," a concept embedded in the first written law, the Code of Hammurabi, some 4,000 years ago, and shown to be in error ever since.

But gold has a different status, with a long history of stability as money and a commodity. Its value also changes relative to other stuff on the market.

Friedman agreed. On July 4, 1977, He wrote an article for Newsweek entitled "Fair versus Free." He wrote:

When "fairness" [or "fair" trade] replaces "freedom" [or "free" trade] all our liberties are in danger.

..

There is no objective standard of "fairness" [or "fair" trade]. "Fairness" [or "fair" trade] is strictly in the eye of the beholder. To a producer or seller, a "fair" price is a high price. To the buyer or consumer, a "fair" price is a low price. How is the conflict to be adjudicated? By competition in a free market? Or by government bureaucrats in a "fair" market?

Businessmen who sing the glories of free enterprise and then demand "fair" competition [and "fair" trade] are enemies, not friends, of free markets. To them, "fair" competition [and "fair" trade] is a euphemism for a price-fixing agreement [and trade protectionism]. For consumers, the more "unfair" the competition [and trade], the better. That assures lowest prices and highest quality.

These are mutually exclusive positions. If one is true, the other is false. How could Friedman write this and at the same time advocate that government bureaucrats should control the money supply?

So, following the teachings of Niccolo Machiavelli, that politics have no relation to morals, all governments now print fiat money. The only difference between government and Monopoly© money is that the former says "Legal Tender," and the paper costs more.

Anyone over 40 can remember that the price of everything in fiat money is higher today than twenty years ago. But, the rising fiat money tide is not a natural phenomenon like the ocean. It is solely created and controlled by the government printing the money. That is why inflation varies among fiat money-issuing countries. Their printing presses run at different speeds.

Not only could inflation not occur in the free market, the value of money would increase for reasons beyond the scope of this article. In other words, the money you put under your mattress for your old age would buy more stuff later than now. Let that last sentence sink in.

Because most people genuinely don't understand inflation, this fact needs emphasis: The government, through the Federal Reserve, is the only reason inflation exists in the United States. Our money is under the Fed's complete control, and fiat money inflation always occurs when government entities want to buy votes and approval.

In his various writings, Rothbard and many others present evidence and reasoning to justify his conclusion that, as he says, "the soundest monetary system and the only one fully compatible with the free market and with the absence of force or fraud from any source is a 100 percent gold standard. This is the only system compatible with the fullest preservation of the rights of property. It is the only system that assures the end of inflation, and with it, of the business cycle." The end of inflation and boom-and-bust.

In arriving at his conclusion, Rothbard expected objections. So he anticipated and answered the protestations before they were raised. He explains why, contrary to Friedman and Krugman, there is never a need for a larger supply of money than that already in existence - meaning real money, not fiat money.