The Reality of Inflation

By Medecci Lineil 

Bank Negara, Majlis Profesor Negara and mainstream economists have been saying to the general public that there is little inflation in the economy given the measurement by the Consumer Price Index (CPI), the one tool which says will better reflect true inflation.

They define the inflation merely as rising prices. The politicians meanwhile talk so much about inflation and high cost of living today with little understanding of what they are

Only Austrian economics can explain correctly what inflation is Austrian economist Ludwig von Mises (1881-1973) explained inflation in his essay:

“Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term ‘inflation’ to refer to the phenomenon that is an inevitable consequences of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been up to now, called inflation….As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequences of inflation, rising prices. Their ventures are doomed to failure because to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.”

From this we can conclude that inflation is an increase in the quantity of money caused by the government. This sound definition also very fundamental and provides a sound guide to correction action. While CPI hides the causal relation that produces general increases in the quantity of money within our economy.

In economics discussion, the definition of inflation as rising prices says absolutely nothing about any specific cause of rising prices. If that is the case, then inflation can be caused by anything and anyone that raise prices such as cost- push inflation. Others say prices rise because wages rise or wages rise because prices rise – wage push inflation. These are only the effects of inflation.

I wonder all this while how can we fight inflation if we pretend not to even have a clear idea of its cause i.e the increase in quantity of money by government?

In this article, I would like to reinforce the quantity of money by analyzing all of the explanations of rising prices allegedly as the cause of inflation that have been misled and dominated for years in public discussion.

Let me begin with cost push inflation in which Sarawak Bus Transport Companies Association (SBTCA) reported recently in The Star Sarawak. The chairman of SBTCA Lau Khing Seng said public bus company in the state were likely to be forced to stop their services on route that were unprofitable due to rising operation costs following the price hike of fuel, workers salary, spare parts, tires and batteries.

Crony capitalism

Because what the cost push inflation is actually claiming is that some prices rise because other prices rise like the rise of wages (for example minimum wage), the rise in the price of steel, the rise in the price of sugar.

They do not offer any explanation of what makes possible the rise in prices of steel, the rise in prices of sugar or wages in fact the truth is that these are lobbied and caused by the government monopolists, unions and regulations.

After all our economy is not a free market capitalist economic system. We are practicing crony capitalism – labour union monopolies, big government, subsidies, government owned enterprises in utilities, telecommunication, sugar, aviation, infrastructure etc.

Cost push inflation also implies the negative effects of the increase in quantity of money, as this additional money raise the price of goods, those who do not get any of this money are hurt, just like SBTCA. And then, the government gives them a quantity too and again to others later.

And this is the tough situation we have today. I keep reading this on newspapers every day “Why government gives money to that particular group but we don’t? Where is the fairness?”

Even I read many ministers and politicians, they comfortably say “RM10 juta untuk bina balai raya, RM100 juta untuk bina sekolah daif seluruh negara” Then, and the oppositions say “RM100 juta untuk bina sekolah daif tak cukup, tapi baik sebagai langkah awal”

For them more money is better than less money regardless the condition of production. They have no idea what money is and what money does.

Let me also make clear this. Many people still take for granted the view that high costs of production basically determine high prices. But as Carl Menger, the founder of Austrian economics explained nearly 140 years ago, past expenses incurred during the production of a good are completely irrelevant to the determination of the current price of a good.

The market price of a good is determined solely by the relative valuations of goods and money by the buyers and sellers of the good in conjunction with the number of units of the good currently in existence.

Using the example of tobacco, Menger argued that if people completely lost their desire for consuming tobacco not only would the prices of cigarettes, cigars and pipes fall to zero, but raw tobacco and the machines specifically designed to produce these items would cease to command a price greater than zero, no matter how much it cost to produce them.

Secondly, wage push inflation. This is referring to the legally privileged, government protected labour unions such as Cuepacs and others. These unions possess monopoly powers in that employers are compelled by law to deal with them and to meet their wage demands or do without labor. Protest and demonstration, losing votes during elections should the government failed to comply these demand.

If it were not joined by expanding the quantity of money, it would not be possible for the unions to impose any long run influences in making prices rise.

Price hikes

If demand and spending stayed at the same, any increase of general price level brought by wage push inflation would be accompanied by a corresponding decline in the supply of goods that can be sold – would cause a corresponding reduction in the quantity of labor that employers could profitably employ – would cause less production.

The obligations to meet the higher wages are limited, so the employers simply do not have financial capacity to employ workers at higher wages compared to lower wages.

Put it another way, every time a union shout a wage increase, it would have to count the number of its members to be added to the category of the unemployed. The unemployment rate and the prices of goods would go up.

But what the government does again through economic intervention when confronted with the prospect of unemployment and rise in prices of goods, they will inject a larger quantity of money into the economic system i.e salaries hike and bonuses.

As a result, additional demand that results the unions to drive up wages and prices without causing additional unemployment.

To elaborate further, the government approves a quantity of money to 1.4 million civil servants and these people appear on the markets with an additional demands, they are in a position to buy more than before, perhaps a demand that did not exist yesterday. What does it mean? Prices are going up.

What about the private sectors workers? They have not received additional money and they are now facing higher prices.

So this is the evidence that government’s expansion of the money supply that allows the unions especially Cuepacs to go on pushing wage rates and prices up very far.

Without monopoly unionism and wage push and expansion the quantity of money supply, the rise in prices it might bring about would be temporary, it could easily be offset by increases of productivity of labour with the result that prices fell.

Last but not least is the velocity of money doctrine. This is the doctrine that claim that the rise in aggregate demand that responsible for the rise in prices as the result of an in increase in the velocity of circulation of money.

The so called velocity of circulation of money is determined by the demand of money. The greater is the demand for money, the lower is the velocity of circulation of money. The smaller is the demand for money, the higher is the velocity of circulation of money.

The question now does velocity have anything to do with prices of goods? No. Prices are the outcome of individuals’ purposeful actions. What causes an increase in velocity contributing to an increase in the demand of consumers’ good and to a rise in prices is precisely the increase in the quantity of money.

The increase in quantity of money, the higher tends to be the velocity of circulation of money. The less increases of quantity in money, the lower tends to be the velocity of circulation of money.

Losing purchasing power

Now let us discuss the cause of inflation.

Under a system of fiat money, the money supply can be increased at any rate the government desire. Like the value of anything else, the greater the quantity of money, the lower is the value of money, the lower value of money means the higher prices of goods.

With expanding the quantity of money, the less tends to demand for money for holding, everyone is spending thus the higher tends to be the velocity of circulation of money – the effect is people conclude that it is better to pay to buy goods right now before their prices rise further.

People conclude that continued holding of cash money, they will suffer a significant loss of purchasing power and so they attempt to reduce their holdings of money.

People easily seen nowadays are being able to borrow easily and profitably with the availability of credit and on interest rates.

The increase or decrease in the money supply is a major factor determining the availability of credit at any given time in the forms of new loans, credit is made easier reduces the rate of interest temporarily.

To prevent the rise of rate of interest, even more cheap credit expansion is required. So, the government is initiating a vicious cycle destroying our monetary system.

I don’t say that the quantity of money should be increased or be decreased. All I say here the increase of quantity of money by government and Bank Negara is bad economics, bad for money and bad for people.

As a conclusion, the discussions above have served further to confirm the increases of quantity of money is the knowledge of causation of inflation.

The endless increase in the quantity of money that cause the rise in prices as shown be the responsibility of the government.

However, mainstream economists and politicians blame something else that will not leave a trail that runs back to government interference in the economic system.

Published in Free Malaysia Today on 11 March 2014.


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