We've learned many new things over the years about inflation. This topic is very relevant today so it would be a good idea to review some of these. Many people still believe in bizarre notions that were popular in the 1950s and 1960s. However, these beliefs are not true today. People didn't have much experience with floating currency before 1970. We've learned a lot since 1970.Different people may interpret the term "inflation" differently. Ludwig von Mises tried once to define inflation, focusing only on its monetary effects. This didn't work out very well. Instead, the term refers a mix of confusing concepts. This is probably the best explanation. People confuse themselves with confusing concepts. We don't want people to get confused so we need to look at the specific phenomena referred to as "inflation".1) An increase in the official CPI or another measure that measures "price movements". Inflation is simply the +1% to +3% increase in some price index. This is not a process, but a measure. There are many reasons prices may fluctuate. This idea is related to the notion that the "purchasing strength" of a currency can also change, in inverse relationship to a price index. The change in "purchasing potential" is synonymous to a currency's value. This is completely false. This is completely false. A zucchini's length might change from "one foot" or "two feet", depending on whether the zucchini is twice as long as it was before. The "foot" is not changing, but the zucchini's length went from twelve inches down to six. They are completely different.2) Prices can change for many reasons that are not monetary. What is the reason that zucchini grew twice as fast as the unchanging 12 inches? We don't know. The practice is that official CPI numbers tends to rise as an economy grows. Wages and prices for domestic services like restaurants, hotels, education, and medical care tend to increase as an economy becomes more prosperous. Equity values and property values tend to increase. Prices for commodities tend to remain stable while prices for manufactured goods tend downward. This is usually recorded as an increase in the official CPI number. One reason central banks have a slightly positive CPI target of +2.0% per annum, as we have seen in the past with healthy growing economies. This does not result in currency values declining. CPI can rise by 5%-10% in high-growth economies. This is due to growth effects only, as was the case in Japan and Hong Kong in the 1960s. These price increases are completely benign. Recessions can also depress prices as wages fall, unemployment increases, and inventory is wiped out. Prices rise during war and fall during peace. Prices can change due to supply/demand issues for individual commodities. We should not assume that a stable currency value produces an unchanged CPI or that changes in CPI are monetary effects. Or that an unchanging CPI would be desirable.3. Monetary effects may cause price changes. This is when the "foot", or measurement, changes from twelve to six inches. This is due to a change of currency value. For example, the foreign exchange market would show this. If the oil price is $20 and the Mexican peso's exchange rate rises from 3/dollar (6/dollar) (maybe in the span of a year as it did in 1995), then the oil price in pesos should go up from 60 to 120 pesos. This is quite common for commodities that are traded internationally, such as oil and imported automobiles. The wages of Mexican workers could then double, in pesos. This is to reflect the halving peso value. This process is more complex and takes longer. It may take several years or even a decade. And since everything is never the same, it isn't very accurate. These short-term (oil price), and long-term (wages adjustment) processes produce an elevated CPI. It may rise about 10% per year for several years.The same is true for the Mexican peso, but it's usually harder to spot the change. How would you know if the USD's value fell by half? The rough measure of gold has been used for many years. The "price in dollars in pesos" increased from 3 to 6, halving the peso's worth. There was also a "rise" in gold's price from $1000/oz. To $2000/oz. If gold were a perfect measure for stable value, it would result in a similar halving in dollar value. Even if gold is ignored, it must be acknowledged that both the USD and EUR fiat currencies are fluid and could fall in half. As markets for goods or services adjust to the new currency's value over time (just like in the case of Mexico), this would result in a price adjustment process. This "price adjustment" is a result of the value change, which could have occurred years ago.These monetary effects will be called "monetary inflation.""Monetary inflation" refers to the value of goods and not their supply. According to some, inflation is "too much money trying to buy too many goods." There are many instances of currencies losing their value rapidly, but there is little to no change in their actual supply. This occurred in 1933 when the U.S. Dollar was devalued to $20.67/oz. of gold to $35/oz. It is made of gold. It took place in Britain in 1931. It happened more recently in 1998 in Thailand or 2009 in Russia. It's very common.The amount of money here hasn't changed. Nominal GDP or the economy hasn't seen much change either. Nothing significant appears to have occurred in terms of "money chasing good" However, the currency's value changed. Even though there was no change in the currency supply, this causes all the usual inflationary effects. Other times, however, there may be a large increase in currency supply. However, if the increase is absorbed into a corresponding rise in demand for currency (so that the currency's value doesn't change), then there won't be inflationary effects. The number of dollars (U.S.-base money) that existed between 1775 and 1900 increased by 163 times. This was due to the expansion of the economy at that time. The dollar's value didn't decrease. While an increase in supply could lead to a decrease in value, the "inflationary effect" is caused by a change of value and not supply. This "change of value" can be seen in foreign exchange markets or in the price for gold, among other indicators.The value of the U.S. Dollar was $35/oz after 1933. The price of gold. The supply of dollars increased dramatically in 1934-1940 (+140%) and even more in 1940-1950 (+124%). In the end, it increased by 440% between 1934-1950 and 1950, with the dollar at $35/oz. There was an "inflation" in 1933 and a devaluation in 1940, but no change in the supply. Then there was a large supply change, but no change in the value.Due to the 1933 dollar devaluation, the US CPI soared tremendously after 1933. Federal ReserveAll this might lead you to conclude that stabilizing the currency value should be a priority. Most countries around the globe do this by linking the value of their national currencies to the euro or dollar. The U.S. and European nations used to share the same basic idea of linking the value their currencies to gold. In principle, the value of the U.S. Dollar was set at $20.67/oz. Before 1933; and after 1935. After that, $35/oz. Similar policies were followed for the British pound and German mark, French Franc, French francs, Italian liras, Japanese yen and other major or minor currencies.At $20.67/oz, the dollar was tied to gold. Before 1933, $35/oz. After that, $35/oz. 1971 saw the beginning of the... [+] floating fiat age. Nathan LewisToday, most prudent central banks have a shadowy reflection of this policy. They want the CPI not to do anything unusual. For example, the Federal Reserve has a target of 2% CPI. We have also seen that CPI changes can be caused by a variety of non-monetary factors, including healthy economic growth. Changes in the CPI due to genuinely monetary reasons (a change of currency value) can be years or even decades behind the declines in monetary value (1995 peso and 1933 dollar devaluations) that caused the rises in nominal prices. This is before you consider that the CPI is a government-produced statistic, which doesn't actually exist in the real world. It has also been altered numerous times over the years to produce a politically acceptable result. This is why it doesn't work.One could argue that gold may not be a perfect indicator of Stable Value. It is a universally used measure of Stable Value that has been in use for centuries. This was even true during the prosperous 1960s. There is no better alternative today, not even a white paper. And certainly, there isn't a real-world solution that has stood the test.
