Inflation is, in fact, nothing more than taxation of everyone at a rate not announced by the government but estimated by its citizens. This inflationary process of printing money out of nothing and then using it to pay debts is camouflaged by calling it monetizing the debt. [1]. It is illegal for individuals to do it.
Perhaps understanding that inflation is really secret taxation may be more easily accomplished by considering a highly simplified example that is restricted to the fundamentals only. It gives the central details of how the wealth lost by the private sector goes to the government.
Consider a nation of only four people: a farmer, a manufacturer, a miner, and an official who is the government. The farmer, the manufacturer, and the miner produce all of the material wealth in this nation and it is the official, the government, that prints and distributes the paper money that the nation uses.
At a particular time suppose that the national product may be represented by an equivalent of 12 bushels of corn and that each of these four people has $3.00, for a total national wealth of $12.00. Thus each of them can buy three bushels of corn at $1.00 per bushel.
However the government wants more corn. Therefore it prints and keeps another $12.00, so that national money supply now has increased to $24.00. Consequently each bushel of corn is now worth $2.00 per bushel. The price has doubled. But the farmer, the manufacturer, and the miner still have only $3.00 each while the official now has $15.00. Hence the farmer, the manufacturer, and the miner can now buy only 1.5 bushels of corn instead of 3 bushels each but the official can buy 7.5 bushels of corn.
Consequently the farmer, the manufacturer, and the miner each lost 1.5 bushels of corn while the government gained 4.5 bushels of corn. With the government’s $15.00 the official had $6.00 to buy three bushels at the $2.00 per bushel price and another $9.00 to buy the 4.50 bushels that the farmer, the manufacturer and miner could not. Obviously those extra 4.5 bushels of corn came directly from what the farmer, the manufacturer, and the miner could have bought before the additional $12.00 was printed. In other words, they were taxed at 50%. This is the hidden tax levied by the government on all of its citizens by means of inflation, but with no explicit voter approval.
Return now to the real world. The general public does not know how much money the government prints each day because it is not told and did not approve it. In the real world the effects of monetizing the debt are not instantaneous, but spread slowly throughout a free economy as the prices of materials and services slowly rise over time as the new money begins circulation throughout the economy. Passing the increased cost to the consumers may vary from supplier to supplier depending upon what each one feels is necessary to survive and upon how much of the rising cost can be absorbed to avoid losing customers. However after one supplier in a particular segment of the economy finds it necessary to raise prices the remaining members in that segment will raise prices because each one feels that doing so will then not cause customers to flee to a competitor. It is this delay that can mask the underlying rate of increase of inflation but it cannot reduce the lost value of the currency and the wealth that ultimately is accrued by the government. Gradually lost purchasing power from the general population’s income and savings accounts and transferred to the government is indeed taxation.
Obviously the effects of inflation will be felt over time—they cannot be avoided. Thus the validity of this simplified example is found in the price increases in all materials and services over a period of 10 years in any particular nation and those increases over 100 years are impressive for all nations on the Earth that embraced inflation.
Governments engage in inflation not only because it gives them more money, as in the above example, but it also enables them to repay long term debts, such as government bonds, with currency that is less valuable than when the debt was incurred. Hence any government claims that it fights inflation are spurious.
Although inflation cannot be stopped entirely, it can be greatly slowed by using precious metals, such as gold, as money in the form of coins. Evidence that the founders of the United States realized this is found Article I of the Constitution that enumerates the powers given to the federal government. Included in Section 8 of Article I in the power “To coin Money, regulate the Value thereof, and of foreign Coin, and to fix the Standards of Weights and Measures;” Note that they wrote coin money, not print money.
Early paper money obeyed this regulation and each dollar was a gold certificate that could be redeemed for a specified amount of gold. Later each dollar became a silver certificate and then still later it became fiat money, money that has no intrinsic value but that is mandated by government to be used in all financial transactions. Since it has no intrinsic value fiat money may be inflated at the whim of the government.
When available the few remaining gold and silver certificates may be purchased from numismatic dealers, such as Coast to Coast Coins in Columbia, MD, and others, with the price depending upon their condition.
Note
1. Finance and Investment Handbook, 7th ed., J. Brown, J.E. Goodman, Barron’s Educational Series, Inc., Hauppauge, NY, 2007, p. 594
