The general public largely accepts that prices tend to go up over time. Chances are high that a dinner for two at a casual restaurant will be more expensive in 2026 than it is in 2016. Unfortunately, this also means the cost of retiring in 2020 or 2030 may be much more expensive.
This is inflation at work. You probably know this — everyone has heard of inflation and most have a general understanding about its effects. You may even believe it is inevitable.
Unfortunately, there is a lot of confusion and misinformation about inflation and its causes. In turn, this makes it difficult to analyze and prepare for inflation. With that in mind, here is a simple breakdown:
What Real Inflation Means:
“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 output…”
Nobel laureate Milton Friedman;
The Counter-Revolution in Monetary Theory (1970)
One of the most famous quotes in economics is Milton Friedman’s “always and everywhere” statement about inflation. Dr. Friedman points out that inflation is deeper than just an increase in the general price level — real inflation requires the supply of money to expand faster than economic productivity.
This is simple supply and demand. When the central bank prints more money (or, in the case of the modern Fed, credits new money electronically to member banks), those extra dollars circulate in the marketplace and bid up the cost of goods, services, labor, and resources.
(For a little color, read this 2007 Monetary Trends report from the St. Louis Federal Reserve Bank, which discusses “the profound impact of Milton Friedman on monetary economics.”)
In fact, Friedman may have borrowed this description from the eminent journalist and scholar Henry Hazlitt, who, in his 1964 work What You Should Know About Inflation, stated that “Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit.”
In other words, modern inflation is controlled by whomever handles the printing presses. There is nothing inevitable about it.
Inflation Is Not Inevitable
Today, Americans tend to accept inflation as though it were an immutable law of nature. When modern investors and savers plan for their retirement, they always factor in future inflation. Even though they are correct to be worried about prices going up over time, it is not the case that inflation is an inevitable aspect of modern economies.
To see this point clearly, consider the following graph about the historical Consumer Price Index (CPI) in the United States.
It is an illustrative chart. If you look at it carefully, you will notice that prices in the United States were actually lower in 1900 than in 1800, meaning there was legitimate price deflation over a period of 100 years.
Keep in mind that the United States transformed from a tiny agrarian economy in 1800 into possibly the wealthiest nation in the history of the world by 1900. All without inflation.
So what explains the relatively new inflation phenomenon starting after WWII*? Here are some critical dates the chart leaves out:
- March 3, 1933 — President Franklin D. Roosevelt closed banks to stop depositors from withdrawing gold reserves at the Federal Reserve Bank of New York.
- April 5, 1933 — President Roosevelt ordered all Americans to turn in their gold in exchange for dollars. (This was the first major strike against gold as money in the U.S.)
- January 30, 1934 — Congress passed the Gold Reserve Act, which prohibited the private ownership of gold as money. The Act also:
- Permitted the U.S. government to pay its debts in dollars (rather than gold).
- Authorized President Roosevelt to arbitrarily devalue the gold dollar by 40%.
- August 15, 1971 — President Richard M. Nixon ends gold standard and forbade the Federal Reserve to redeem dollars with gold.
*Due to price and wage controls during the War,
the CPI statistics between 1941 and 1945
probably under-represent inflation.
There is a clear correlation between the U.S. government abandoning gold — then criminalizing it — and subsequent spikes in the CPI.
Inflation as Government Policy
Historically, inflation rises rapidly wherever a government and central bank are not constrained by a working commodity standard (such as the U.S. gold standard or the U.K. sterling silver standard of the 19th century).
Why do governments want inflation? A lot of policy papers have been dedicated to this question over time, but there are generally two accepted causal-realist explanations:
- Inflation allows governments to borrow more and go into debt. Debt is politically attractive because it allows governments to expand without raising taxes.
- New money is non-neutral. The first recipients of new Fed money are usually governments and politically connected corporations or individuals. Prices take time to adjust upward, so these first recipients are gifted real wealth because they can spend or invest new money at the old prices.
So long as the U.S. government engages in unrestrained borrowing and the Federal Reserve is allowed to expand its balance sheet, inflation will be on the horizon.
Dealing with Inflation
The next question many investors ask is: “so what I can I do about rising inflation?”
Unfortunately, your options are very limited as long as the Fed leaves interest rates near all-time lows. Traditional savings accounts, CDs, and money markets offer very poor returns, which leaves your secure savings vulnerable to inflation effects.
Precious metals remain an attractive alternative. American Bullion already wrote about the link between higher inflation and higher gold prices. There are also reasons to consider adding silver or palladium to your retirement plans.
We are committed to providing the education you need to tackle difficult problems. If you are interested in leveraging the benefits of commodity investments, we can discuss your options and help you every step of the way. Our #1 goal is for you to take control of your own finances – and we promise to be transparent, safe, and efficient in the process.
Although the information in this commentary has been obtained from sources believed to be reliable, American Bullion does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice. American Bullion will not be liable for any errors or omissions in this information nor for the availability of this information. All content provided on this blog is for informational purposes only and should not be used to make buy or sell decisions for any type of precious metals.