Inflation

Most people know inflation as a general rise in prices.

The common perception is that inflation is normal and expected. Although historically that might ring true in the last century, there have been periods where inflation was a non-event. Deflation, the opposite of inflation, is a general fall in prices, and this has occurred throughout man’s economic history, as well as periods where neither existed (stable prices).

There are four types of inflation: Supply side, demand side, regulatory and monetary.

Demand side inflation is when a good or service is in high demand and is sought after by many.

Think housing in the mid-2000s, Japanese real estate in the mid 80’s or anything else that becomes in high demand for whatever the reason. As the demand outpaces the supply, prices rise. More people want the item in question and therefore people are willing to pay more for it.

As prices keep going up, demand eventually falls off. This is why it is said, “high prices cure high prices.” At some point, fewer people can afford whatever is in demand, and the higher prices eventually curb the demand.

Supply side inflation is driven by a scarcity situation that makes availability more difficult.

Imagine a crop disease that wipes out the harvest or any other event that dries up the source. Prices rise as people are willing to bid up the price of an item due to its scarcity.

Quite simply, when demand increases OR supply decreases, the price “inflates”, hence the name inflation.

Regulatory inflation is when the price of something is artificially raised by adding a tax, tariff, or other “fee”

usually levied on it by an entity that has power or control over its distribution. This type of inflation occurs when a government or regulatory body attaches an arbitrary cost to the transaction. 

Both demand, supply, and regulatory inflation are asset specific, meaning it is not a general rise in all prices, but instead a rise in the price of a particular asset. It is, however, not currency specific, meaning prices will rise no matter what currency is used to buy it. 

The most common and persistent type of inflation is monetary inflation. This is purely a general rise in prices that affects only the currency in which the transaction is completed, but unlike the other three types of inflation, is not asset specific. All prices will tend to rise. Note the distinct difference.

Monetary inflation is brought about by an increase in the money supply. 

Think Mexican Peso or more recently, Zimbabwe. No one really knows how bad the inflation in Zimbabwe got, but estimates are upwards of 4 quadrillion percent at its worst point.

This monetary type of inflation is the most common and is brought about by increasing the amount of whichever currency is used for the transaction.  Monetary inflation is currency specific, meaning a price of an item might be rising when priced in pesos, but might actually be falling when priced in Euros or U.S. dollars. Unlike the other three types of inflation, monetary inflation is not asset specific but is currency specific. 

With the advent of central banking, where a monetary authority is given control over a civilizations’ currency and can create it at will, monetary inflation increases when the central bank creates more of the currency for whatever reason. 

Think stimulus, bailouts, or other social spending not paid for by borrowing. Governments do borrow to fund activities, but also routinely “create” currency in addition to borrowing. 

The term “Banana Republic” came about to describe governments that egregiously print copious amounts of currency to fund activities.

Once again the Mexican Peso illustrates the concept quite succinctly. 

The eventual result of currency creation (commonly referred to as money printing) is an eventual and persistent overall increase in the price of all goods and services but only in the respective currency.

This type of inflation slowly impacts a societies’ lower income levels first, and if the inflation persists, the damage slowly works its way up to the higher and higher income levels, until only the very wealthy remain. 

Banana Republic type economies typically exhibit the haves and the have-not’s wealth structure, whereas the have-nots grossly outnumber the haves, until the resulting wealth strata, when illustrated, looks like a pyramid. The vast majority of wealth is held by a very small percentage of the population at the top of the pyramid. 

It could be argued that central banking, as the sole source of a currency, is the sole cause of a pyramid- type wealth distribution, by being the sole cause of monetary inflation.

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Photo by Nathan Dumlao on Unsplash