Thursday, January 22, 2009

Saving Part 2: Introducing Inflation

In my previous entry, I made the following comment.
When the saver finally does begin spending his savings for consumption, there is more wealth available for purchase than there was when he began saving.
To see this principle in action, one need look no further than the emerging technology industry. If one buys his computer, video game system, or plasma TV today, he'll pay a higher price than if he saved his money and bought it at some future date. He can then spend the rest on something else. The reason one is able to buy more later than earlier is because the available wealth in that sector, both in terms of quantity and quality, has increased over time. New, more efficient ways of producing these items have been implemented. Less materials, less space, and/or less work are required to produce them, so his share of it has increased in size, though not necessarily in proportion.

The same principle is constantly operating in every area of a healthy economy. Those few areas for which new processes are not developed can also be increased if necessary, as resources from other areas can be freed up via efficiency improvements in those sectors.

However, this probably doesn't coincide with the average person's experience. "Prices always go up over time," I so often hear. How can prices go up when the general stock of wealth is increasing, and production methods improving? One word: inflation.

I can hear it now. "Well, duh!" one might say. "Prices go up because prices go up? That reasoning is so circular the circle can be seen in a single statement!"

Inflation is NOT rising prices. Inflation can CAUSE rising prices, but the term itself refers to an increase in the money supply, and more specifically, an expansion of the supply of money beyond the basic commodity upon which it is based. Imagine increasing the size of a balloon by filling it with air. The quantity of rubber has not been increased, but the size of the balloon has. "Inflation" as a term was coined in an era when money was based upon a supply of gold, and referred to the increase in the supply of gold-based negotiable instruments relative to the actual quantity of gold. And, much like the balloon, if the money supply were expanded too far, it could, and did, pop.

Of course, these days, we don't use gold for money, and the "base" upon which our money is built is the decisions of the federal reserve banks, growing and shrinking the monetary base at will, which banks are able to issue additional drafts against much the same way they once did with gold. The term "inflation" isn't quite so illustrative or literal as it was under the "gold standard," but it should still be reserved for changes in the size of the money supply, rather than being transferred wholesale from cause to effect... because if we call the effect "inflation," what do we call the cause? Nothing... and that is precisely how the apologists for the current system would have it.

I'm rambling.

To return to today's topic (now that' I've defined what I mean by "inflation"), inflation is the reason that, despite increasing efficiency, prices continue to rise. For however fast the overall supply of goods and services grows, the money supply grows faster. If it did not, prices would go down over time. What would this mean?

This would mean that the benefits of economic growth would be shared among all responsible people. Anyone who was saving money against a rainy day, or for their future, or for their kids' future, or for whatever purpose, rather than spending it all and ending up down on their luck at the first sign of disaster, would benefit from overall economic growth, because when the day came to spend it, they could get more for it than if they had spent it right away. This is justified, because if nobody labored without immediately consuming (ie. saved nothing for the future), that extra wealth would never have existed. Saving money is a socially beneficial act, and with non-inflatable money supply, this benefit goes to the saver. It also goes to the non-saver, since even he benefits from lower prices, but the saver benefits even more.

By saying that savers would benefit under another system, am I suggesting that savers are NOT the ones reaping the benefits of economic growth under our system? I am. And the answer to the question, "But who DOES reap the benefits under our current system" is to be found in the answer to another question. "Where does the new money come from?"

This, I shall explore in my next post.


Geetika said...

Very well written...its high time we all realize how even a small percentage of inflation can eat up the real value of our net worth over a period of time.

Tarvok said...

Thank's for the compliment. :)