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Thursday, May 15, 2014

How Inflation Picks Your Pocket

Mises Daily: Thursday, May 15, 2014 by Dan Sanchez
[ Editor’s Note: This article is adapted from a talk delivered at the Mises Institute’s seminar “Inflation: Causes, Consequences, and Cure.”

In the denouement of the film There Will Be Blood, the antihero Daniel Planview dramatically reveals to his nemesis that he has secretly siphoned away all of the latter's underground oil. 

"Drainage!" he bellows, as only Daniel Day-Lewis can, "Drained dry. I'm so sorry. Here, if you have a milkshake, and I have a milkshake, and I have a straw. There it is, that's a straw, you see? You watching? And my straw reaches across the room, and starts to drink your milkshake. I... drink... your... milkshake! [sucking sound]"

Through inflation (expanding the money supply), as I will show, the state and its cronies "drink our milkshake" every day. Only, it does so surreptitiously, with nary a sucking sound to be heard.

Understandably, everyone would like to see his own personal money supply increase. That would obviously make the individual better off. But does it make sense to conclude from that, that if a whole society’s money supply increased, that the society would be better off?

To use a favorite example of economist Murray Rothbard’s, say an “Angel Gabriel” magically multiplied everyone’s money supply tenfold overnight. 

Would all of society wake up richer? If so, then that’s great news, because our “angels” in the government have a similar power. Under fiat money, the quantity of money is whatever the government says it is. So if “more money” makes the whole society wealthier, the government can enrich everybody with a simple government declaration.

Say the government increases the money supply by just having people add zeroes to their bills. Isn’t it regrettable, after all, that not everyone can afford a new computer? Some people only have a dollar to their name. To alleviate this situation, the government could just have everyone add three zeroes to their bills. Now everyone has at least $1,000, and can afford a new computer!

But why stop there? Not everyone can afford a private jet. So why not keep adding zeroes until everyone can? Voilà, our society will then be so rich, that we’ll all be zooming across the country every weekend.

Obviously something is wrong with this line of reasoning. When speaking to student groups, to show them what the problem is, I walk them through the following thought experiment.

I tell them to imagine that the room we are in is the whole world; that outside of it is just empty space, and that the entire world economy is contained within this lecture hall. The floorspace is the available land. The objects in front of them are all the capital goods, like tools (pencils) and factories (tables). Other objects are the consumers’ goods, like food (the doughnuts in the back), home electronics (mobile phones), and homes (other tables). And we, the people in the lecture hall, are the economy’s population. All the resources are owned by individuals among us. And each individual owns his own body and can use it for labor.

Each individual also owns money, I tell them. “Let’s say it’s a fiat money system, and that a piece of paper at your table is your computer screen showing the balance of your money stock. And let’s say by coincidence that everyone has exactly a million dollars. So write 1 followed by six zeroes (leave out the commas).”

Now let’s inflate and see what happens, I say. “Everyone go ahead and write a zero at the end of your money balance at the same time on the count of three. One, two, three!”

I tell them to look around the room. Did anything change? Did the floorspace extend; that is to say, is there more or better land for farming, industry, or for living? Are there suddenly more or better pens (tools) or tables (factories and homes)? Are there more or better doughnuts (food) or mobile phones (home electronics)? Are there more of us? Are we smarter or stronger as workers?

Thinking about these questions makes it very clear to the students that increasing the money supply would not make society more prosperous, because it does not increase or improve the consumable and producing “stuff” available to humanity.

Then I point out that, in real life, inflation doesn’t happen that evenly. A few people get the new money first: generally privileged bankers. So I tell the students at one table that they are the privileged bankers. And then I tell only those students to add another zero to their bank balances.

I ask again, is there now more consumable or producing “stuff”? Of course, still, no. Society as a whole isn’t wealthier. But are the people at the “privileged banker” table wealthier because of the new money? There’s no denying it. They now have ten times more money than anyone else does, as well as ten times more than they themselves would have had otherwise.

But being wealthier, means they can get more actual “stuff.” And if, as we’ve established, the new money didn’t create more total stuff, they can’t get more stuff, unless other people get less stuff. This government inflation (defined as an increase in the money supply), therefore, is necessarily a redistribution of wealth. It’s a zero-sum game: a win-lose situation, unlike events in a free market, which are win-win. A loser is effectively taxed by an act of the government for the sake of the winner.

Who loses, then? Who gets less “stuff”?...  Continue reading…