October5th

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Ready for an economics lesson? Ready for a rude awakening? Okay, hurr it goes:

The government is stealing your money…

just thought I’d let you know!

Inflation is what economists endearingly refer to as an “indirect tax.” Meaning that the government is taxing the money that you already have, but they’re not exactly telling you…which is why it’s twice as scary. But first, I’ll explain to you what exactly inflation is, then we’ll discuss what causes it, and finally we’ll discuss some rare cases of “Hyper-Inflation”

So we’ve all heard of inflation, and we all get a more or less bad feeling in our gut every time we hear it. Inflation is the reason that bread now costs more than $0.05 and why a gallon of milk is more than 10x the price of what it used to be. Now, granted, there are other factors that could lead to things becoming more expensive over time, but the most relevant cause is simply inflation. Inflation is calculated using the CPI (Consumer Price Index) which is calculated using a basket of goods that the average consumer buys. For example, the basket might include some soup, a gallon of milk, loaf of bread, bottle of soap, some tomatoes, some cereal, etc. They determine the cost of this exact basket every year, so they take the current year’s, compare it to last year’s, find the difference, divide it by last years cost and you’ve got your inflation rate! The reason they calculate it this way is because by using a normal ‘basket of goods’ you can rest assured that fighter planes, air tankers, Boeing jets, etc. aren’t included…because you and I don’t buy those things – so we don’t care. There are other ways to calculate inflation, but this is the most common; there are also numerous issues with calculating the inflation rate this way, but again, this is the most common way, so that’s what we’re going to use as an example.

So basically inflation is this: It is the decrease in the “value”/”Purchasing Power” of the dollar in your pocket. If the inflation rate is 3%, you’ll need $1.03 to buy something that only cost just $1 last year. This doesn’t seem like that big of a deal, except that it keeps compounding year after year.

The cause of this inflation is primarily the government printing money (other factors exist), but the simplest example I can give you is this:

There is a city, in the middle of no where, with exactly 100 people, and everyone has $1. So there are 100 people and $100. Everything is great! Mr. A makes baskets and sells them for $1 and Ms. B bakes bread and sells them 2 loafs/$1! Bargains I tell you! Well, one day a strange flying machine slowly goes over the village and drops another $100 onto the town. everyone scrambles to get some of it and now everyone has $2. Everything is even better now! Everyone has TWO DOLLARS as opposed to an hour ago when they all had only ONE DOLLAR! Well, Mr. A goes to buy a loaf of bread and finds than Ms. B is now charging $1 a loaf!!! What happened to getting 2/$1?! Well, Everyone has $2 now, so although they used to use all of their money to buy 2 loafs of bread – they’re STILL using all their money to buy 2 loafs of bread, but it just happens to be $2 now. So the money supply increased 100% and so did inflation. So although everyone thinks they have more money, the value of their money immediately decreased. Now this may not seem like such a big deal, right? Ms. B still have enough to buy a basket, which now costs $2 and Mr. A can still buy as much bread as he used to have, it just costs him both of his dollars. BUT let’s say there was a guy in town who kept $10 in his mattress. What happened to his money as soon as those 100 dollar bills were dropped from the flying machine? His $10 purchasing power became $5. His $10 used to buy TWENTY loafs of bread, now it buys FIVE.

Okay – that was a severely simplistic view of what causes inflation, because there so many factors that play into it – but that’s a huge part of it.

“Hyper Inflation”

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Hyper Inflation is when inflation gets OUT OF CONTROL – Once it reaches this point, it is very hard to reign it all back in. Hyper Inflation is caused by a huge increase in the money supply – either through borrowing or printing in which case there is so much money available that people lose faith in the monetary system. There is a swift change in the supply and demand for money and price skyrocket. It’s easiest to illustrate with an example:

After WWI Germany, via the Treaty of Versailles, was held solely responsible for the war and was demanded to pay reparations in gold-backed Marks to the other countries involved. However, in 1914, Germany abandoned the idea of actually backing it’s currency with gold, and instead made all its paper money technically worthless except for people’s faith in the government. I’m sure you can see where this is going…The was was supposed to be short and well-planned. So the government began borrowing and printing money to finance the war; however their war plans didn’t end as hoped. THEN they were held responsible for the war! So they needed an influx of money and what’s easier than merely printing your own?! So the presses ran and the ink trucks kept coming.

Prices doubled every 4 days, and restaurants couldn’t update their menus fast enough to keep up with the rising prices. Workers would receive their pay in bundles of paper cash as they would rush to the store to buy whatever they could before prices would go up.

It eventually got so bad that burning the paper money was cheaper than going to buy wood to burn:

Kids would play with bricks of money since toys had gotten too expensive:

To explain further the magnitude of the hyper-inflationary period in Germany, I include this excerpt from an Essay on the German Hyperinflation by George J. W. Goodman. Full article can be found HERE.

“Before World War I Germany was a prosperous country, with a gold-backed currency, expanding industry, and world leadership in optics, chemicals, and machinery. The German Mark, the British shilling, the French franc, and the Italian lira all had about equal value, and all were exchanged four or five to the dollar. That was in 1914. In 1923, at the most fevered moment of the German hyperinflation, the exchange rate between the dollar and the Mark was one trillion Marks to one dollar, and a wheelbarrow full of money would not even buy a newspaper. Most Germans were taken by surprise by the financial tornado.”

Although such cases of hyperinflation are very rare, Zimbabwe had a monthly inflation rate of 79,600,000,000% (prices doubled every 24 hours) – you’d think this was many years ago, right? Surely governments would learn their lesson, huh?! No…this was LAST YEAR – 2008.

So I hope I’ve opened your eyes to what exactly inflation is and how serious it can be when governments take it upon themselves to print money to cover their own costs. Now you’ll have people (ie- the government) claim it DOES NOT print money to cover their own costs, but they do, and if you’d like the break down of how they use this newly printed money along with treasury bonds to pay their own debt, let me know and I’ll do it in another post.

I’ll leave you with this quote from the US Treasury website:

“During fiscal year 2007, the Bureau of Engraving and Printing (BEP) produced approximately 38 million notes a day with a face value of approximately $750 million.”

Per year: $2,737,500,000,000.00

Greatchadayis,

Ross

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