On Inflation

Most people dislike inflation. If so, why inflation continue to be a problem in our life?

Most, but not all, people dislike inflation. If you possess some possession, such as a house, you will appreciate the appreciation, or inflation, of your possession. The more you possess, the more you appreciate the appreciation of your possession. If you possess some political power, you love to help people. You especially love to help those who have generously help you in your career. The best way to help your friends is to print more money and distribute them among your friends. That will generate inflation. In summary, if you are politically or financially powerful, you appreciate appreciation, or inflation. Generation wise,  the younger generally possess less than the older.

For the powerful, they appreciate high appreciation of their wealth while managing  public resentment toward inflation.  That is the key to understand inflation, or appreciation.

The world is dominated by the dominating class. Naturally for them, many tools are available to maximize appreciation of wealth for the powerful minority and minimize public resentment toward inflation. In this note, we will discuss several. The first is theoretical framing. The second is to take advantage of emergencies. The third is technical maneuvers, such as the construction of CPI index.

First, the mainstream economic theory claims that moderate inflation is good for economic growth for it stimulate investment activities. Is this claim consistent with reality? History shows again and again that economic growth is often fueled by the deflation of important economic sectors in society. In the recent decades, semiconductor industry is leading the global economic development. Semiconductor industry has experienced great deflation in this period. The prices of computers have dropped sharply over the decades. A mainframe computer used to cost million dollars. Today, a one thousand dollar laptop has greater computational power than a mainframe decades ago. The sharp reduction of computer price over time did not cause the investment to shrink. It stimulates investment in the semiconductor industry and related information industry for the market size becomes much larger.

The example of semiconductor industry is not an exception. It is a rule. Industrial Revolution, started around 1750, was the mass reduction of iron prices and coal prices due to technology improvement in making iron (Jevons, 1865; Chen, 2005). Electricity had been produced by battery since 1800. But only after the development of electric generators around the end of nineteen century, electricity prices became very cheap. The age of electricity began. We can list many such examples.

The mainstream economic theory claims deflation hurts economy badly. An often used example is deflation during the great depression. The following table is UK inflation data, starting from 1921.

Source: P 376, by Robert Skidelsky, from afterword in General Theory, 2018 edition

We can see that deflation occurred long before the onset of the great depression. Many research works point out the connection between depression and deflation. Few attempt to associate deflation with the roaring twenties, when many technical advancements were made.

In recent years, modern monetary theory (MMT) comes into vogue. MMT claims that there is no limit to how much a government can print money. This monetary theory is not really modern. Governments have been trying to print more money or debase money all the time, so they can distribute more money to themselves and their friends. They are only constrained by the concern of public rebellion.

Second, ruling elites will take advantage of emergency situations to print more money in the name of saving the economy. A recent example is the so called pandemic of COVID19. During this period, massive amount of money is distributed in the name of helping people in need during the pandemic. If most of the money goes to people in need of food, you wouldn’t expect a massive rally in the stock market and real estate market. Instead, a stock market boom and real estate boom provided an enviable return during the pandemic, when many people lost their jobs and many small businesses closed their doors due to government policies. Naturally, most money is distributed to most powerful people. This, of course, is not a new phenomenon. But the scale of such operation probably reaches a new high during this pandemic.

Third, technical maneuvers are often employed to hide the actual magnitude of inflation. We will use the construction of Canadian CPI as an example.

US GDP per capita is higher than Canada. US average house price is lower than Canada. In 2023, US GDP per capita is 80k USD, Canadian one is 53k USD. Average house price in US is 431k USD, Canadian one is 486k USD. From these numbers, one would expect weight of housing in CPI would be higher in Canada than in USA.

However, weight of Housing in US CPI Basket is 42.6%. Weight of Shelter in Canadian CPI Basket is 29.78%. Housing is deemed affordable if its cost is lower than 30% of the total household cost. By making the cost of housing weight 29.78%, housing becomes affordable in Canada. In particular, from CPI weights, housing is much more affordable in Canada than in US, despite the facts that Americans earn more and houses in America cost less.

Prices of houses in Canada have appreciated, or inflated significantly during the past. By making the weight of housing small, CPI significantly underestimate the magnitude of inflation in Canada.

Cosmetics are expensive not because they help reveal the truth. They are expensive because they help modify and cover up the truth. Similarly, economists are expensive not because they help reveal the truth. They are expensive because they help modify and cover up the truth. It takes a great amount of skill and effort to define, refine, and redefine Canadian CPI,  to make Canadian housing look affordable, at a time when high housing costs are crushing many Canadian households. 

Basic measurement units are often kept constant for a long time. The sizes of meter, kilogram, second, and centigrade are constant since 1799.

Money is the universal measurement of all economic activities. A stable measurement will be the best for most people in a society. But the dominant class benefit from the inflation, or appreciation of the asset values. This greatly influences the theory of economics and practice of the governments.   

References

Chen, J., 2005. The physical foundation of economics: An analytical thermodynamic theory. World Scientific.

Jevons, W.S., 1865. The coal question; an inquiry concerning the progress of the nation and the probable exhaustion of our coal-mines. Macmillan.

Keynes, J. M. 2018, The General Theory of Employment, Interest and Money, Palgrave Macmillan