Mr. Moderate

The Law of Supply and Demand operates on exchanges of money for goods and services as much as it operates on direct exchanges (barter) of goods and services for other goods and services. Without other factors intervening, if the supply of money is increased (such as if the government prints more money and passes it out to the people), then the larger quantity of money chasing a fixed amount of goods and services will itself tend to cause inflation, which means that there is an increase in prices without a change in the overall supply.

Again, we are dealing largely with the psychology of the consuming public who has the money available to spend. When the government passes out small tax rebate checks as an incentive to stimulate a sluggish economy, the hope is that people will feel good about having extra money and end up spending more than they are given. As the extra spending ripples through the economy, it tends to generate several times as much new business as was injected by the government through the tax rebate scheme. Since the reason for the government doing this in the first place was that the economy was not doing well, there is no realistic chance that this extra money will cause measurable price inflation.

Substantial price inflation usually happens when the psychology of the market is such that the sellers expect to sell everything they can possibly produce, so they raise prices in accordance with the Law of Supply and Demand. Such expectations may be prompted by the idea that the government is spending way too freely, which is putting way too much money into circulation, and that excess supply of money is going to express itself through substantial new spending. Hyper-inflation occurs when the history of past inflation is so persistent that people come to feel that they have to spend any money they have as soon as they receive it or else it will be nearly worthless before they can manage to spend it. Such feelings are frequently prompted by the idea that the government is “just printing money” and is not exerting anything that might be called “fiscal discipline.”

In that those senses, inflation is more psychological than it is based on hard facts. The money is worth less because consumers come to expect that it will be worth less, and this eventually becomes a self-fulfilling prophecy. Since President Reagan mastered the art of browbeating inflationary expectations to death, the government has been able to hide hugely-inflationary policies with a mantra of fiscal discipline out of the meetings of the Federal Reserve.

So, if you are paying attention here, you should now understand that measurements of inflation will almost certainly be within a small factor of what the general public feels that they will be, regardless of any “fundamentals” within the economy. The government of the United States has been successfully flooding the world with money for many decades, and the reason the United States has escaped the hyper-inflation of other nations which engaged in similar policies is solely due to a deliberate media campaign which convinces everybody that all is well and inflation will remain low.

Big businesses understand what is going on here, however. And they have been engaged in a deliberate policy of reducing their own costs of labor so as to increase their own profits. They get away with this in part because most workers have the expectation that inflation will now remain low, so they don’t need to receive substantial wage increases every year. Meanwhile, the inflation-adjusted value of the disposible income of most workers goes down over time due to taxes, outsourcing, and other policies designed to depress the overall cost of labor. But the drumbeat of the marketing campaign continues on, convincing Americans that they still have it good, in spite of every evidence to the contrary. And if things do start to look down, the government just, once again, cranks up the printing presses (real or virtual “stroke of a pen” types, as described below).

Of course, government printing presses are not the only source of money. The government keeps a tight rein on that kind of money as part of its psychological warfare against inflation. The real culprit is credit inflation. Credit represents money that any bank can create with the stroke of a pen. But commercial banks are limited in the amount of credit they can create by certain policies which are set by the Federal Reserve. The Federal Reserve, in turn, adjusts those policies from time-to-time in order to control inflation by controlling credit expectations. We are, as I write this, going through a minor financial crisis with so-called “sub-prime” home loans. This crisis was triggered when lending policies were adjusted to prevent the creation of new loans of that class, and this crisis has been widely publicized so as to lower inflation expectations overall.

But the Federal Reserve has no limits on how much money it can create. With the stroke of a pen, billions or trillions of dollars are made available to the government to finance war debts or other deficit spending, either “on the books” or “off the books.” Note that Congress has conspired to place many of the most deficit-ridden programs “off the books” so that the consuming (taxpaying and voting) public doesn’t come to fear the consequences of continuing to run these huge deficits “forever.”

To return to the topic of this page, increases in the money supply will generally increase the demand for goods and services if everything else is held as the same. Similarly, increases in prices (which we call inflation) will decrease the demand for goods and services if everything else is held as the same. So, we can conclude that the demand for goods and services is directly proportional to the money supply and inversely proportional to the perceived level of inflation. At least, that remains true until the hyper-inflation phenomena of “hoarding” (buying anything to get rid of worthless money) kicks into place. If that ever happens, then an economy spins totally out of control until the consuming public can be brought back to the point of having enough confidence in the money they receive to keep it or spend it according to their personal needs or wishes.