This might have been one of my easily confused money terms, but I didn't think of it back then.
Inflation and rising prices are often used interchangeably but they're not the same thing. Inflation is an increase in the money supply, or put another way, a dilution of its value. (Or put even more cynically, theft.) Rising prices eventually result from inflation because people have more dollars (say) in their hands with which to bid up the price of anything that the money can buy.
An example that's used in Howard Ruff's How to Prosper During the Coming Bad Years in the 21st Century:
If you went to an antique auction and you and everyone else in the room had $1,000 with which to bid, the highest price for which the antiques could be sold is $1,000. But if somehow you were able to put an extra $100 in cash or credit in the hands of some of the people in the room, the price of the antiques would go up, because there would be more money available to bid.
Prices rise and fall for other reasons besides inflation. Shortages can increase prices. (Just look at the Wii Balance Board now.) Subsidies increase prices. Increased fundamental demand can increase prices. So inflation is not the entire cause of rising prices. In fact, prices can fall under inflation, and prices for goods can skyrocket even in non-inflationary or slightly deflationary times, like now.
On average, in the long run, a currency that is not backed by some tangible resource (like gold) can, and probably will, be inflated, and this means that, in the long run, the price of things will go up, and the value of the currency you hold will go down.
I’m just learning all kinds of new things this morning! I didn’t know that the terms weren’t interchangeable, but seeing your explanation really helps it make sense in my head.
Thanks for the great post 🙂 Enjoy your day!
[ "Inflation is an increase in the money supply, or put another way, a dilution of its value. (Or put even more cynically, theft.) …" ]
…. Who is the thief ??
Interesting thoughts. I've got a couple of questions: How is inflation measured? My understanding is that the government uses a price basket system (CPI) and actually compares the prices of "goods" in that basket to determine inflation levels. Why don't they just use L1 if it's based on the money supply?
Also, the bidders in the example "could" spend more. But, we can't assume that they "would". So, if they don't spend more (they save 100) would you have a measurement of inflation?
I disagree. Inflation IS rising prices. One method we use to measure inflation, or rising prices, is the CPI, or Consumer Price Index, which is the aggregate price, or cost, of a basket of goods. If in July the aggregate cost is higher than in June, we have experienced inflation.
There are variants of inflation: Consumer prices, wholesale prices, commodity prices, etc.
Some say (like Milton Friedman) that inflation is a monetary phenomenon. If the growth of the money supply is constrained, then there won't be any inflation.
This, from a practical perspective, is poppycock. Our government could retrain the money supply and we could still experience inflation because of external shocks (imagine OPEC reducing output of oil to the extent that oil shot up to $500 a barrel).
As for your quote of Howard Ruff: I'd suggest you read somebody else. He has been a bear for decades, and once in a while, he's right.
The example doesn't make a lot of sense.
Prices are determined, in a free market, by the forces of supply and demand. If the auction item is worth $1000 to somebody, that's the price it will fetch. Just because a billionaire is in the room doesn't make it so that a hamburger would cost $5000 at Burger King.
It's a dubious argument at best.
I really like your blog, and I've been reading it for quite some time, but I thought I'd give my two cents to set things a little straighter on this topic.