Inflation is a thorny issue with economists. It is necessary in certain instances but too much can drive an economy to ruin. It's all about paper money.
In and of itself paper money serves a purpose; it's handy, easily carried around, and as long as it represents value it has worth. But inflation tends to dilute paper currency and therein lies the problem. It's a dilemma. What we will view in this essay are; the causes of inflation, the degress to which it is beneficial, and the dangers of rampant inflation.
Firstly, inflation is necessary as a couterpoise to the depressant effect of a growing population on a fixed base currency: hard money. There is only so much currency available and the more people there are producing and consuming goods, the greater the need for the liquidity that more currency provides. While the inflationary trend in such a case devalues the currency, in small, well regulated amounts, it is beneficial. But it must always be kept in mind that paper currency is not money; it merely represents value. The proper role of paper money is the transferrence of wealth, not the creation of some false feeling of prosperity.
Inflation usually occurs when too much currency pursues too few goods; prices are bid higher and those who have adequate stocks of currency pay them, while those with less are hard pressed. A person who earns fifty dollars an hour doesn't mind paying $3.00 for a latté, a person earning ten dollars an hour would consider such a purchase a luxury. It's all relative, but allowed to grow beyond a certain level inflaton can cripple an economy. By its very nature inflation shatters the constraints that a hard currency places on its partcipants: Hard times? Just print more money!
At the domestic level inflation is bad enough; in terms of foreign trade it is calamitous as a cheaper currency tends to gravitate to offshore banks. This is because it takes more inflated dollars to purchase things abroad and fewer foreign currency units to purchase things here. What happens is that foreign governemnets assume a poition of power over the domestic economy by threatening to divest themselves of this devalued currency as France tried in the late 1960's. One of the attributes of money is the willingness of the issuing party to receive it in rerurn for goods, services, or other considerations. The international medium of exchange is still gold even though we have taken ourselves off the standard. A foreign government only has to specify that it will return so many dollars for so much gold, and the United States government would be obliged to sell the metal. The erosion that would take place is obvious: more dollars in circulation, less gold to back them in foreign exchange.
So we print more paper money ( coupons ) in the mistaken belief that volume equals value. The fallacy of this notion may be seen in the stock market. Once upon a time it was possible to amortize a stock purchase in ten, fifteen, perhaps twenty years.
This is a function of the Price/Earnings Ratio. If a stock sells for ten dollars a share and earns dividends of one dollar per year, in ten years the stock would have paid for itself, and the rest would be pure profit. In those days millions of shares were traded daily, today it's billions of shares because P/E ratios are now 30, 40, or in some cases approaching fifty. Looking at the Price/Earnings Ratio another way is to consider that what it truly represents is interest on the money invested. Flip the ratio over and you get, in the case of the ten-dollar stock, 1/10 or 10% interest. A P/E of thirty returns only 3.33%, so naturally investors trade at higher volumes: when you're earning dimes instead of dollars you need more of them.
Once, the Nationa Debt was measured in millions, then hundreds of millions, the billions, then hundreds of billions: the latest adminstration is proposing a budget of 3.1 trillion dollars. That's inflation!
But there is another side of the issue that government regulators don't seem to consider. I'll cover that in Part Three.
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