What is inflation?

Inflation is an increase in the quantity of money. If gold is used as money, then a huge gold discovery would increase or inflate the quantity of money. In most countries, inflation occurs when the central bank creates new money.

Inflation does not mean rising prices, though prices usually rise after inflating the currency. This is because the new money bids up prices. Just like if rich people showed up at an auction and outbid everyone else.

However, prices could actually fall after inflation if new inventions lower costs more than inflation increases prices. If factor labor costs five percent less in China and the money quantity was inflated by two percent, then prices would decrease three percent. Still the prices would have been five percent lower if the banks had not created new money.

The popular Consumer Price Index (CPI) merely measures prices, not inflation. Governments and central banks don’t fight inflation, they cause it.

The inflation rate of Federal Reserve dollars (or digits) has been about 12 percent per year, or 100 percent, since 2006.

Annual changes in quantity of federal reserve digits (dollars) as of May 2014

Quantity of Federal Reserve digits (dollars) since 1959.

 

I have hunch that the word inflation came into use when banks issued receipts for gold that they did not have. In essence, their bank notes were “full of hot air.”

When people used silver and gold coins as money, the inflation process was more complicated, yet still produced more money that was of lesser value. Governments or kings would melt down ten silver ounce coins, add in one ounce of cheap metal, then create eleven coins and mandate that the value of each coin be the same as a pure coin. When the king used a coin to buy a meal, the recipient was taxed about nine percent since the recipient received about nine percent less in value. The process of diluting coins was called debasement. Now the process involves computer digits and is called inflation.

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