A subjectivist analysis of the inflationary process

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended. Information may be out of date. For further questions contact me.

The analysis of the inflationary process clearly shows who are the winners
and who pay for the bonanza stemming from the presumed cornucopia of
the central bank’s money-creating mechanisms. Picture credit: Wikipedia

I originally intended to discuss the workings of (crony-)capitalist Quantitative Easing in the U.S.A., Japan and the UK, but fellow blogger and economist Vuk Vukovic has already done so in a series of posts, which I would certainly recommend to any one reading this article. Thus I need not proceed into an assessment of these policies, their particularities and their likely impact. Instead I find it appropriate to distance myself, for this one time, from the political events related to the subject, the outright currency wars and “we-they” syndromes they engender, so as to focus on the mechanics of the inflationary process as such. The subject I will delve in is slightly more academic and theoretical than the occasional analyses on the expected or desired effects of a monetary expansion, yet it can provide, I think, a very solid foundation for interpreting current phenomena and a fortiriori for appreciating their sociopolitical ramifications, in as far as cronyism, corporatism and bottom-up redistribution of wealth, resources and power are concerned.

The mainstream of the economics discipline continues to think of the inflationary process along the lines of the quantity theory of money, as the latter was originally developed by the Salamancan Scholastics and the polymath Nicolaus Copernicus. While economists in our day are much more sophisticated than the late medieval thinkers, in as far as appreciating the fact that an increase in the supply of money may not necessarily result in generalized increased prices; contemporary scholars have nevertheless failed lamentably to escape from the largely unrealistic set of assumptions concerning the process of a monetary expansion. Such a process was seen back then and is, to a great extent, still seen today as a universal, generalized, equilibrated, proportional, one-shot increase in aggregate magnitudes, such as the ‘price level’, which can be formalized in aggregative accounting identities concerning the economy as a whole.

While that view may be useful in propounding macroeconomic theorems whose underlying fallacies can only be exposed by an a posteriori evaluation of their alleged merits in juxtaposition to the actual facts, always to the extent that such “facts” can provide us with the approximate truth –with myself as a praxeologist being highly skeptical about it– ; it is nonetheless readily apparent that the explicit macroeconomic reasoning leaves much to be desired as to the qualitative effects and consequences of the inflationary process in the context of time. In short the standardized view of inflation completely neglects the impact a monetary expansion has on relative prices, the economic relationships between the varying classes of people who will gain access to the new money and finally the capital structure which is directly influenced, inter alia, by time-preferences, expectations and relative prices.

Moreover the mainstream account does not recognize the praxeologic axiom that all economic phenomena, all human action that is, take place in time; meaning that as time passes, minor, yet significant, or occasionally drastic changes occur in the complex interweaving web of factors that influence an agent’s economic behavior and choices (for more on such themes I strongly recommend Eugen von Böhm-Bawerk, Capital and Interest, as well as the towering masterpiece of Ludwig von Mises, Human Action). Mainstream thinking is primarily static, by drawing out the qualitative aspects of the time dimension; or recognizes in the passage of time, ancillary changes to otherwise highly predictable trends. Hence the tendency to think of the inflationary process as a universal, aggregate expansion with symmetric effects across the board.

A more accurate understanding of the inflationary process would treat it as a series of incremental increases in the supply of money coming in consecutive waves over the passing of time, each with a particular and diverse set of benign or deleterious effects on the people that gain access to it depending on the relative advantage or disadvantage they have found their selves in, at the point when this monetary cascade was set in motion and then brought upon them.

To better appreciate this inflationary process I believe we need to go back to the founding father of modern economics, Richard Cantillon (no it is not Adam Smith). It so happens, in the history of thought, for old knowledge to be swept aside and forgotten, not because of valid refutations, but due to shifts in the fashions of reasoning (due to reasons that escape the purview of this article), making the progress of economic thought more of a zig-zag-back-and-forth pattern rather than a straight line towards a more profound understanding of the subject matter.

In his magnificent treatise, Essai sur la Nature du Commerce en General (Essay on the Nature of Commerce in General – a ‘must read’ for anyone with a serious interest in economics and economic history), Richard Cantillon provides us with the following scintillating analysis (excerpted from Part II: Chapter Six of the book – all emphasis is mine):

If the increase of hard money comes from gold and silver mines within the state, the owner of these mines, the entrepreneurs, the smelters, refiners, and all the other workers will increase their expenses in proportion to their profits. Their households will consume more meat, wine, or beer than before. They will become accustomed to wearing better clothes, having finer linens, and to having more ornate houses and other desirable goods. Consequently, they will give employment to several artisans who did not have that much work before and who, for the same reason, will increase their expenditures. All this increased expenditures on meat, wine, wool, etc., necessarily reduces the share of the other inhabitants in the state who do not participate at first in the wealth of the mines in question. The bargaining process of the market, with the demand for meat, wine, wool, etc., being stronger than usual, will not fail to increase their prices.

These high prices will encourage farmers to employ more land to produce the following year, and these same farmers will profit from the increased prices and will increase their expenditure on their families like the others. Those who will suffer from these higher prices and increased consumption will be, first of all, the property owners, during the term of their leases, then their domestic servants and all the workmen or fixed wage earners who support their families on a salary. They all must diminish their expenditures in proportion to the new consumption, which will compel a large number of them to emigrate and to seek a living elsewhere. The property owners will dismiss many of them, and the rest will demand a wage increase in order to live as before. It is in this manner that a considerable increase of money from mines increases consumption and, by diminishing the number of inhabitants, greater expenditures result by those who remain.

If money continues to be extracted from the mines, the abundance of money will increase all prices to such a point that not only will the property owners raise their rents considerably when the leases expire and resume their old lifestyle, increasing their servants’ wages proportionally, but the artisans and workmen will increase the prices of the articles they produce so high that there will be a considerable gains in buying them from foreigners who make them much cheaper. This will naturally encourage several people to import products at lower prices from foreign factories, and this will gradually ruin the artisans and manufacturers of the state who will be unable to sustain themselves by working at such low rates because of the high cost of living.

When the overabundance of money from the mines has diminished the number of inhabitants in a state, accustomed those who remain to excessive expenditures, raised the prices of farm products and the wages for labor to high levels, and ruined the manufactures of the state by the purchase of foreign products by property owners and mine workers, the money produced by the mines will necessarily go abroad to pay for the imports. This will gradually impoverish the state and make it, in a way, dependent on foreigners to whom it is obliged to send money every year as it is extracted from the mines. The great circulation of money, which was widespread in the beginning, ceases; poverty and misery follow and the exploitation of the mines appears to be only advantageous to those employed in them and to the foreigners who profit thereby.

I find this analysis of great interest for two main reasons:

  1. It outlines the workings of a proto-keynesian multiplier effect, though the underpinning assumptions and methodology are profoundly different from the ones Lord Keynes utilized in developing his macroeconomic theories. Cantillon sees a “ripple” effect, today known as a “Cantillon effect”, rather than an expansionary and allegedly benign impact on the economy in general, as the latter appears in Keynes’ work and the consequent keynesian literature hitherto. </p> The “multiplier” of Cantillon is established on methodologically individualist, “micro” foundations, seeing each and every group of people in the process as economic actors who operate within a given framework and who are likely to act in accordance with the changing conditions, each individual or group of individuals affecting the other in varying ways relative to their position in the inflationary process, which occurs in the passing of time.
In contrast the keynesian multiplier derives from an accounting illusion in how gross &#8220;macro&#8221; figures are affected and with all their equally aggregative components being examined as entities in their own capacity _qua_ economic agents, even though they are not –and could never be properly considered as– acting individuals or groups of individuals. As such the illustration of Cantillon anticipates and completely obliterates this artificial division, central in modern economics, between the micro and the macro spheres, by correctly combining the two in an integrated frame of reasoning and observation.

Caveat I am not implying that Cantillon was flawless, as that would be a hagiographic not an objective, academic depiction of the founding father of economics (something that some others do with now-dead economists to legitimize every absurd libel they may call sound economic policy, be it &#8220;keynesians&#8221; or &#8220;neoliberals&#8221;). I am merely suggesting that he provided a much more subjectivist and therefore realistic foundation to economics than the heap of illusions and muddled aggregative thinking that was developed soon after by the classical economists and the early 20th century Anglo-Saxon economics that followed them. Cantillon&#8217;s somewhat primitive but clearly promising _methodological individualism_ was developed and improved later on in economic history by the early Austrian School, led by Carl Menger and then by such important thinkers as Ludwig von Mises, F.A. Hayek and Murray N. Rothbard (in mentioning them I am not tacitly suggesting that their theories are homogenous, for that would be a crass distortion of reality).</li> 

  * The second reason why I appreciate the above-quoted contribution of Cantillon is that it provides us with a very useful analytical device for examining the unprecedented cheap (for certain few) money bonanza of our days and for evaluating the economic, social and political implications this monetary relaxation is likely to have over the medium-to-long term. Thus while we are no longer environed by a monetary system based on precious metals such as gold and silver, therefore not expecting an increase in the money supply by the discovery of more mines or the more efficient exploitation of the existing ones; we may still apply the &#8220;Cantillon effect&#8221; to central banking and the way all monetary expansions occur, each affecting different classes of people _unequally and disproportionately_. 
    In the modern monetary system an expansion of the media of exchange, be it fiat money or the private money –e.g. financial derivatives– that derives from it and other assets that are in complex ways rigged by government edicts and regulations (such as assets whose underlying risk is determined by the Basel accords), may only be initiated by a central bank that holds the coercive monopoly to create money out of thin air and to arbitrarily determine primary interest rates (in other words the despotic power to grossly distort the economy in total). When a central bank expands its balance sheet or lowers interests rates, it injects new money into the financial system. That money is mostly profitable for those financiers who first gain access to it, as at that point in time they are the only ones who become better off relative to those who did not reach it first. 
    In time two, these financiers may use their increased power to either strengthen their position in the system, usually to further cartelize their industry or to deepen their entrenchment with the state in some other way; or to make great profits when prices in sovereign bond markets and commodities are yet to be influenced by the inflationary expectations and increased demand. In time three those who first gained access to the new money are far better off than they were initially, closely followed by other financiers who may now be seen as second class to the former. 
    Once the profits in sovereign bond and commodities markets diminish because of a bullish rally, the inflationary pressure will gradually move into lesser or more risk-bearing markets such as the stocks market, until it eventually reaches out consumer goods and finally wages, with the latter two being the only components of official &#8220;inflation&#8221;. At each stage the group of people more proximate to the new money will gain the upper hand over those who receive it later in time, which in simple terms means that by this fact alone the distance between the ultra-rich and the very-rich will increase to the benefit of the former; while the chasm between the 1% and the other 99% of society, will widen further, as the latter will only make use of all that inflation far later in the process when the treasure will have long turned into carbon.
    It should be noted however that the inflationary process which originated in the central bank expanding the money supply, may never be reflected in official price &#8220;inflation&#8221;, for three main reasons: **(i)** the capital requirements that states have imposed on _nominally_ private banks force much of that money directly into state coffers to finance immediate state expenses and roll over existing debt, via the selling of government bonds – a shameful Faustian Bargain which serves the short-term interests of incumbent governments and the wildly-speculative propensities of state-sponsored financial sharks (I use the phrase &#8220;nominally private banks&#8221; because of the symbiosis between banks and state which does not allow for a proper use of the term &#8220;private&#8221; as opposed to &#8220;public&#8221;), **(ii)** many of the central bank&#8217;s monetary operations may be balanced off by a _sterilization process_ that absorbs liquidity from other areas to counter the expansion and thus mitigate the upward pressures on the official inflation indices; a sterilization process which in practical terms means that the genuinely creditworthy will be crowded out by those who enjoy the inflationary infusions (for a more tangible example see my first assessment of the Outright Monetary Transactions), **(iii)** a generalized inflation may never be realized because in the process there might be an economic shock, such as a recession or a financial crisis which will hamper or severely damage the transmission channels – however the disruptions to the economy, caused by the inflationary process, which magnifies the vicissitudes of the largely unstable financial markets, will not be brought to an abrupt end, but rather change form, from monetary to fiscal.</li> </ol> 
    Anyone not deluded by the much-touted statist apologia that peddles inflation as a more or less humanitarian policy for the poor and crippled down, will realize that through the mechanics of the inflationary process the ones who benefit the most are the elite of the plutocracy and the state, while the ones who suffer dearly are those at the lower parts of the income distribution. The latter will either have to pay higher interest rates than what would have otherwise been the case in a free(d) money market; or they will witness their purchasing power and savings being eroded, while their relative position to the corporate establishment further deteriorating as they never enjoy the initial stages of the monetary expansion which are in effect a straightforward subsidy to established financiers; or as is the case nowadays they will be forced, under the threat or the use of the jailhouses, the guns and the tear gas of the state, to pay for bailouts to _&#8220;too big to fail&#8221;_ mega-corporations and to undergo inane &#8220;austerity&#8221; which in effect preserves toxic debts and perpetuates economic malpractices, while collectivizing the losses of certain plutocrats whose interests are interwoven with the state elite, at the cost of diminishing social welfare and political clout.
    In concluding this article I must recognize that there certainly is much more that could be said in expounding on this vast and multifaceted subject and in providing a textual exegesis to the far-reaching deductions that may be inferred from it, particularly towards a broader formulation of the subjectivist interpretation of phenomena along the business cycle and the political process. However I uphold that treading on such fields would force me to digress from the issue I hereby touched upon, at the expense of alienating the reader. 
    What I draw as a general epistemological and sociopolitical observation from the use of the individualistic, deductive and subjectivist methodological organon in analysing the inflationary process, is that modern economics, having failed to develop any genuinely subjectivist interpretation of phenomena and being trapped in scurrilous fictions, pernicious illusions and egregious fallacies, has in effect provided grist to the mill of the sagacity of corporatists and crony capitalists. The often chimerical theories and models of economists lend the scientific patina of calculus, statistics and geometry to financial malpractices and political opportunism, the effects of which we the unprivileged experience in the form of impoverishment and immiseration in periodic intervals throughout our lives. 
    The mainstream of the economic science must therefore be held largely responsible for plunging us to the human-made morass of this 5-year-old economic crisis. In my humble opinion incumbent economists should stop pretending that nothing is wrong with their ways and should above all find the audacity to tell the public that their knowledge is far more limited than what they purport to show through their constant exhortations and mathematical scientism. Having no delusions whatsoever, I am pretty much convinced that they will never do so voluntarily, for they will lose their prestigious position as technocratic experts of the state apparatus and its panoply of planning boards.