Why I oppose inflationary policies

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Throughout many of my writings on monetary affairs one can identify my abhorrence of inflationary policies. One can detect my distaste of the professorial palaver and the humbuggery of political pontification that promote them. My opposition to inflationism takes place on many levels. On the purely academic/economic I find the macroeconomics underpinning these views as inherently flawed and fallacious. False methods and unrealistic assumptions that have been consciously distorting the reality of human action in favor of mathematical conveniency and algebraic manipulation, resulting in those magical arcs and curves that supposedly depict human behavior and the mechanics of the economy. On the political level, I always feel an inclination to commit mayhem whenever inflationary policies are presented as beneficial for the lower parts of the income distribution. Whenever they are embellished with pseudo-socialistic oratory that ostensibly favors the hard-working people who toil against the markets and the speculators.

Let me be clear. My opposition to inflation is rooted in the belief that it only benefits those relatively few who first gain access to the inflationary money; while those who come last pay the entire cost, ending up being worse-off. In that sense this can never be a policy that favors society in general, more so the working class and those groups who are not part of the state apparatus. When I speak against inflation, I oppose vested interests.

To understand why this is the case, see how inflation is brought into being through expansionary monetary policy. A central bank, say the Fed in the US, will step in to buy government bonds or other assets in order to supply extra money into the system. These additional funds will supposedly reach out the real economy, ultimately making everyone better off, in a smooth, equilibrated, proportional way in a seemingly universal expansion. In truth however all that happens is that the open market operations of the central bank, or its “quantitative easing”, result in asset inflation. The prices of stocks, bonds, financial derivatives etc. rise since the extra money is channeled towards that direction for easy and swift profits.

Speculators love inflation and the reason for that is very precise and specific. If I am a speculator who wants to make profit big and fast, I want the price of the financial products at my portfolio to keep rising. If I bought a financial product in present time at 100 I want it to be 100+something in the nearer future so that I may make profit in between the fast exchanges and exploit the expectations of others for even higher prices in the remoter future. As a speculator I have every interest in ensuring that this inflationary process is perpetuated. If by any chance I fail because of the burst of the inflationary bubble, I know that some wise people out there will be eager to bail me out, because I will have become “too big to fail”.

What about the broader society? How does the above process affect them? They are the ones who will experience the later stages of the inflationary process in at least four ways:

  1. the misallocation of resources into financial products instead of the real economy, has the effect of diminishing the production of real goods and services, thus reducing employment opportunities, resulting in either unemployment or depressed real wages,
  2. the general inflation that will gradually kick in has the effect of reducing real purchasing power and eroding real savings, resulting in an overall impoverishment of the people,
  3. when things turn bad, that is when a financial crisis hits, the people will have to pay higher taxes and/or bail out the speculators who lost from the gambling/inflationist bonanza,
  4. the rising influence of the speculators undermines democracy and establishes corporatism, since the financiers have greater bargaining power over the government, hence elected politicians tend to favor corporate interest much more than social/democratic needs/demands.

Anyone who has studied economic history knows that those expounding on the “benefits” of inflation were all speculators and greedy financiers, excluding do-gooder groups who are just trapped in fallacious thinking (discussed below). One such figure was John Law (1671-1729), a notorious gambler and banker who openly supported the existence of a central bank with monopoly over the creation of (infinite) paper money. He put his scheme to practice in 1716 as head of the Banque General in France, which soon after became Banque Royale. Law was also made the head of the Mississippi company, a French company operating in the Louisiana region, which allowed him to create the notorious hyper-inflationist Mississippi bubble of 1717-1720. Prices skyrocketed during that bubble, making some individuals “millionaires”–a concept that was unfathomable at the time–at the cost of all those who naively assumed that the increase in prices would continue forever. The inflationary policy of Law favored a tiny minority of people at the expense of all the rest, ironically perhaps, including Law himself. In a similar fashion you will find that today the most fervent supporters of inflationary policies are “market experts” who work for mega-banks such as Goldman Sachs, JP Morgan etc. These corporations were responsible for the crisis in the first place through their pre-2008 over-speculation.

A classification should be made of course between these people and academics. The motives of the latter are profoundly different. Academics of economics are indeed trying to provide feasible solutions to real issues using the scientific method. However their method is inherently wrong. Instead of using my own words to explain why that holds true, I shall use a quote excerpted from a recent article of the perhaps controversial figure, George Soros, which I find absolutely correct.

George Soros says:

Ever since the Crash of 2008 there has been a widespread recognition, both among economists and the general public, that economic theory has failed. But there is no consensus, even among participants in this conference, on the extent of that failure. As a sponsor of INET I am delighted, because it shows that INET is open to a variety of new economic thinking. But I am also the proponent of an alternative interpretation of financial markets and in that capacity I take a different position.</p>

I believe that the failure is more profound than generally recognized. It goes back to the foundations of economic theory. Economics tried to model itself on Newtonian physics. It sought to establish universally and timelessly valid laws governing reality. But economics is a social science and there is a fundamental difference between the natural and social sciences. Social phenomena have thinking participants who base their decisions on imperfect knowledge. That is what economic theory has tried to ignore.

Scientific method needs an independent criterion, by which the truth or validity of its theories can be judged. Natural phenomena constitute such a criterion; social phenomena do not. That is because natural phenomena consist of facts that unfold independently of the scientific statements that relate to them. The facts then serve as objective evidence by which the validity of scientific theories can be judged. That has enabled natural science to produce amazing results.

Social events, by contrast, have thinking participants who have a will of their own. They are not detached observers but engaged decision makers whose decisions greatly influence the course of events. Therefore the events do not constitute an independent criterion by which participants can decide whether their views are valid. In the absence of an independent criterion people have to base their decisions not on knowledge but on an inherently biased and to greater or lesser extent distorted interpretation of reality. Their lack of perfect knowledge or fallibility introduces an element of indeterminacy into the course of events that is absent when the events relate to the behavior of inanimate objects. The resulting uncertainty hinders the social sciences in producing laws similar to Newton’s physics.

These are the main reasons I oppose inflation, especially when I am convinced that there are real alternative solutions. You may draw your own conclusions out of all these thoughts.

Picture credit: Lietaer.com