Inflation. We are seeing it every day.
All of a sudden, we are spending a lot more for a pound of hamburger, a gallon of milk, and new school clothes for our kids.
Not to mention that when we headed to the store we had to stop and get gas which has now gone up by nearly double in the last 6 months.
So, we can see it, but what is causing it?
The federal government doesn’t seem concerned. In fact, they are wanting to spend trillions of dollars more for new programs. How can they afford that when we are just barely making ends meet?
Well, it’s really quite simple. We give them our money, and they decide where it is spent.
The first big trigger for inflation was the Progressive Era, which was a period of intense social and political reform aimed at making progress toward a better society.
Progressive Era reformers sought to harness the power of the federal government to eliminate unethical and unfair business practices, reduce corruption, and counteract the negative social effects of industrialization.
In other words, the idea of Social Darwinism, survival of the fittest, was attacked by the progressives who felt the role of the federal government was to provide a better life for the masses.
All of the programs they have initiated over the years cost money. A lot of money.
The Progressive Era was interrupted by World War I, during which federal power expanded even more.
The railroads were nationalized, shipping was regulated, and the United States Food Administration, created in 1917, controlled all aspects of the food industry, from agriculture to distribution to sales.
Similar regulation was applied to fuels, and eventually to the whole economy.When the federal income tax was introduced in 1913 (16th amendment), the highest tax bracket was 7 percent for all income above $20,000. Bear in mind, in 1913 the average yearly salary was $687.
Because of the demand for war-related spending, by 1918 the highest rate rose to 77 percent beginning at $4,000.
So, the federal government now had our money, but they ran into a problem with how to collect it.
The answer, withholding tax.
Before World War II, when income tax rates were far lower than now, there was no withholding system; everyone paid his annual bill in one lump sum, on March 15.
The problem with that system was that the federal government had to wait till March 15th every year to refill its coffers.
So, the government came up with a plan to use every employer as an unpaid tax collector, extracting the tax quietly and silently from each paycheck.
So, rather than paying a huge sum at the end of the year, taxpayers were slowly bled to death week by week.
This also made increasing taxes much easier since many people didn’t really notice an extra nickel or dime deducted from their check when taxes were increased for federal programs.
Now, back to inflation. Once the Feds had your money, and had also come up with a way to make sure they got it, all that was left was to determine a way to use it to control the economy. The answer?
The Federal Reserve System.
The Progressives in Congress, under President Woodrow Wilson, now passed the Federal Reserve Act on December 23rd, 1913.
1. They set up 12 regional banking districts, each with a federal reserve bank.
2. The federal reserve banks were owned by the member banks of the federal reserve system. (All national banks were required to join)
3. Member banks had to subscribe 6% of their capital to the federal reserve bank in their region.
4. Federal reserve banks would the use this capital to back federal reserve notes (Dollars. Take a look at one, it says “Federal Reserve Note”)
Now this is over simplified, but here is how the system works.
Article by Peter Jacobsen
Foundation for Economic Education
Peter Jacobsen is an Assistant Professor of Economics at Ottawa University He received his PhD in economics from George Mason University and obtained his BS from Southeast Missouri State University. His website can be found here.
One way the government keeps track of inflation is by using the consumer price index (CPI). The CPI uses some of the common goods consumers buy, and they keep track of the prices of these goods each year.
A CPI growth of 4.2% means this “basket” of goods the average consumer buys has gotten 4.2% more expensive. Economists call this measure inflation.
The CPI is by no means a perfect measure of inflation, nor could any measure be, but it provides some kind of benchmark to compare how much prices are changing over time.
So,why is inflation increasing now? It’s all about the money. Imagine tomorrow that suddenly all US money becomes a 10x larger number. Ten dollar bills become 100 dollar bills, bank accounts with $10,000 turn into accounts with $100,000, and the four quarters in your cup holder transform into a 10 dollar bill.
This might sound nice at first, but consider what happens next. If prices stay the same, suddenly people rush out to buy new things. Suddenly, a student with a $7000 student loan can buy a Porsche. Someone can afford a down payment on a house who was months away before. A kid with a generous allowance buys a flat-screen TV.
But now the problems appear. All cars for sale are being driven off the lot. TV shelves are empty. House offers pour in only minutes after listing. There is more money, but the exact same amount of goods exist. With so many customers demanding new goods, sellers have 10 customers fighting over one product. So, what happens? The price is goes up.
In fact, prices in this world will make, on average, the same change as bank accounts. One dollar candy bars become $10, average quality TVs cost thousands of dollars, and the $100,000 two-bedroom house in Missouri becomes a million-dollar purchase.
If more dollars chase the exact same goods, prices will rise.
Although the above example is simplified, the general idea holds in the real world. Unfortunately, not everyone has gotten 10x more money, but new money has been introduced to the economy.
The quantity of money has increased more than 32.9% since January 2020.
That means nearly one-quarter of the money in circulation has been created since then. A change like this is unprecedented in recent history.
The newly printed money helped fund the slew of trillion-dollar coronavirus spending which benefitted massive corporations. It also was an attempt to satisfy consumers’ demand to hold money so they would be comfortable spending again. And spending they are.
As lockdowns end and finally allow consumers to return to normal economic activity, the new money begins to move through the economy more quickly. Banks have more money to lend out and people are building new homes. As more homes are built, the demand for wood increases. As the demand for wood increases, the price of wood goes up. Sound familiar?
Although the new money didn’t hit all markets at the same time, and it may take some time for demand to return to pre-lockdown levels, the inflation numbers indicate this process has begun.
In order for inflation to slow down, either spending would have to slow down, or the government would have to lower the money supply.
Given all the new money floating around, it shouldn’t surprise anyone if this rate of inflation were to last for a while or even increase.
The Federal Reserve members aren’t worried, and, in fact, they claim to not be considering contractionary monetary policy until inflation is this level for some time. Many economists argue inflation would need to be much higher to be worth worrying about. But inflation need not be hyperinflation to be harmful to many. Inflation’s effects are not equal.
After a year of lockdowns leading to job losses and pay cuts, many Americans aren’t in a position to pay higher prices. It’s easy for someone with a comfortable job or nest egg to scoff at these price increases, but retirees, working-class, and poor Americans feel the difference.
The government prints money. It distributes it thru the federal reserve banks. The government basically loans the money to the federal reserve bank and charges them interest. Let’s say 2%. This is what is referred to as the prime rate.
The federal reserve bank then has cash to loan to the member bank (your local banks). The Federal reserve bank tacks on their percentage. Let say another 2%. We are now at 4%.
So now you want to buy a car. You go to the local back to get a loan. Your local bank needs to make a profit, so they tack on another 2%. So, you get a loan and pay 6%.
Now, I am not an economist, and like I said, this is an oversimplification, but it basically shows how the feds control the economy.
If the interest rate is low, more people buy stuff. Cars, houses, etc. Businesses now raise their prices because people have money to spend. In other words, inflation. This is how the feds can pump money into the economy.
If interest rates are high, people tighten their belts and don’t buy new cars and houses. Businesses now have to lower their prices to get people to buy their stuff. Deflation.
Now bear in mind. you took out a loan for that new car when interest rates were low. Now they are high, but you are still paying on that 5 year loan.
Where does that money go? To your local bank who then has to pay back the federal reserve bank. This is how the feds can pull money out of the system.
See how this works? By setting the prime rate, The Federal Reserve can control the economy and basically decide if they want to set prices for everything you buy, either higher or lower. Money in, money out.
Who runs this mess? The Federal Reserve Board.
The Secretary of the Treasury, and 7 people appointed by the President.
Think about that folks, 8 people determine what price you pay for virtually everything you buy.
It is up to them to manage our economy and keep inflation under control.
Bet you will pay attention, next time they talk about the prime rate.
How did the Federal Government get so powerful?
Simple. They took your money, decided how it would be spent, and then took control of your buying power.
So, if they screw up just how bad can inflation get?
Now most of us are familiar with the horror stories of hyper-inflation in Germany following WWI.
After the war, Germany was forced to pay the allies for all of the damages caused during the conflict. Germany, having lost the war, had no money to pay these bills. So, what did they do?
They printed money.
- This flood of money led to hyperinflation as the more money was printed, the more prices rose.
- Prices ran out of control, for example, a loaf of bread, which cost 250 marks in January 1923, had risen to 200,000 million marks in November 1923.
- By autumn 1923 it cost more to print a note than the note was worth.
- During the crisis, workers were often paid twice per day because prices rose so fast their wages were virtually worthless by lunchtime.
Can this happen in modern times? You bet.
The Bottom Line
Hyperinflation has severe consequences, for the stability of a nation’s economy, its government, and its people.
It is often a symptom of crises that are already present, and it reveals the true nature of money. Rather than being just an economic object used as a medium of exchange, a store of value, and a unit of account, money is a symbol of underlying social realities.
Its stability and value depend upon the stability of a country’s social and political institutions.
So, folks, as we look at spending trillions of dollars on the infrastructure bill and creating even more costly federal programs, we really should stop and take a look at what history tells us about the effects of inflation.
Prices going up at the grocery store, the gas pump, and your local department stores, along with supply shortages, while the government continues to print money and then spend it like a drunken sailor, is a sure recipe for disaster.