Inflation - Some Causes and Consequences

We all know what inflation is - the newspapers say so everyday - an increase in prices. At least, that is what we are led to believe. Free-market economists know that an increase in the money supply is the cause of continually rising prices. Inflation, by definition, is an increase in the money supply. It is impossible for prices and wages to continue to increase unless there is an increase in the total amount of money in circulation. That is, if everyone is getting paid more and is also spending more on goods and services then it can only be because there is more money in existence.

An analogy that I like to use is a card game - say the game of bridge, where each person is dealt 13 cards. The aim is to bid higher than the opposition team - but it is obvious that it is impossible to bid higher than 13 tricks, simply because there is a fixed number of cards in the pack. But what happens if an outsider comes up to one of the players and says, "Psst, here - have another ace!". Obviously that person is going to be able to bid higher than before - and he will have an advantage over other players. The same applies to monetary inflation - the person or group to first receive the new money is the first to benefit from it. They can buy the goods at the existing price. But as the money filters through the economy, prices are raised and the last people to get the increased wages will have no benefit because the prices will have already gone up.

As I said before, the common concept of inflation is rising prices. But it is not just the ordinary person who does not understand the true definition. It also appears that people as important (and I use the word cautiously) as the Prime Minister, do not understand - or if he does then he is deliberately misleading the public. He seems to think that inflation is rising prices because he advocates price controls. At the recent Economic Summit Treasurer Keating said the government's economic policy is "based on expansionary fiscal policy with our prices and incomes accord as a major anti- inflation instrument". He also said "without a price and income policy there will be inflation". In March this year Argentina imposed price controls "to arrest 200% inflation".

In fact, most ludicrous of all, I have heard [Australian] Labor [Party] government speakers, and also an employee of the Reserve Bank (I am not sure of his position) who I rang one day, say that the growth of money supply is designed to accomodate the amount of inflation that there has been!!

This is not merely playing with words. The consequences of the misuse of the word "inflation" leads to such policies as wage and price controls with resultant shortages, blackmarkets and loss of product quality. The effect is worse on the people such policies are designed to help, the poor. Shortages mean that the goods will be unavailable to them at any price, unless they enter the blackmarkets and pay even more than the uncontrolled prices would have been. Milton Friedman says that the imposition of price and wage controls is a sure sign that the government wants to inflate. This is because the controls mask (at least initially) the effects of the inflation.

Other consequences of inflation are well known - the eroding of the value of life insurance policies, of superannuatuion and of savings - and then the interest earned on savings is taxed - to guarantee a loss of value in real terms.

Of course the government has a vested interest in the perpetuation of inflation. It can pay off its debts in cheaper dollars, for example government bonds, which are "Government Guaranteed". Sure they are guaranteed - you will get your $1000 back all right, but there is no guarantee as to what the purchasing power of that $1000 will be. I should also note that some writers have suggested that in future governments will have a moratorium on the repayments of bonds. They could say, "We will just postpone the maturity date of your bonds for another 6 months - for the good of the country, you know!"

There is also further revenue generated because of "bracket creep" because of the "progressive" (another misleading word) tax scales. Taxpayers move up into the next tax rate and the government can innocently say, "We didn't put taxes up"!

So how does inflation start? By government over- expenditure and the creation of a deficit. The government has committed itself to pay out a certain amount of money. But what if it does not have that money on hand? All the people it has committed itself to pay must still be paid - it is not as if the overexpenditure can simply be ignored. There are only three ways of obtaining the extra money: by borrowing, by taxation, or by "printing money".

If the money is borrowed it must still be paid back one day in the future - with interest - and if the government did not have the money this time, how is it going to pay back even more (because of the interest) in the future? We see this crisis with some countries now - they have to take out new loans just to pay off the interest on previous loans. Just think what we could do personally if we could keep borrowing without regard to paying off the loan - will the bank believe us if we say, "don't worry, just give us another loan for now. We will pay it all back - later - promise!"

Another means is taxation. This is of course a great burden on productivity and it is politically unfavourable, but not so unfavourable as to prevent the high rates of taxes that we now have.

The third "solution" is the easiest for the government because the effects are not immediately obvious. That is the "print money" option, where the government finds that paper money does grow on trees! Not that the government itself directly prints money. The process is via the Reserve Bank and is called "monetization" of the debt. Suppose the government wishes to borrow $10 million. It goes to the Reserve Bank and says, "We want to borrow $10 million". The Bank says, "OK, what is your security?" to which the government replies, "This $10 million government note (or bond, or security)". So the Bank then says, "Fine, we will credit your account with us by $10 million and hold the security". The government can then draw cheques on its account and pay its creditors. The point is that the increase of the government's account with the Reserve Bank was a mere book-keeping entry and the so called new "funds" appeared from thin air.

The actual dollar notes are printed by the Reserve Bank and are available on demand to commercial banks. If a commercial bank needs cash it goes to the Reserve bank and obtains cash in return for debiting its account with the Reserve bank. This action is performed by the Note Issue Department of the Reserve Bank and is how that Department makes its profit. That is, the Department sells $1 notes to banks for $1, but the cost to the Reserve Bank is only the printing costs plus overheads.

In Australia there is no limit to the quantity of paper money that may be printed except for the funds held by banks. The reason we don't see the country flooded with actual paper money is because most currency transactions are carried out by the use of cheques.

We have discussed some of the mechanisms and consequences of inflation in an economic sense; let's now look at some of the deeper consequences and effects on society.

First a note of explanation. What follows is going to be Biblically oriented. Now, the impression that may be gained by listening to many so-called religious people is that socialism and government intervention in the guise of help for the poor are valid. Nothing could be further from the truth. The only system of economics which can validly be supported by the Bible is free-market economics, subject to Biblical laws.

But because man is determined to play god he will not recognise any law order external to himself which can govern his way of life and impose limitations upon his fiat powers. The totalitarian state, as creator of fiat money by legalised counterfeiting is always the wealthiest and most powerful force in society. The claim of the modern state is that it is god walking on earth and sovereign of all, with power to create fiat money and fiat laws. This philosophy is evidenced by the tax system. The state in effect claims to own everything, and it is only by an act of grace that the taxpayer is allowed to keep "exemptions". The common cry is that "tax avoiders" are causing the state to lose revenue, the implication being that the tax belongs to the state and is being stolen from it.

The state thinks that it has a cure for everything: intervention, and by still more intervention the state attempts to undo the effects of its original intervention.

Inflation is thus a consequence of the state playing god and is of a religious origin.

Inflation, by cheapening the value of money, robs creditors and rewards debtors. The state of course is the biggest debtor of all. Inflation is the theft of the value of money and so the state is the leading thief. It encourages thieves and favours debtors, for example, by allowing deductions for interest payments on debts but there is no benefit for savings, the interest received being taxed.

However, inflation cannot work unless the state has a large number of allies among the people. They may be rich or poor, and in fact they do include both corporations and the poor. Everybody is out to get their special tax concessions or housing grants or subsidies or bounty. The hope is to get something for nothing.

Many people believe that the way to deal with a thieving state is to become thieves themselves, or long term debtors in an inflationary economy. But such an attitude gives a person a vested interest in the continuation of inflation. I make the distinction here between protection from inflation by means of the purchase of gold or land or tools of trade, and the aim just to make a profit from inflation without regard to the underlying consequences. If people have a large interest in debt liquidation by inflation then they will tend to vote accordingly.

This leads to the question of bribery. The Bible never condemns the giving of bribes in order to impede the progress of traitorous governments. What is condemned is the taking of bribes to pervert righteous judgement. In this regard both the people and the state are to blame: the people for taking the bribes of handouts, and the state for accepting the votes to keep themselves in power. As an aside, the state's view is the reverse of the Biblical one. If, for example, you attempt to bribe a police officer if you get a speeding ticket then you will be the one in trouble.

All the hard-money advocates know that gold and silver have been accepted for centuries as trustworthy mediums of exchange. Not surprisingly then, as early as chapter 2 of Genesis, it is mentioned where gold was to be found. When the Bible speaks of "weights" it often means money because money in the Bible meant weights of gold and silver. The Bible condemns debased weights as despoiling the people and being contrary to law and justice.

So the key factor in the cause of inflation is the covetousness of man: the desire to seek gain by fraudulent means. Thus the so-called "war on inflation" is a farce. The government creates inflation and needs it to maintain its powers. The people, in general, like inflation because it gratifies their covetness and allows them to commit theft legally.

Of course, after a while inflation has unhappy consequences for all concerned and hostilities increase. Then begins the game of hunting for the culprits - the speculators, the hoarders, the capitalists, the workers or unions. Each party blames the others.

Thus unless there is a wider understanding of the causes and consequences of inflation, and unless people withdraw from being dependent on the state and demanding everything from it, inflation will continue.

Bob Long, July 1983.

[Originally presented as a talk to the Tax Payers United group, in Brisbane, Australia.]


  1. The Centre for Independent Studies, Wage-Price Control. Myth and Reality, 1978.
  2. Henry Hazlitt, Economics in One Lesson. Arlington House, 1979.
  3. R.J. Rushdoony, The Roots of Inflation. Ross House Books, 1982.
  4. R.J. Rushdoony, The Institutes of Biblical Law, Vol. 1. The Presbyterian and Reformed Publishing Co., 1973.
  5. Reserve Bank of Australia, Functions and Operations.