“No subject is so much discussed today-or so little understood-as inflation.” – Henry Hazlitt[i]
The above quote is the opening line from one of Henry Hazlitt’s most important essays and now the Econ Circus March book of the month! Normally when Hazlitt is introduced to someone it is with Economics in One Lesson, however as an introduction to Austrian economics I find this book better thanks to a very personal reason I’d like to share:
The question, what is inflation, will forever be the “red pill” that opened my eyes to Austrian economics many years ago. Once the word becomes understood, it allows a person to better conceptualize the problem with mainstream economics which should inevitably lead to the discovery of Austrian economics. Hazlitt wrote an entire book on this idea but also expands on this by showing how inflation relates to other Austrian ideas including the gold standard. Written in 1960 it includes history from the free market perspective while allowing the reader to see the failures of mainstream economics of that era; which, sadly enough are no different than the problems of today.
Inflation, as understood by most people and by mainstream economics, is “the increase in prices.” But does this make sense? Most people are comfortable using the word inflation this way, however it is limiting as it leads to numerous problems and is untenable as a definition.
The first problem is that “prices” must be defined. Often the CPI Index is used, however this is problematic because the CPI index is based on an arbitrary basket of goods which are assigned an arbitrary “relative importance” to each good. The basket of goods will then arbitrarily change on a monthly basis, while assets such as houses and stocks are excluded. Ultimately, we can say the arithmetic is probably accurate, but it is still fake data because it tries to capture a number that cannot be calculated. The number of geographic regions, demographics, economic circumstances and purchases can never be captured in an index number, while the notion of assigning a relative importance to such goods (e.g. two chickens are 0.2 importance for the month but three eggs are 0.3 important for the month) should automatically disqualify the calculation as absurd.
The second problem is: “if inflation means an increase in prices, what causes said increase?” We must consider the notion of supply and demand. But prices can also change due to technological innovation, through government minimum wage or other interventions, price controls, unionization that pushed prices up, or simply for no other reason than human preference. There is also another reason for prices increase that mainstream economists will rarely talk about, which is the increase in the money supply. If prices can increase or decrease for a variety of reasons and these reasons may be difficult to source, then how does the Fed “control” their arbitrary inflation target of 2%?
The more you think about it the less sense it makes. Per the narrative, the Fed will control inflation by raising interest rates. This is somehow being linked to unemployment or the Philips Curve. But wasn’t the Phillips curve proven wrong decades ago, hence the terms “stagflation”? Does anyone stop to wonder why prices should go up at 2% a year and not 4%, 10%, or why shouldn’t they go down 3%?
The reason most people fail to understand inflation is because they have been taught through the mainstream media and academia that there is only one definition for the word which is untrue. The Austrians have been using a very different definition for close to 150 years and decades before the mainstream academia started to use it differently. Once the original and still honest definition of inflation is understood it will create a healthy skeptical attitude to those who are just starting to consider economics. Like most people who discover they have been lied to, they are forced to start doubting the narrative and a new question of paramount importance is formed: “what else are they not telling me?”
Compare the nebulous mainstream definition of inflation to a quote from page 1 of this book:
Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit. If you turn to the American College Dictionary, for example, you will find the first definition of inflation given as follows: “Undue expansion or increase of the currency of a country, esp. by the issuing of paper money not redeemable in specie.[ii]
The Austrian school has always understood inflation to mean “the increase in the supply of money and credit.” Also consider that the Austrian school did not make up this definition; rather they simply used the existing idea of inflation and have never deviated from what they understood to be true.
Once a person realizes inflation is an action with many results, as opposed to a result with unknown causes, the entire notion of economics and what is real versus what is fake comes into question. Inflation as an action means the Fed’s money creation of $4 Trillion is inflation. It also means that since 2007, the M2 money supply went from approximately $7 Trillion to $15 trillion, which is also inflation.
This matters because these acts of inflation are the reason behind the increase in stocks, bonds and real estate prices, as well as a large reason for the general increase in the prices of goods and services. Despite the decade long mainstream media complaints of “stubbornly low inflation,” the average person who makes a fixed or somewhat normal salary knows the cost of living items like rent, tuition, healthcare, food and restaurants has not increased at less than 2% a year for the last decade.
Understanding inflation becomes freeing because it allows the average person to realize that this cognitive dissonance is real; what they are being told on the television and by the experts is a complete lie. But the silver lining is that you can now discover over a century of great authors who stand for the truth in economics, who are not trying to control you and who have never stopped fighting against the mainstream narrative.
The book What You Should Know about Inflation is available for a free PDF download from Mises Institute or can be purchased online from their store. This book is highly recommended! Especially for anyone whom has yet to experience the ease of Hazlitt’s writing, start with this book.
[i] Henry Hazlitt, What You Should Know About Inflation, (Auburn, The Ludwig von Mises Institute, 2007), 1.
[ii] Ibid. 1.