High inflation is a kind of dangerous disease. Sometimes it is fatal to face this disease. In such circumstances, delicate manipulations and highly skilled economic policymakers are required. Because if inflation is left unchecked at high levels, it can lead to the destruction of an entire generation.
A shocking example of such a historical disaster is what happened after the first world war, where countries like Germany, Austria and Russia experienced extreme uncontrolled high inflation with the consequences we all know. Another typical example is the uncontrolled high inflation in Latin American countries, which led to economic disaster while strengthening totalitarian regimes.
Therefore, all countries should be cautious about this disease, especially today when policymakers face an unprecedentedly high inflation rate. For everyone involved with the phenomenon of inflation, whether it concerns politicians or investors and traders, it is most important to clarify the causes that cause inflation, how to deal with it, and the consequences of dealing with inflation.
Let's get the blame squarely clear: It's all about printing money
Inflation is a phenomenon that has its roots in monetary policy. It is essentially the result of an excess amount of money in the economy relative to the actual amount of money produced by industries, services, natural resources, and innovation.
Sometimes the prices of certain goods and services increase because of significant discoveries in natural resources or innovation. Indeed, discovery or innovation creates new wealth and, therefore, new money and an increase in price levels for some goods and services. But this cannot create inflationary conditions. The only ones who can do that are governments.
Governments are the ones who control the money in the economy. Therefore, governments' decisions about the amount of money in the economy are responsible for inflation.
Governments do not accept this responsibility and primarily shift it to other entities. They usually focus on irrational decisions and behaviours of some entrepreneurs, unions and consumers. Or they shift the blame to exogenous conditions such as irrationally high commodity prices or to irrational geopolitical actions of some states. Indeed, all of the above seem like they could be responsible for creating inflation.
However, this cannot be true for one simple reason: because neither unions, consumers, businessmen, nor anyone else is able to print money. Only government central banks print money.
And the fact is that all economic evidence proves that the correlation between the increase in the amount of money and inflation is absolute. The same does not happen with the aforementioned factors, such as the behaviour of businessmen, consumers and commodities. None of these coefficients is identified with inflation in the long term.
In fact, in every part of the world and in every period of history, the printing of excess money is the only reason that, sooner or later, always creates an increase in inflation, wherever and whenever it occurs. Therefore, the sole responsibility for inflation, wherever and whenever it occurs, is the government and only the government.
But the reasonable question is, why are governments driven to print money and thus increase inflation?
We force governments to print money.
The truth is that governments print money and therefore increase government spending not because they want to but because citizens and businesses demand it. Indeed, the fundamental reason governments print money is because they are under intense pressure from each of us. Look at what happens in times of crisis like the pandemic, the financial crisis of 2008, or the European debt crisis just a few years ago.
Everyone called for increased public spending on the plausible argument that businesses and households needed support. Remember Mr Draghi's famous statement that the central bank, in other words, the governments of European countries, "will do whatever is necessary to ensure price stability", i.e. print as much money as is needed to support the economies and markets.
"Money trees" do not exist; all that exists are taxes
The result of everyone's demand for money printing by governments was increased government spending. But while government spending is rising and everyone knows, especially governments, that there are no "money trees", no one ever wants to talk about how this spending will be repaid.
There is only one way for governments to pay for their spending: through taxes.
The rule is simple: taxes must always equal government spending. If spending increases, taxes must also increase. However, raising taxes on citizens and businesses is a highly unpopular practice that governments avoid implementing directly. Governments only raise taxes directly when forced to do so because they have no other alternatives. So, if they don't raise direct taxes, they have to do something else.
Hidden taxation. How governments always win
The alternative for governments is to create hidden taxation techniques, whereby everyone will be required to repay government spending. Still, no one will be able to blame the governments directly. The method devised and always followed to finance government spending is to raise money by governments through inflation. Essentially, inflation is a type of tax where governments extract money from taxpayers in many different ways, the main ones being:
Governments print money, and as a result, people and businesses increase their deposits significantly. Remember what happened in the last few years as bank deposit accounts soared to record levels with money printing and the pandemic. Then, through a complex process (which is detailed in my book: Financial Economics Strategic Risk & Investment Management Under Cover), governments force commercial banks to buy the bonds issued by their central banks using their customers' deposits, that is, individuals and businesses who, especially in times of crisis, believe that their financial wealth is secured in commercial banks.
Then, for some time, central banks create a low-interest rate environment for government bonds. Thus, the cost of borrowing for governments that continue to print money while increasing their spending to finance people and businesses is meagre to zero. But issuing bonds increases public expenditure and, obviously, the national debt. However, since the cost of spending and deficits is zero and always less than inflation, inflation, in the long run, wipes out both deficits and public debt.
This is how depositors repay government spending, as this is the ultimate goal of governments: the government debt created by increased government spending is compensated by the inflation created by money printing. The depositors' alternative is to invest in the real economy, increasing aggregate output and thereby helping to reduce the debt-to-GDP ratio. Either way, governments are the winners.
Τhe result of inflation and the cause of inflation
As mentioned above, there is the counter-argument that inflation is due to other factors, such as Unions' pressures to increase workers' wages. However, this narrative is far from the truth. The difference between the effect of inflation and the cause of inflation needs to be clarified. Rising wages are the result, not the cause of inflation. The fact is that there is no evidence to prove that the increase in wages can create inflation in the mid-term and long-term.
Similarly, another view is that inflation results from international events such as rising energy prices. For example, today, after the war in Ukraine, the narrative is that energy prices are skyrocketing worldwide and generating intractable global inflation. But this narrative is not easily supported, and the proof is that inflation, despite the spike in energy prices, varies significantly from country to country. A rapid increase in energy prices can indeed create imbalances in markets; however, there is no evidence that energy prices generate inflation in the medium or long term.
At the end of the day, the printing of money can cause an increase in energy prices and not the other way around. The evidence shows that the government's excess money supply creates inflation—nothing else.
The question is not whether a government is able to stop the rise of inflation
Since governments control inflation, it can easily be assumed that governments can tame inflation whenever they want. The strategy they should follow is straightforward: If they print less money, inflation will stabilize or decrease. This is the only way they can stop the rise of inflation.
But the question is not whether a government can stop the rise of inflation. The answer is that it can. The critical question is whether the government has the will to do this. To this question, the answer is not simple. The point is that if one is addicted to the conditions of printing money, it is difficult to get rid of those conditions.
They are all addicted to money printing
Printing money not only has positive consequences for governments, but it also has positive consequences for many of us. In reality, when governments print money, many individuals and entities benefit. An excess supply of money helps businesses grow significantly, and production increases, as does consumption. But if the money printing policy continues for a long time, the government is taking huge risks. As time goes on and inflation increases significantly, there is a point where we all lose. And this is where governments must step in to tame inflation.
Today we seem to be at precisely that point. It is the point where governments should have the will to tame inflation. But when governments decide to tame inflation at the beginning of this effort, they will face significant difficulties as they will be forced to reduce the money supply and, therefore, slow economic growth; also, at the beginning of this effort, unemployment will increase.
This is a scenario that no one wants to face. Everyone has become addicted to the previous conditions of excessive money printing and inflation. And although people and entities claim that they lose from inflation and nobody wants it, the truth is somewhat different. Rising prices benefit the value of their wealth since inflation increases the value of their real estate, when in reality, as with countries' debts, it is inflation that pays off much of their borrowing. As explained earlier, governments are the ones who benefit the most, but people and businesses also benefit from inflation.
Inflation widens inequality and produces populism and totalitarianism
Not all people and entities have the same wealth to benefit equally from inflation. This means that a significant increase in inflation would gradually create a large gap between people and a similarly large gap between entities which would lead to totalitarianism. Characteristic examples are countries like Latin America and recently in countries like Turkey, where inflation widens the gap and leads to totalitarian regimes.
Suppose Western countries do not immediately take measures to tame inflation. In that case, sooner or later, it is very likely that they will find themselves in situations similar to those after the First World War: the gap will widen and populism will dominate, significantly increasing the global risks and geopolitical instability.
Under these circumstances, in a period such as the present, where inflation tends to remain for a long time at high levels, it would be a great mistake for governments to abdicate their responsibility for the cure of inflation by seeking its treatment from exogenous factors, such as exerting pressure to reduce commodity prices or exert pressure on business people or trade unions. Such efforts would have only short-term results.
Given that governments are responsible for inflation, it stands to reason that they should also be accountable for its cure.
Governments must take full responsibility for curing inflation
The fact is that governments should commit to a plan to reduce the money supply and stick to it. Investors and traders should know that this means a reduction in money printing, so in the beginning, everyone will have to deal with the negative consequences of this enormous challenge.
The success of this plan will depend on whether and to what extent there will be a gradual de-escalation of inflation to the extent that households and businesses can adapt to the new conditions. The plan should be implemented gradually because a sharp reduction in the money supply would be disastrous. So, it will take time to achieve the goal of reducing inflation.
The key point seems to be one and only one: Governments should take full responsibility for curbing inflation. If they do not do this, it will be like handing out a bomb to be defused by those, who have neither the tools nor the responsibility to do so. Even worse, it will be if they shift the responsibility of curing inflation to external international factors, as today, to factors that lead the energy prices. Because then, they will take on even greater risk since the external factors that will be called upon to neutralize the inflation bomb with their interests in mind are very likely, not to defuse but to detonate it.
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