> tough on the causes of inflation.
>
Is this not the central issue?
It seems that UK economic policy has been reduced to 'control of inflation', or
to be more precise, keeping down the Retail Price Index. Low and stable inflation
means greater certainty and therefore more investment. Consistent responses to
changes in inflationary pressures in the economy reduce the amplitude of the
business cycle with beneficial results for confidence. However, since raising the
overall tax burden is out politically (and probably practically) this leaves us
with the sole instrument of interest rates. The consequence of this currently,
combined with global economic uncertainty, is another bout of 'stagflation' - the
worst of both worlds. What is more - interest rates, by their uneven effects on
exporters and importers and on net borrowers and lenders have a fundamentally
distorting effect on the distribution of rewards for enterprise and industry.
So - trying to control inflation leaves us with a mess. Better to look at the
causes.
The main cause of inflation is money. No money - no inflation. But money is
useful - it helps to lubricate transactions and generally keep the economy
moving. So could we have money but no inflation? I believe it's possible - but it
is clear that most economists and economic policy-makers do not accept that our
current modes of the creation and distribution of money are at the root of most
of our economic and social dilemmas. The following essay may help to convince.
Money - what is it? - Dr Diarmid Weir
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What is money anyway? Although primarily thought of as a means of exchange, being
indestructible, it also has value in its own right. When measuring up total
wealth we add money capital to real forms of capital; material capital, human
capital, social capital. Yet money isn’t really a separate form of capital,
because in the end it has no use value until it is converted into one of the
other sorts of capital. What process can then explain how we can come to give
money exchange-value with real wealth? Is not the only acceptable way to see
money as future value? It represents the anticipated performance of labour,
future solar energy or resources in the earth’s crust that have not yet been
discovered. There is a limit to how much future value can acceptably be used in
the present economy, however. Future resources must have a degree of uncertainty
attached to them. There are limits to our reserves of fossil fuels, for example.
Global warming may destroy fertile land. Property will eventually require to be
renovated. Future populations may fall not rise. Accountants represent this by
‘discounting’ - the concept that a nominal present value is worth more than the
same nominal future value.
The gold standard
When widely acceptable money was first issued the value was guaranteed by a claim
on some tangible thing of known value - usually a certain weight of gold. Since
not all holders of money would be expected to claim their gold at once the
reserve of gold held by the money issuer need not equal the value of all money
issued. While the total amount of money issued was of less value than the future
labour and natural resources that could reasonably be assumed to be available
within the relevant jurisdiction new money could retain its nominal value after
issue. However, once the nominal value of all money in circulation began to
exceed the total value of the goods and services people were prepared to accept
had a good chance of being available in the future, the value of money began to
fall - inflation.
The limit to money-value
To simplify this, consider ‘money’ in the form of an IOU issued by one individual
to another in return for services rendered. The maximum value of this ‘money’
could not exceed the value of goods and services the issuer of the money could
himself reasonably be expected to supply in the future. This, in turn would
depend on the natural materials he controlled or was likely to control, and the
labour and skills he was likely to be able to command in his lifetime. Clearly
the more people involved in the money system, the greater the amount of future
value can be assumed. But for any finite size of population or limited resources,
there comes a distance into the future beyond which safe assumptions can no
longer be made.
The stock of wealth
Let us assume that everyone’s income truly represents all the assets they are
known to hold, in terms of their potential for labour, skills and the natural
resources they control. That earning potential is reflected in the proportion of
the money stock they have access to over a period of time. Assuming no
significant change in the total stock of wealth or population change and no
active measures to redistribute labour, skills or natural resources, then
relative incomes should remain more or less unchanged. But what if the nominal
value of the money stock increases as a result of the issue of new money? If
there is equal knowledge of this, this should not affect relative incomes and
therefore relative purchasing power is not affected. This means in effect that
the real value of the money stock is unchanged. The rise in nominal value is
inflation.
The recurrent problem of inflation in our economy in recent decades shows that we
have long since passed the point where the rate of supply of money is matched by
the finding of genuinely new resources, but old resources can still gain real
value through rises in ‘productivity’. Let us assume a productivity gain in the
whole economy, assumed to be distributed evenly and raising everyone’s earning
potential by the same proportion. This, although not altering relative purchasing
power, would raise everyone’s absolute power. Unless the nominal value of the
total money stock is raised in the same proportion, the nominal value of money
rises - with the inconvenience this entails in terms of revaluing assets and
‘menu’ costs. Given that future resources too can be assumed now to generate more
income, it is reasonable to transfer this value from the future to the present
economy and to distribute it in the proportions of present wealth.
Importing ‘future value’
If, however, the nominal stock of money increases by a certain proportion, which
is not accounted for by a productivity gain, and is not revalued to offset the
increase, then what has happened is that new future value - which as I have
argued should not really have any true value, all realistic projected future
value having already been accounted for - has been absorbed into the present
economy. This is dangerous because decisions may now be made on the basis of a
stock of something that may in the end turn out not to exist. If the working
population falls, skills are lost or natural resources are depleted then money
capital may end up with no value. This has implications for the whole population
but also favours those spending money in the present, over those who may spend it
in the future.
There is a second issue of distribution. Since the extra future value has no
basis in any known present resources there is no basis for distributing it in any
other way than equally between all people. At this distance in the future there
is no basis for assuming anything other than equal income-generating potential.
(Were this actually done then the reality of the new money’s lack of value would
soon spread through the economy, resulting simply in inflation.)
Fiction and Deception
However the fiction that undetermined future value can be imported into the
present economy and then exchanged for real value in the present is maintained in
the British and US economies and probably most other developed economies, because
the extra money is not distributed equally, but is distributed by banks as loans
in proportion to earning capacity - that is the capacity to repay. The deception
is maintained by basing the measure of the falling value of money in the value of
items disproportionately purchased by those who do not have access to the new
money - in the Retail Price Index (RPI). In the UK, between 1982 and 1997, the
broad money stock (M4) rose at an average rate of 10.9% per year, while nominal
national income only rose at an average of 7.2%. The RPI only rose by an average
of 4.5%.
The results of this process will be:
1) The reliance on assumptions about future resources and skills which have no
basis in present knowledge
2) Assumed future income that would rightly belong to those currently in command
of relatively few human and material resources, is redistributed in advance to
those currently in control of relatively more, widening not just income
inequality but also inequality of control of resources.
Thus the discrepancy between the money stock growth and the recognised inflation
rate produces a situation where unrealistic assumptions are being made about the
future of human and material resources. The present benefit of this goes to a
small section of society - the already wealthy - at present cost to the already
poor.
In the long term……..
Future benefits and costs are similarly distributed in the short and medium term
but are likely to even up in the long term because:
1 Many of the resources to have been excessively depleted are also essential to
the rich
2 For the changes in money distribution and resource control to be maintained
relies on legal convention to be upheld. When these changes become too great this
will break down.
What the ‘rich’ need to realise is that once resources are depleted and legal
convention has broken down, the difficulty and costs to them of replacing
resources and reinstating the rule of law will be little different to that for
the poor. We will all end up in the same leaky and inhospitable boat. We would do
better to work together in open cooperation to build a better vessel.
Diarmid Weir 8th July 1998
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