The “Inflation Tax” is a very real phenomenon, and it is very much a part of our current economic and political condition. Why can’t the government just go and print the money for all the spending we want to do? Until you understand that inflation is a tax, you will never really be able to give a great answer to that question.
The first thing you need to understand is that no government, no matter how big or how small, has any purchasing power of its own; it has to get its purchasing power from its citizens. If a government wants to spend $100 on a new street sign, it first must go to its citizens to get the money to do so. This is all very simple and obvious when you are talking about a local or state government, but it becomes less obvious when dealing with the Federal government because of the size of the budgets, and because of the Fed’s ability to print money.
In general, the government has one of three sources for its purchasing power: taxation of its citizens, borrowing from foreign and domestic lenders, or the printing of money.
It is the money-printing thing that causes all of the confusion.
The second thing you need to understand is that there is a difference between wealth and money. Wealth is an accumulation of purchasing power – it is the difference between what you produce versus what you consume. This is true of a household and of a nation. If you produce a lot but consume relatively little, the production that you did not convert into consumption will accumulate as future purchasing power. Thus you have created wealth.
Money is NOT wealth – it is the tool we use to allocate purchasing power among members of a society. Increasing the amount of money in circulation does NOT create more wealth, it just changes the allocation of the existing purchasing power. The creation of wealth has nothing to do with the money supply – wealth can be created even if the money supply is decreasing as long as production exceeds consumption. It can also be created when the money supply is increasing, but the point is that the expansion of the money supply is not what creates a nation’s wealth. Just ask the folks in Zimbabwe.
To return to our first point, the government has no purchasing power of its own, so when it prints money it creates this illusion that it has fashioned wealth (or demand, or whatever term they want to use) out of thin air. But it is an illusion. They have not created more wealth nor more purchasing power, because the government has no purchasing power of its own that it has not taken from its citizens in one form or another. By printing new money, the government transfers some of the purchasing power of the dollars that are currently in circulation to those new dollars that roll steaming off of the figurative printing press.
That means that the government gets new dollars that can buy things, but at the expense of your old dollars that cannot buy as much as they used to before the new ones were printed. There is no increase in purchasing power because the printed money has not produced anything – there has been no creation of wealth and thus no increase in purchasing power.
It would be like adding yards to a football field, but leaving the field the same actual length. You could double the number of yards on the field and it would not make the field any longer – it would just reduce the size of each yard. But the consequence of playing football on a 200-yard field that is the same physical length as the 100-yard field with which we are all familiar would be that the players on the “200-yard” field would re-write all the statistical records. There is no increase in the factual length, but there is a difference in the way it is measured.
If you can imagine your purchasing power as yards on that football field, when the number of yards on the field were doubled the actual length of your yardage was cut in half. Maybe you had 6 yards on that field; when the field was increased to 200 yards you still had your 6 yards, but they were only worth what 3 yards would have been worth before the measurement was changed.
That is exactly what happens when the government prints money. It robs the dollars you presently own of some of their purchasing power by putting that purchasing power in the new dollars they create.
For all that the proponents of inflationary money printing will say that it is for the good of the working man, nothing could be further from the truth. Working-class people have precious little savings to begin with – the last thing they need is for those savings to be diminished by the printing of money. Furthermore, their wages are also eroded by the shrinking purchasing power of each dollar they earn, so their cost of living skyrockets and their standard of living plummets. Inflation is THE most regressive form of taxation that could ever be conceived.
It is an insidious and dishonest way to fund a government. By printing money the politicians can seize your purchasing power without taxing you, and that usually means that they can do so without you really realizing it. They can then use that purchasing power for whatever purpose they want – but you can be assured that at the end of the day the purpose they choose will be one that gets them reelected.
This is the reason that sound money is crucial to the survival of a society. A money supply that is based on a real and tangible sum of wealth cannot be debased so easily or so casually. Sound money – a gold standard – imposes discipline on lawmakers and forces them to spend only that purchasing power they come by through honest and transparent means. Without that discipline the only thing that stands between the US and Zimbabwe is the character, integrity, and intellect of our elected officials.
Does that concern you as much as it concerns me?