Inflation 101%, II

A Nickel ain't worth a dime anymore. – Yogi Berra

Read part one if you haven’t already ??

Inflation is considered healthy for the economy; people are spending money, and the price of goods is slowly rising due to demand. It is also easier to borrow money. Not only this, but in the U.K., the minimum wage rises every April 1st. Should your salary be higher than the minimum wage, it means that your salary will not necessarily be increased; this will depend on your company. An unpopular and badly received practice is to lower employee salaries, which is rarely done for obvious reasons. It would result in strikes and bad publicity. But during an inflationary economy, this is unnecessary since the employees are effectively taking a pay cut should their salary not be increased on a yearly basis. For example, if your salary was ￡30,000 in 2021, it would have to be increased to ￡31,380 in 2022 to keep up with inflation. Conversely, in the absence of this increase, you would be taking a shadow pay cut.

To circumvent being dependent on the employer's whims and the awkwardness of a salary increase request, many workers do what is called job-hopping; by changing jobs, they are able to apply and re-negotiate for a higher salary. In fact, half of U.K. workers plan to change jobs in the next three years, but only ten percent of the workforce actually does so, and this is predominately among those under 25 years old. In addition to this, a study conducted by four economists from the Massachusetts Institute of Technology found that if workers were adequately aware of the labour market and their options, at least 10% of jobs would not be viable at current wages.

Despite the increase in average salary on a yearly basis, some sectors are more dependent on the minimum wage increase. For a radio shop clerk, for instance, this economic rise reflects poorly on his area of expertise. While prices increase, his salary is reduced due to low demand. In this scenario, without being too facetious about it, what he should do is undertake some job-hopping. So let us agree that inflation is good because demand is up, jobs are being created, and salaries are rising as well.

Money devaluation isn't a concept recently created but can be traced back thousands of years. In ancient times, the coins did not represent a specific value, such as the British Pound does; the coinage was the value itself. This material fact did not stop rulers from creating new money. In the Roman Empire, for example, following the expansion of its territory and army as well as the increase of dealings with coinage, the devaluation of the denarius, a silver coin, progressively took place. The advice of Septimius Severus to his son, Caracalla, was supposedly "live in harmony; enrich the troops; ignore everyone else," an advice his son took to heart. Aside from famously murdering his brother, he also said, "Nobody should have any money but I, so that I may bestow it upon the soldiers." At the very least, the middle portion of his father's advice had been followed.

As emperors changed, a denarius's purity progressively decreased. From Augustus reign, a denarius held 95% purity; this percentage decreased to about 2% over the next 270 years. This was done by stretching the silver and adding impurities to the coinage. An ingenious way to recalibrate circulating coins was by asking them to be brought for repairs, where they were subsequently stolen from their original silver value. This increased the supply but decreased its value. At its end, before a new coin was issued and identically decreased in value, a denarius became a copper coin that was rapidly dipped in silver.

In 301 A.D., to tackle the spiralling inflation, the emperor Diocletian, who himself was born poor and became military commander before being proclaimed emperor by the army, attempted to impose wage and price controls. However, his attempt at curling prices was unsuccessful and highly criticised. The Edict of Maximum Prices was widely resisted and unevenly enforced, causing ’minute price variation brawls', few goods to be put up for sale, and the rise of black markets. None of the following emperors managed to fix the failing economy, its rising taxes, or its inability to pay soldiers. Inflation is considered to be one of the causes of the fall of the Roman Empire. Similar issues have happened elsewhere. In order to fund his wars and expensive lifestyle, Henry VIII ordered the debasement of the currency, now known as the Great Debasement. The new silver currency, at times made almost entirely of copper, earned him the surname Henry coppernose, as the coating would first rub off on his nose and face, providing him with a blush. Such devaluations have occurred in ancient Egypt and China as well.

Recent examples of hyperinflation have been seen in the U.K. during the 1970s, where it rose to 13%, or in Germany after the First World War, where inflation rose to 29,500%. At the end of this hyper-inflationary episode, you could only buy 1 egg with the money that just a few years earlier would've been enough to buy around 500 billion eggs in Germany. The circulating photos of the aftermath, where children play with piles of cash, serve as modern reminders of what happens when too much money is created.

Inflation is a quiet but effective way for the government to transfer resources from the people to itself without raising taxes. A hundred-dollar bill would buy less in 1998 than a $20 bill would buy in the 1960s. This means that anyone who kept his money in a safe over those years would have lost 80 percent of its value, because no safe can keep your money safe from politicians who control the printing presses. – Thomas Sowell, American economist

These days, real money is not backed by a tangible asset like gold, particularly in countries where money is printed on demand. It is, in a sense, as fictional as the infamous Dogecoin cryptocurrency. As we have seen in the examples above, increasing the money supply drastically can have terrible consequences. Yet we still print money. The role of taxation comes to mind; then, what is the point if money can be made to appear out of thin air? Well, thanks to it, they are able to spend money without feeding into inflation but also to decrease the circulating money supply and therefore put another foot on its rise. Technically, the government does not really need our money, which is the core basis of the Modern Monetary Theory (MMT). Revenue poses no restriction on the spending budget for countries that issue their own currency.? Nor does debt affect it like in other countries. It only has to decide how much money it needs and go ahead and spend it. Taxes serve other macroeconomic purposes, such as limiting wealth gaps or influencing population behaviour, e.g., fertility rate. We are aware that certain products are taxed more highly than others. For example, sin taxes for tobacco and alcohol do not raise money for the NHS to fight the consequences derived from their consumption, but to discourage people from consuming these products to a certain degree. It reflects little on funding dispositions.

These factors decrease incentives for higher taxation for wealthier individuals. We do not need to raise money at all. Lower revenue from the top earners would mean less investing on their part, which affects economic growth and job creation. Which can also lead to stagflation, rising inflation, stagnant salaries, and rising unemployment. Also, thanks to very well-paid accountants, they find ways to fiddle their way out of taxable income. So while inflation and normal taxes have consequences for everyone and should be relative to the wealth held, they really affect those on the bottom percentile the most. As the singer Leonard Cohen succinctly puts it in Everybody Knows, 'the poor stay poor, the rich get rich, that's how it goes'.?

Let us look at Gresham's Law, named after Sir Thomas Gresham, a financier during the 16th century.This law divides money into two categories: good money and bad money. A modern parallel would be: you receive a large sum of money, and you decide to award ￡10,000 to your daughter for her excellent grades. This is good for today's money she has received. However, you only allow her to spend it for five years when she reaches 18 years of age. After five years at an annual average inflation rate of 2.5%, her money would have the purchase power equivalent to ￡8,685.92, despite the identical nominal amount (and ￡3,613.84 after twenty years). Essentially, fiat is antithetical to the patient.?

Gresham's Law dictates that bad money drives away good money. In other words, people will keep hold of the older, higher-value coinage when the intrinsic value of a currency is reduced by minting new ones with a lower metallic content, all the while an identical equivalency between these two is imposed. The coins are hoarded, be it for collection purposes due to their limited availability or the increase in value alongside the metal. This has happened recently in the United States with the Coinage Act of 1965, where the government reduced and eliminated the silver content of several of its coins, causing the older coins of identical nominal value to disappear from circulation.

While this concept bears Gresham's name, it has been known for thousands of years. In 405 BC, the Greek playwright Aristophanes wrote the following in his play, The Frogs:

"I’ll tell you what I think about the way

This city treats her soundest men today:

By coincidence more sad than funny,

It’s very like the way we treat our money.

The noble silver drachma, which is old

We were so proud of, and the one of gold

Coins that rang so true

Throughout the world have ceased to circulate.

Instead the purses of Athenian shoppers

Are full of phoney silver-plated coppers.

Just so, when men are needed by the nation,

The best have withdrawn from circulation."

Turning from precious metals to fiat money does not resolve this problem. In the instance of a government debasing the currency by printing money, alternative sources of money preservation subsequently arise. Fiat money becomes used for transactions while other assets are preferred to increase or maintain wealth equivalency—such as cryptocurrencies, which we will see in a later chapter.?

Sometimes what is called deflation can happen; the most infamous example is probably the plummeting of salaries in the aftermath of the Black Death in medieval England. This results from either a sharp rise in the total supply of goods and services or from a decline in the demand for them. A lower demand for a specific good leads to a corresponding decrease in price. This means lower profits for the company, which now has to consider whether it will either lay off workers or decrease their salaries to reduce spending. Similarly, customers reduce their spending as they expect goods to fall in price. This creates a nefarious domino effect on the economy. Holders of debt, on the other hand, see their relative debt increase as salaries and prices go down. A way to tackle this issue, and this has been seen recently in 2020 Europe, is to set the interest rate to negative. In other words, you are paying to hold your money in the bank. The motivation behind this is to force people to increase their spending and investing, which will consequently stimulate the economy. It's worth bearing in mind that if your interest rate is below the annual inflation rate, you technically hold a negative interest rate.

This should demonstrate to the everyday reader that fiat money holds different value depending on how long you keep a hold of it. Regardless of the time and place, the government's interests are oftentimes not aligned with those of its citizens, whose ignorance of certain subjects becomes more of an advantage.

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