Most people take inflation as being the increase in the price of goods and services and a lot of time blame greedy businesses, labour unions and speculators for inflation. It certainly seems to be a valid explanation of inflation but in this article we will look back at the classical definition of inflation that has not been taught in schools or universities for about fifty years. It is only when we understand what inflation is that we are better able to protect ourselves from it.
In my previous article entitled Understanding Money I noted how the goldsmiths and the bankers started issuing promissory notes for money and that money was gold and silver coinage or specie. We also saw that the bankers, along with the UK government, stopped redeeming theses notes for gold after the beginning of the First World War. By 1933 the US banks did the same and in 1971 President Nixon also took the dollar off the Bretton Woods agreement in which the US Treasury promised other governments to redeem one troy ounce of gold for $35 in currency.
What we need to understand is that inflation is purely a monetary phenomenon. The Oxford English Dictionary of 1925 defined “inflate” as “abnormally increase (State’s currency esp. by issue of inconvertible paper)”. So in the UK, governments and the Bank of England have been issuing inconvertible (into gold) currency and credit since 1914 and the world in general since 1971. So the currency that we use is really a promissory note for another promissory note as that is what the Bank of England now tells us if we ask them about the promise from the chief cashier at the top of its notes. I myself have phoned the Bank of England press office about this and I was advised that “I Promise to pay the bear on demand the sum of £20” simply means is that I may exchange an old and/or damaged £20 note for a new one.
You might be asking: what does all this have to do with inflation? So prior to 1914 UK banks had to convert bank notes on demand by the bearer or customer into gold sovereigns. So if you went to your bank with a £5 note, the bank would pay you with 5 gold sovereigns as each sovereign had a face value of £1. The convertibility of the currency into real money or gold forced the banks and the Bank of England to limit the issuance of currency and credit unbacked by real money or gold as there was the risk that too many customers might ask for redemption all at once. To understand how inflating or creating too much inconvertible currency results in higher prices, one only needs to understand the law of supply and demand.
If we went to a market to buy a turkey for Christmas only to find out that because of a delivery problem there were only 5 turkeys instead of the usual 100 turkeys, it would be natural for the seller of the turkeys to raise the price of turkeys and still be able to sell them. So the supply of currency relative to turkeys would go up dramatically and that would lead to an increase in the value of turkeys relative to currency. If you read Understanding Money you should know that money evolved from barter and that under a barter system one person exchanges something of value for another thing of value. Therefore when the banking and credit system is able to create inconvertible currency, or what is nowadays called fiat currency, without limit that currency becomes worth less versus real goods and services that cannot be created at the same pace as the currency.
So the consequence of inflation is the loss of purchasing power of the currency and that feels like prices are rising but it is actually the currency that is dropping in value. Nowadays though, we are told that the government measures of price rises like the CPI or RPI are inflation even tough price rises or the drop in the value of the currency are caused by the over issuance of currency. The reason schools and universities don’t teach the real definition of inflation, in my opinion, is that the financial sector has become so powerful that its influence has become widespread in society. The government plays along with it because inflation means it can borrow more in order to buy votes. Nowadays we are told that higher holiday prices or higher secondhand car prices caused inflation or the CPI to rise and that is how we are being fooled and distracted from the real creators of inflation. It is actually the excess creation of currency and credit relative to services and goods that lead to the rise in holiday or secondhand car prices.
So now we will use the Bank of England’s own so-called Inflation Calculator, which in reality calculates the rise in the cost of living since 1209. Another way to look at it is the how the currency of the realm has performed through time. First we will look at how the many pounds one needed in 1914 to buy the same amount of goods that £1 could buy in 1209. So according to the Old Lady’s own calculator, https://www.bankofengland.co.uk/monetary-policy/inflation/inflation-calculator, by 1914 the pound had lost on average 0.4% per annum over 705 years and one needed £17.65 of 1914 pounds to buy the equivalent of £1 in 1209. From 1209 to 2019 the average increase in prices more than doubles to 0.9% per annum so the impact of 105 years of fiat currency and the abandonment of a sound money system has been dramatic. So we need £2051.99 of today’s money to buy the equivalent of £1 in 1209 and £17.65 in 1914.
We have also been told that since Gordon Brown, then Chancellor of the Exchequer, gave the Bank of England independence in 1997 that inflation has been under control and sometimes we are even told that there is a danger of falling prices. To dispel that myth let us look at how the pound in your pocket has fared since 1997. So according to the inflation calculator the average rate of price rises since 1997 has been 2.8% per annum and you now need £1.83 to buy what you could with £1 in 1997.
It is very hard to then protect one’s savings versus inflation and especially now with the rate of interest being kept at almost zero since the GFC of 2008. Investors and savers have had to put their hard-earned savings at risk in the stock market and riskier investments that provide a higher yield or interest. Getting on the property ladder has helped too as bricks and mortars are limited in supply unlike fiat currency. Having some gold sovereigns and silver Britannias have also helped savers as the same concept of the law and supply and demand that applies to property applies to real money or gold and silver.
So the next time you are told the packaged holidays led to a rise in inflation just remember that is government and our current monetary system that are responsible for it.
N.B. The views here are my opinion and not investment advice.