Friday, March 30, 2007

Engines of Inflation

Puru Saxena on the true nature of inflation:

Central banks are the engines of inflation. Whether it is the Federal Reserve in the US or the Bank of England in the UK, the sole purpose of these institutions is to inflate. At the same time, they understate the ongoing inflation problem and manage the public's fears. Therefore, in order to protect your wealth in this era of constant inflation, it is absolutely essential that you properly define and understand inflation. In other words, you need to distinguish between "cause" and "effect".

Today, most people have been conditioned to believe that inflation is an increase in prices as captured by the official "Consumer Price Index". However, the truth is that inflation is an increase in the quantity of money and credit. As the supply of money and credit are inflated (the cause), prices of goods, services and assets rise within an economy (the effect).

This is inflation as it is classically defined. Unfortunately, in the minds of the public, the effects of inflation (rising prices, etc.) have been mistaken as the cause. This has led to a great deal of confusion and the resulting misdiagnosis of many economic problems.

For further explanation, see Puru's article,
"Engines of Inflation".