Why Government Leaders Are to Blame for High Inflation
Why Government Leaders Are to Blame for High Inflation
Understanding inflation's true causes, economic impact, and how policymaker decisions have created today's inflationary crisis
Introduction
The word inflation, pregnant with horror, has been in the headlines almost every day for the past year. Considering that the world economy has experienced its highest inflation rate in four decades, the attention has been warranted.
But should we really be terrified of inflation? What do we understand about the causes and effects of inflationary conditions? This straightforward analysis will explain inflation and its impact on the economy without confusing or complicated jargon.
Current Reality
We're experiencing the highest inflation rates in four decades, yet many investors are still uncertain about how to protect their wealth. Understanding inflation's true causes is the first step toward making informed investment decisions, including whether to add gold to your portfolio as an inflation hedge.
Table of Contents
What Is Inflation? The Real Definition
A good technical definition of inflation is "a general increase in prices and fall in the purchasing value of money" (emphasis mine).
Key Components of Inflation
- General price level increase
- Loss of purchasing power
- Broad-based price rises
- Currency devaluation effects
What Inflation Is NOT
- Simple supply and demand price changes
- Isolated sector price increases
- Temporary market disruptions
- Normal economic fluctuations
The second part about a loss of purchasing power is the key piece to the inflation puzzle. Inflation is not simply a rise in prices, which could be due to things like increased demand, reduced supply, or other normal economic factors. It is broadly a rise in all prices.
Milton Friedman's Monetary Theory
Milton Friedman, an economist who won the Nobel Prize for his work on inflation, viewed inflation as "anywhere and everywhere, always a monetary phenomenon." In other words, inflation is due to an excess growth of the money supply relative to the goods and services available in the economy.
Friedman's Core Thesis
Inflation is fundamentally a monetary phenomenon caused by excessive money creation relative to economic output. This monetarist view emphasizes the direct relationship between money supply growth and price levels.
Historical Evidence
Although this "monetarist" view has fallen out of favor within the economics profession, the data still strongly supports Friedman's assertion about money supply and inflation correlation.
Contributing Factors
Interest rate levels and supply chain health can drive inflation higher on the margins, but never without accompanying monetary expansion.
The Monetary Reality
The fact remains that there has never been a period of inflation that didn't coincide with a massive increase in the supply of money. This fundamental relationship explains why precious metals have maintained their purchasing power over centuries while fiat currencies have consistently depreciated.
Economic Impact and the Cantillon Effect
Changes in interest rates or the money supply typically have an inflationary effect with a lag time of 9 months to 18 months. Inflation tends to creep up slowly, and then all at once.
Inflation's Unequal Impact
- Worst impact on low-income families
- Higher proportion spent on necessities
- Limited ability to hedge against inflation
- Fixed income erosion
Wealthy Protection Mechanisms
- Asset price appreciation
- Real estate holdings
- Stock market exposure
- Access to inflation hedges
The Cantillon Effect
Such unequal outcomes are predicted by an economic principle known as the Cantillon Effect. This explains why Friedman often insisted that inflation is a hidden tax that nobody got to vote on, given that decision-makers at central banks, such as the Fed, are unelected.
The rate of inflation directly impacts manufacturers' expectations about future prices and influences what consumers expect to pay for products. The key point is for inflation to be consistent and predictable for the economy to run efficiently. "Surprise" inflation has pernicious effects on consumption, investment, and the orderly functioning of supply chains.
Federal Reserve Inflation Target
This is why the U.S. Congress created a 2% annual inflation target for the Federal Reserve, the country's central bank. However, when actual inflation significantly exceeds this target, it creates conditions where investors seek alternative stores of value like physical gold and silver.
Why Policymakers Got It Wrong
Policymakers at the Fed, the European Central Bank (ECB), and other government bureaucracies were apparently caught off-guard entirely by the explosion in inflation in 2022. This dubious list includes some of the world's most influential economic leaders.
Christine Lagarde
Head of the ECB and former managing director of the International Monetary Fund (IMF). Despite decades of experience, failed to anticipate current inflation.
Janet Yellen
Secretary of the Treasury and former Fed chair who recently apologized for being wrong about inflation, despite her extensive central banking experience.
Jerome Powell
Current Fed chief who incorrectly characterized inflation as "transitory" and later admitted Fed members were "still learning" about inflation.
Predictable Failure
In point of fact, an eventual rise in inflation was all but inevitable. Central banks kept interest rates near zero (or even used negative interest rates) for nearly a decade following the global financial crisis. At some point, this policy was always going to end in high inflation.
Policy Mistakes
- Decade of near-zero interest rates
- Massive quantitative easing programs
- Ignoring historical precedents
- Overconfidence in economic models
Pandemic Response
- Trillions in emergency government spending
- Unprecedented money creation
- Supply chain disruptions ignored
- Labor market distortions
Trillions of dollars in emergency spending by governments during the COVID pandemic added fuel to the fire. Despite decades of academic literature about inflation and numerous historical examples, these leaders failed to anticipate the obvious consequences of their policies.
Misguided Policy Responses
Sadly, plenty of thought leaders in economics and government have since tried to spin higher inflation as actually a good thing. (It does make the national debt easier to pay off, after all.) This flip-flopping and lack of accountability significantly erodes confidence in leadership and causes more social upheaval.
The Cure Worse Than the Disease
Even worse, the shift in policy to respond to high inflation—rapidly raising interest rates—is going to have its own negative effects. As rates quickly climb, lower economic growth and higher unemployment are largely unavoidable consequences.
Interest Rate Risks
- Economic growth slowdown
- Increased unemployment risk
- Market volatility
- Debt service burden increases
Policy Tool Limitations
- Interest rates are blunt instruments
- Lag effects create overshooting
- Unintended economic consequences
- Limited precision in targeting
The Real Problem
Raising interest rates by itself is a rather blunt tool with which to manage the economy. Without a thoughtful change in fiscal policy (i.e., government spending), the "cure" will indeed be no better than the disease of inflation itself.
Remember the lag time mentioned earlier—policy responses invariably come too late and often "make the cure worse than the disease." The heavy-handed responses from government policymakers to inflation typically create new problems while failing to address the root monetary causes.
Investment Implications for Precious Metals
Understanding inflation's true causes and the policy failures that created our current situation has important implications for investors considering precious metals as part of their portfolio strategy.
Historical Inflation Hedge
Throughout history, gold has maintained purchasing power during inflationary periods because it cannot be created by monetary authorities.
Policy Uncertainty
The demonstrated failure of policymakers to anticipate or properly respond to inflation increases the value of assets independent of government policy.
Currency Debasement Protection
Silver and gold provide protection against the hidden tax of inflation that Friedman warned about.
Strategic Considerations
Given the demonstrated policy failures and the fundamental monetary nature of inflation, investors may want to consider precious metals allocation as insurance against continued currency debasement. The key is understanding that gold and silver serve as wealth preservation tools rather than speculative investments.
Investment Strategy
Friedman's insight that inflation is "always a monetary phenomenon" suggests that as long as governments continue printing money to finance spending, the conditions that favor precious metals as stores of value will persist. This makes physical gold and silver particularly relevant for long-term wealth preservation strategies.
Conclusion
The current inflationary crisis was both predictable and preventable. Policymakers' failure to understand the fundamental monetary nature of inflation, combined with their continued reliance on the same tools that created the problem, suggests that inflationary pressures may persist longer than many expect.
Milton Friedman's warning that inflation is a hidden tax imposed by unelected officials has proven prophetic. As central banks and governments continue to prioritize short-term political objectives over sound monetary policy, the case for holding assets that cannot be debased by government decree becomes increasingly compelling.
Final Thoughts
For investors seeking to protect their purchasing power against the ongoing monetary policy failures, understanding inflation's true causes is essential. The demonstrated inability of even the most experienced policymakers to anticipate or properly respond to inflation underscores the importance of holding assets—like gold and silver—that have preserved wealth through centuries of monetary mismanagement.