Inflation I

The great enemy of “living off investments” is called inflation.

In the first place, it must be made clear for the purists that it has been stepped over the deeper digressions that differ between the Consumer Price Index (CPI) and inflation. The CPI is based on calculating the price of a basket of primary goods and watching its evolution in the future. This should serve as a comparison to know how much the cost of living has gone up. However, as it normally happens when there are political interests in the mix, the official CPI data isn’t consistent. To make the number seem less, in an almost generalized way, from time to time governments change the way they calculate it and the composition of the basket of goods. Taxes, leisure expenses and self-production aren’t usually included.

It’s curious, given that the CPI is a value that doesn’t have any intrinsic meaning and is only useful for the possibility of comparing it. Constantly changing the methodology doesn’t seem the most appropriate thing to do.

The logical chain that is camouflaged by inflation is the following:

1. In the quest to remain in power, leaders spend more than what they earn, thus generating debt.

2. Raising taxes to pay this debt is unpopular, so they resort to an “invisible” tax that consists of devaluing the money so that the debt is lower, although a simultaneous loss of citizens’ purchasing power comes with it.

It isn’t easy to realize this loss of purchasing power, because the basket used in the CPI isn’t always homogeneous and closed, such that governments can manipulate the data so that their citizens aren’t aware of the theft. Somehow many people think that inflation is like a drought or the ever-rising sun, a fact of nature. And perhaps that is true, because the lust for power is natural in human beings. Nevertheless, not by any means is it inevitable, given that it is a product of tangible and provoked economic actions. In general, inflation is understood as the continuous and sustained growth of price levels in an economy. The CPI would act as an added indicator.

The formal definition of inflation, however, can be more complex and depends on different schools of economic thought. The Austrian School considers inflation directly in its origin: the issue of paper money. That is, inflation is the increase of the money supply (once again, various definitions exist on what money supply is). From this point of view, it’s not possible to have a generalized growth in prices without issuing money. Obviously, there is a consumption of goods and a creation of new goods (with possible changes in productivity), but this variation is negligible against the issuance of money.

To sum up the concept in a simpler way: inflation is the increase of the money supply and the consequence is the hike in the prices of goods. This begs the highly topical question of whether it will always be true that, as long as the money supply increases, prices will necessarily go up.

It will continue…