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Inflation and Deflation

The CHIPs free-market approach to regulating the money supply brings up a question about inflation and deflation. We have come to accept those words as though they are a natural part of life. But it is possible they are only so within the context of a central banking economy.

As was mentioned before, there was virtually no inflation of the currency during the century or so prior to the creation of the Federal Reserve. How was that possible? Likely, it was because of the stability that comes from allowing the natural feedback processes existing in a free money market to do their work. As long as gold was the prevailing measure of value, and people were free to decide how much credit would exist in the economy, there was no particular reason why the currency would ever have to become debased.

So what is the natural course of a more open monetary policy? What should we expect of our currencies in an economy free from a government sponsored money monopoly?

First, we can recognize that if money is backed by something of inherent value, there is no need for inflation or deflation, at least in relation to the value of the backing commodity. For example, a CHIP will always be worth an hour of unskilled labor as long as the contracts backing it specify it as such. It won’t matter how many people take out CHIP loans so it won’t matter how big or small the money supply gets. One CHIP will always be worth the same amount of labor, regardless of how many CHIPs are in circulation.

But how would CHIPs affect the price of real things we buy like gas, or food, or entertainment? We have become accustomed to prices always rising on nearly everything. It seems like each year it becomes more and more expensive to live. Whether inflation is officially reported or not, it definitely feels like inflation if prices are always on the rise.

The answer is this: Inflation and its effects, such as the ever-rising prices we see are artificial. They are the artifacts of a system that is engineered and managed to create steady inflation at a rate of about 3% per year. If your wages don’t go up by the same amount, you are actually getting a pay cut each year because your purchasing power continues to decrease.

In order to imagine what would naturally occur in a free economy, think what happened in the computer industry during the years between 1980 and 2005. During that time, we saw rapidly advancing technology in computer processing speed, memory size, memory speed and hard disk storage capacities. The price of a computer was continually falling. Companies could only keep prices up by continuing to improve and expand their capabilities.

Some of the older generation will remember that an average computer always cost somewhere around $1000. But the moment you got it home, it was already worthless and obsolete because better and faster ones had just been introduced.

What we saw in computers felt like deflation, in a way. But it wasn’t really that the money was getting more valuable–the product was just getting cheaper. And the phenomenon was limited to technology.

In contrast food, clothing and housing were still gradually getting more expensive. But something was making computer processing power less and less expensive every year. What was it, and more importantly, why couldn’t we see that happening in the other things we wanted to buy?

Maybe we would see that same dynamic in other kinds of commodities we buy if not for the artificial interference of big government and big business. Maybe they work together to keep prices on the rise.

Let us return to our thought experiment to better understand why. Imagine our five stranded islanders were beginning to learn how to cultivate various crops to feed themselves. Maybe two of them were engaged in farming and could produce enough fruits and vegetables to keep all five pretty well fed. But it was a full-time job for the two, just to keep the gardens planted, weeded and harvested.

Over a period of time, everyone would become accustomed to paying a certain amount for a bushel of potatoes, for example. In this way, prices would eventually stabilize, or find a natural, market level of equilibrium.

But now imagine one of the farmers came up with an idea of how to do things better. So he spent some extra time and invented a plow he could use to reduce the amount of time it took to prepare and plant a bed of potatoes. Perhaps this new system was so efficient, he could roughly double his potato production, although it didn’t really affect the production of tree-grown foods like bananas and mangoes.

What would happen to prices of the various foods? It is clear that as potatoes became more plentiful, their prices would begin to fall. People would be able to buy more potatoes with the same amount of money. They might even start eating more potatoes and less of other things that might be more expensive to produce.

The two farmers could either keep producing at the new and improved levels and everyone could get fatter and happier eating all they wanted to. Or, the farmers could spend less time growing the potatoes and go on to make other things that might improve their quality of life.

This example illustrates how in a free economy, the prices of things should normally be expected to fall over time. Typically they won’t fall to zero because someone still has to do some kind of work to produce most things. But as time goes by, people will naturally invent new ways of doing things. This new technology will make it possible to either make the same things more economically, or make new and improved things with the same amount of time and effort.

The free market might also adapt by people just spending less time making the things they need and spending more time swimming, sun bathing or doing other things that make them more happy and comfortable. In any case, quality of life improves because things become less expensive. Either we get to buy more things, or we can work less to buy the things we want and need.

So why can’t we just live in a society where technology gradually improves efficiencies to the point where people don’t have to work so hard all the time just to survive? Maybe we could instead begin to accumulate assets on our balance sheets and become more and more prosperous.

This becomes very difficult when there are parasites in the system who would prefer to keep us continually engaged and working so they can funnel off a bit of our energy for themselves. They know, if the workers slow down, the gravy train that supports the ruling class comes to a halt.

So in order to keep everyone busy, there needs to be a way to keep us all perpetually in debt and working–trying in vain to dig out of an ever deepening hole. War, terror and pestilence can do a pretty job of this. If you destroy enough capital and infrastructure, people will have to get back to work to rebuild it all.

In addition to such natural and man-made disasters, we also have a money supply that is, by design, constantly increasing. This means it continually loses a certain amount of its purchasing power every year. And so do we.

It is like a hidden 3% annual tax on wealth. But it is even worse than that. It causes your real wages to decrease every year. It causes your savings to shrink every year. And it makes the things you need to buy more and more expensive every year.

The only thing that seems good about inflation is that it makes it feel cheaper to borrow money. The idea is, you can borrow money today to buy the things you need and then you can repay it later when you are earning at a higher rate. But this too, is just a trick.

The truth is, a programmed inflation rate merely causes an artificial skew, or distortion in the natural price of money. In other words, if not for inflation, you would simply pay a different interest rate on the money you borrow. Take away the government sponsored subsidy of borrowing and the natural price for borrowing would return to its naturally lower, market level.

Unfortunately, you are going to pay one way or another.

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