So Where Does Inflation Come From?

Inflation is a monetary phenomenon. The more money, the more inflation. That's why inflation is commonly described as "too much money chasing too few goods."

Milton Friedman won a Nobel Prize for proving what had been obvious to everyone before the 20th century--that rising prices were a function of more money.

Mo' Money. That's why bouts of inflation followed discoveries of gold and silver--or sudden influxes of gold and silver, as when the Spanish conquered Mexico and Peru in the 16th century, which lead to a trebling of the price level in Spain and a generalized inflation across much of Europe during that century.

Spaniards thought they were rich after conquistador-ing all that gold and silver, and it was, but it blew through all that money on vainglorious foreign wars, while neglecting to increase agricultural and craft production ("industry" wasn't really an idea yet) in the homeland. Spain had too many Don Quixotes, and not enough inventors and tinkerers.

This site here, The Big Picture provides a great overview of the relationship between money supply and the price level.

As anyone can see, the relationship is close, indeed. And so back to that St. Louis Fed chart, showing the monetary "hockey stick."

Inflation: A "Reliable" Feature Of Modern Times

Inflation is the central economic fact of the 20th century. Why? Because in the 20th century, currencies were disconnected from gold and silver. Governments around the world institutionalized "fiat currency," through the creation of central banks, and the result has been inflation. The chart above shows inflation in the US over the last two centuries. Note the huge spike after the establishment of the Federal Reserve System--a US central bank--in 1913.

To put it bluntly, once governments figured out that they could print money, they did. And the US was no exception.

The same 20th century institutions are still in place for the 21st century. So why should the 21st century be any different, inflation-wise?

As they say, "To hold paper is to trust politicians." And as we can see, that's a mistake.

The Next Inflation

Are we looking at a return to the stagflation of the 1970s? We are if we're lucky. This data, from the Federal Reserve Bank St. Louis, suggests that the situation could get a lot worse than what was seen in the 70s.

I know it's kind of astounding to think that America would embrace such a hyperinflationary policy; go ahead and click here if you want to see a larger version of the chart and all the supporting data.

You have to look closely at the blue line, which is the adjusted monetary base, but if you do, you will see that it has spiked upward in the last year. And that means inflation. Big time.