Earlier we had an opportunity to agree or disagree regarding certain economic factors that we felt were the cause of inflation. We will begin our investigation by considering the fact that inflation is not caused by individual producers raising their prices. This is true whether we are talking about oil cartels, individual merchants, labor unions, or particular industries. I think the power of story can help us see this more clearly. Let's return again to our primitive friends: Two-Toes Tom, Scarface-Salesman Sam, Wanda[P1] Wonder-Weaver, and Healthy-Hunter Harold.
INFLATION is a sustained increase in the general level of ALL prices.
One evening all of our friends were sitting by the campfire discussing an interesting new idea. Scarface-Salesman Sam had just returned from visiting a faraway tribe. He said that everybody there was involved in a new concept called inflation. It appeared that it was benefiting everyone in the tribe. The idea was that if they all raised their prices by twice, then they would all have twice as much. Who wouldn't like that? Why hadn't they thought of that sooner? Just think of all the wealth they could have accumulated by now!
Our friends decided that it was high time they adopt this concept for their own tribe. They all rushed back to their tents to get some of their products to trade; there was no sense letting any more time get by.
On the way back to his tent, Healthy-Hunter Harold was just beaming. "Think of it . . . from now on, I'll only have to trade four packages of fresh meat for two stone axes instead of the usual eight. I can put twice as many trades together." Wanda Wonder-Weaver was also excited, since she would now be getting twice as much for her blankets. Two-Toes Tom, who had been tired a lot lately, was glad that now he could finally slow down a little, since he would be getting the same amount, but only having to produce half as many stone plows.
Excitedly, they all returned to the campfire to get started with their trading. Healthy-Hunter Harold wanted to go first with his fresh meat. Instead of the usual eightpackages, he only brought four to trade with Sam for two of his stone axes. But alas! Sam was standing there with only one axe that he intended to trade with Harold for the regular eight packages of meat. Sam argued that since it was his idea, he should be able to go first, i.e., one axe for eight packages of meat. Harold informed him that would be fine, but the eight packages of meat would come off Sam's body!
It began to dawn on Wanda Wonder-Weaver what was happening. Whether Sam raised his prices and Harold paid it, or Harold raised his price and Sam paid it, you still haven't caused inflation. For if one price goes up, then the other price must come down. She realized that it wouldn't make any difference how many people were involved, or how many products were involved, or for what reasons they wanted to raise the price, they could not cause inflation, i.e., a sustained increase in the level of all prices, simply by raising their individual prices. For if one product goes up in price, then one, or a combination of other prices, must fall by precisely the same amount. Even if there is a scarcity of a product due to poor crops, strikes, or exports, the increase in the price paid for the scarce product will only result in your having less money left over with which to make other purchases.
If an oil cartel, e.g., OPEC, raises its price of oil by $50 billion, there should be $50 billion less in the system for consumers to purchase other goods. These other goods would then sit on the shelves and go unpurchased, thus causing a recession in business.
Wanda Wonder-Weaver gathered her blankets together and headed back to her tent. Ol' Two-Toes Tom sadly went to sleep, dreaming of how close they had all come to being wealthy!
You now can see that for whatever reasons prices are raised, e.g., scarcity, monopolies, wage and price fights, you cannot cause inflation . . . a sustained increase in the general level of all prices. You will see later that the raising of prices is a necessary result of inflation, not the cause.
That night Scarface-Salesman Sam went to bed troubled. What had he forgotten? Why didn't inflation work around the campfire that night with his friends? Then he remembered that the other tribe wasn't trying to make it work with the barter system. They were using a medium of exchange-"money." In fact, they were using gold coins. Sam knew that his tribe had used tiger teeth as money before. Why wouldn't inflationwork with tiger teeth just as well as with coins?
The next morning he was up early to explain his new idea to the others. He told them that he had finally figured it out. First of all, they must go off the barter system and exclusively use tiger teeth as money. Secondly, if they would bring together all of their tiger teeth that they had used as money they could then count them. Thirdly, if they would double the number of tiger teeth that they were using as money, it would then be possible to charge twice as much for the same number of products.
At that point Wanda Wonder-Weaver stopped her weaving on her blanket and laughed out loud!
With that kind of thinking . . . it's no wonder you guys are still primitive!
Can't you see? . . . When you double the money supply and the supply of goodsstays the same, you cut the purchasing power of the money in half . . .
that is . . . it takes twice as much to purchase the same product.
On the surface it might appear that everything would be going up in value. But it is not. The only way to have a sustained increase in the general level of all prices is to have a sustained decrease in the general value of the money.
Another way of stating that all prices are rising at the same time would be to say that the money system is falling in value.
The reason for Scarface-Salesman Sam's misunderstanding of the concept of inflation was due to his misunderstanding of the motive behind the concept. All he observed was that the merchants were getting higher prices for their products, but failed to see that the real value they were receiving was less. He didn't know that the king of the tribe was extracting from his people a silent tax through inflation to pay off the debt of his last spending spree, knowing full well that if the people understood what he was doing, they would revolt or elect a new tribal chief. You can't ultimately play games with smoke and mirrors or tents and tiger teeth.
(Research ideas from Dr. Jackson's new writing project on Cultural Economics)
© Dr. James W. Jackson
Permission granted by Winston-Crown Publishing House