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Inflation Myths

As food prices are soaring in India, quack economists are in the process of reinstating certain myths on inflation. Many are proposing false remedies. Such fallacies should be dealt with in some detail:

1)Finance Minister should fix the value of the Rupee.

A proposition of Amar Singh, the general secretary of the Samajwadi Party was that the Government should fix the Rupee-Dollar exchange rates. “If the rate is brought down to Rs 39 to $1 from Rs 43 now, inflation could be reduced by two to four percentage points swiftly.”, says he. Fixing of exchange rates can work only if the economy is on a Gold Standard. Amar Singh is talking of an entirely different kind of fixing the exchange rates-Fixed exchange rates in fiat money. Fluctuating fiat money is bad enough. How bad is fixed exchange rates in fiat money? The Government doesn’t have the information to fix exchange rates in fiat money. If left free, the exchange rate of fiat currencies would depend on the supply and demand of currencies in terms of other. Fluctuating fiat currency has its own demerits, like crippling international trade and not providing a check against inflation. But, it is any time better than fixed exchange rate in fiat money.

Under the Gold Standard, all currencies will be tied to gold, and exchange rates will be fixed at a particular rate and they would be fixed for ever. Each currency would bear a fixed relationship to gold and every other currency. It would be convertible at that rate whenever a conversion is demanded. The result of introducing the gold standard would be an international currency system. Under a gold standard, each currency would be defined in terms of gold. Gold is money and money is gold. One might ask why the government should define the currency as a particular weight of gold. The gold lying in the vaults of the central bank can’t be denationalized without redefining the currency as a particular weight of gold. Who should denationalize the gold? Definitely, it should be the Government as the Gold lies in the vaults of the central bank.

2) An increase in food subsidy would ensure low prices

As Henry Hazlitt and Ayn Rand had noted, “Government “aid” to business is sometimes as much to be feared as government hostility.” It is forgotten that the Government doesn’t create wealth. All it gives away is what it had taken in, whether directly or indirectly. By giving subsidies, the Government subsidizes the incompetent at the expense of the competent, and as a result, the whole society is made worse off.

3)In India, inflation was mostly caused by droughts.

Some Indian Economists with inadequate knowledge of the subject were pointing out in the past that inflation is not always a monetary phenomenon and in India, inflation has always occurred after major droughts. But, it is well known that the prices have been rising continuously in India for the past several decades. Their argument would imply that there were droughts continuously and material civilization is slowly disappearing, which, obviously isn’t true. It should be apparent now that it is utterly illogical to blame inflation on droughts and famines. It should also be kept in mind that famines are created by Governments.

4)A decrease in supply of goods is the cause of price rise.

Whatever be the popular perception, in reality, the tendency has been that the supply increases each and every year. If so, the real effect has to be that the prices should fall every year. (It happened in the United States when the country was more or less on a Gold Standard.)

Even in cases when supply has come down, as in Chile in 1970’s and Uruguay in 1960’s the role of falling supply has been minor in the price rise. The supply had only fallen to a certain extent, but the prices rose thousands of times. Moreover, if we take falling supply as a cause for general price rise, it would imply that the supply has been falling through out every year, as prices have been rising at an amazing pace. That would imply the general disappearance of human civilization, which obviously isn’t happening. Such an analysis would make it obvious that the falling supply is not the reason and something else is wrong. Moreover, if there was free trade, goods would move in to the country where there is falling supply. That would have solved the problem. It should be kept in mind that it is the Governments which are the biggest enemy of free trade.

It should also be taken in to account that supply would fall if there is an extreme rise in aggregate demand. It means that supply would fall with an increase in paper money, which obviously is one of the causes for a fall in supply in many of the cases. Every time inflation occurs, people scream that there is a fall in supply going on. It is so ridiculous. It was pointed out by Henry Hazlitt that “In Germany of 1923, after priced had soared hundreds of billions of times, high officials and even the people were blaming it on the shortage of goods and at the same time foreigners were buying German products at a price lower than what would they have had paid in their home country with their own currency or gold. Even in conditions of war, we do not see a general rise in prices due to a decrease in supply.”

A fall in supply also can’t explain the debtor/creditor effects of inflation. During an inflation, the debtors gain at the expense of creditors. A fall in supply of goods can’t explain this. Only an exorbitant rise in the amount of paper money can be an adequate explanation for this. Moreover, the argument that a fall in supply is the cause of inflation would imply that a rise in supply would lead to deflation and depression. It is obvious that a rise in supply would lead only to prosperity and this alone would be enough for us to reject a fall in supply as the cause of inflation.

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