Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output…
Arguably one of the quotes used most to define inflation, Friedman’s characterization is not quite correct. Inflation is not specifically defined by an increase in the money supply corresponding with a lowering of the preference for the public to hold money. The important part to remember about Friedman’s quote is that inflation really is always a monetary phenomenon, in that what is generally regarded as inflation is a byproduct of the deliberate increase in the money supply.
Mises takes the Friedman fallacy apart in Human Action by declaring, “What many people today call inflation or deflation is no longer the great increase or decrease in the supply of money, but its inexorable consequences, the general tendency toward a rise or a fall in commodity prices and wage rates.” What inflation really is is the increase in the money supply beyond any backing of stock specie regardless of the effects on the general price level. Prices are merely an after effect.
With this basic concept in mind, consider a recent New York Times article on India’s faltering economic boom.
NELLORE, India — India has long struggled to provide enough electricity to light its homes and power its industry around the clock. In recent years, the government and private sector sought to change that by building scores of new power plants.
But that campaign is now running into difficulties because the country cannot get enough fuel — principally coal — to run the plants. Clumsy policies, poor management and environmental concerns have hampered the country’s efforts to dig up fuel fast enough to keep up with its growing need for power.
For years, India, along with China, has been widely regarded an economic success story. After the economy was liberalized in the early 1990s, gross domestic product has increased substantially year over year. Freer economies tend to produce better standards of living despite the neo-Marxist rhetoric in contemporary mainstream news editorials that passes for “analysis.” People are generally willing to invest their land, capital, labor, and time toward more productive efforts if they are guaranteed a return to keep and don’t face a litany of regulation and bureaucratic hurdles. This has been widely known since the classical liberal era of the 19th century.
While it can be reckoned that India’s massive growth is due in part to freeing up a significant portion of its economy, it may have been financed in large part by the inflationary policies of India’s central bank, the Reserve Bank of India. According to the CIA World Factbook, the country has been experiencing a double digit increase in consumer prices for the past few years and a rate of above 5% since 2006. The only way to cause such an increase in prices is debasement of India’s currency, the rupee. One look at the foreign exchange rate between the U.S. dollar, which in itself has been massively devalued over the past decade, and the rupee tells the inflation story rather well.
Additionally, in a recent BBC article, it was reported that consumer prices are still up 6.89% from a year ago as the RBI is considering further cuts to the borrowing interest rate in order to jump start what has been seen as a pullback in the country’s growth trend.
What isn’t mentioned is the fact that if India’s growth was sustainable, it wouldn’t require another bout of monetary inflation to keep the proverbial “good times” from coming to a grinding halt.
It is clear that India, along with China, is stuck between a rock and a hard place as the results of previous currency debasement is catching up to it as growth stagnates and prices rise. Such is the lag result of deliberate inflation.
As the Austrian school teaches, inflation not only robs savers of their income by decreasing its value in real terms, it also causes discoordination in how investors and entrepreneurs invest in long term production. By decreasing the rate of interest through increasing the amount of money, long term investments appear to be viable and profitable. The reality is that all that has been created by central banks is simply more “mediums of transactions” and not any real savings or wealth. Consumers, in most cases, still consume at the same rate as before and leave less resources available for use in capital goods industries.
What was once a harmonious process of saving for long term investment becomes a tug-of-war between consumers and producers in need of capital and intermediate goods.
The result is malinvestment which must eventually be liquidated once the currency debasement slows down and more of the public realizes that once-viable business ventures are no longer profitable. Mises famously analogized this phenomenon to a home builder who attempts construction on a new place of residence believing himself to be in possession of enough raw materials to complete the project. Due to previous inflationary policies however, he was tricked into thinking there existed enough saved capital for him to complete the project. Eventually he realizes he does not have enough materials to finish the house and must abandon the project at a loss.
The same concept can be applied to India. According to the New York Times article, the country’s energy infrastructure has been unable to keep up with demand. If an inflationary boom has lead much of this perceived “growth,” and it appears it has, that it can deduced that much of the country’s capital base and supply of real savings has been deteriorating. This has left less wealth and resources to be devoted to maintaining an adequate supply of energy. The result has been hardship as the market is left with attempting to coordinate itself once again with a new reality.
Though not completely to blame for the country’s lack of energy (subsidies, price controls, and other regulations impair energy development as the state owns many power companies within India), the after effects of inflation are wreaking their ugly head. While it would bring short term pain, the solution to the dilemma is to cease all inflating and allow the market to finally clear and correct itself. Unfortunately, it appears that the opposite approach is being followed which will only kick the can down the road to be dealt with another day.
It just goes to show that Mises’ all important lesson on the dangers of central banking and money printing are still just as relevant today as they were a century ago.