Wednesday, September 2, 2009

Just prices and inflation

I think there is a connection between the folk myth of just prices and the ability of governments (and their enabling private banks) to inflate. The two primary reasons given for monopolizing currency issuance and creating central banks are:

1) Controlling inflation and maintaining "price stability"
2) Minimizing unemployment

The concept of "just price" is a folk myth that there is a certain price above which a seller is "unjust" to charge. This price is usually held to be around the going price in "normal" circumstances. For example, theatres "gouge" their customers by charging them 3x or more the price they would pay for drinks and popcorn if purchased almost anywhere else. The implication is that the theatre is, in some sense, immoral and engaging in unconscionable behavior by charging far above the "going rate" for refreshments.

However, this analysis neglects to note that everyone who is holding property (and not selling) has an implicit price tag of infinity on their property. If you stock up on water in preparation for a potential natural disaster, the "price" of the water you are storing in your garage is infinity. You're not selling. When the disaster strikes, you might share your water with friends, but you're not going to put up a sign in your front yard saying "Buy water here at the just price" even while you jeer local merchants for daring to raise their prices due to the natural disaster. However evil the merchant is, his price is infinitely lower than yours because at least he's selling water at some finite price.

Connected to the idea of just price is the idea of price-setting, that is, that sellers, by virtue of their capitalization or their scale or their pull or clout, "set" prices in the market. If you want a bag of potato chips, you have no choice but to pay at least the lowest price at which potato chips are being sold in your area by a local retailer. If that retailer raises his price, then you will have to pay more. If all the retailers raise their prices, you won't be able to escape and you will just have to cough up more cash for potato chips. In this way, you are at the mercy of retailers. Or so the reasoning goes. People usually apply this fallacious reasoning to gas prices more frequently than potato chips since gasoline is a "necessity" and potato chips, apparently, are not (I beg to differ!).

Since retailers and merchants, generally, have a "power" to "set prices" to whatever level they choose and since retailers and merchants are greedy, they will constantly keep pushing up prices. They will charge you as much as they can get away with, legally, so they keep pushing the price higher and higher. This is the folk-myth of "cost-push" inflation. Greedy corporations that produce raw materials keep raising their price higher and ever higher. This, in turn, increases the cost of producing secondary products and those greedy corporations that produce secondary products push their prices even higher to both account for their increased costs, plus an added premium for their own greed, and so on. This process continues while the poor consumer at the bottom of this economic pyramid is crushed under an ever-heavier burden of corporate greed, stealing his wealth through the process of inflationary price-setting.

Enter the heroes at the central bank and the financial regulators. Their job is to "fight" inflation by regulating the markets and the money supply to "check" the greed of corporations. When prices start to rise too fast in any one area, the government's job is to step in and stop the unchecked greed and re-establish "just" prices.

This is, of course, pure nonsense. As Dr. Friedman famously said, "Inflation is everywhere a monetary phenomenon." Inflation - a general rise in price levels - is only, ever the result of an expansion of the monetary base. The phrase commonly used is, "more money chasing the same amount of goods." Inflation could not be the result of anything else, unless the economy were constantly producing fewer and less valuable goods and services (same amount of money chasing fewer goods). But we clearly observe that quite the opposite is the case, there is a constantly increasing trend in both consumption and production. Without expansion of the money supply, prices would gradually fall (same amount of money chasing more goods).

Inflation exists because the currency issuer always benefits by inflating his currency. If the Federal Reserve "expands" the money supply by, say, 5%, then our money will purchase (1.0/1.05)% = 95.2% of what it did before the Federal Reserve expanded the money supply. So, our money loses purchasing power exactly to the extent that they print new money.

Prices of individual goods and services are, as they always have been, subject to the law of supply and demand. You can "set" the price of the "World's Best Dad" coffee mug sitting on your desk to anything you like. But good luck finding anyone who will pay more than $0.75 for it in a garage sale. And as long as you're not selling it, you've set its price to infinity. You greedy, greedy person, you!

But because people tend to believe the folk-myth that prices constantly rise as a result of the greed of price-setting merchants, the government is able to escape blame from a large segment of the population for the rise in prices. And this is why governments can get away with inflating to the extent they do without being held to account by the general public. Thank you very much, St. Augustine!

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