US inflation is not just a US problem. Image: Screengrab / iStock

A general, worldwide increase in all prices is inflation. Inflation is distinguished from hikes and spikes in individual relative prices, such as a leap in the price of gasoline relative to the price (for example) of bread, where the price of a gallon of fuel rises from three loaves of bread to five loaves of bread. 

True inflation is not caused by individual, particular markets that are beset by supply-chain kinks or short-run production drop-offs or sudden changes in the degree to which suppliers exercise monopoly power – a power that has inexplicably lain idle until now. 

Such a general increase in all prices – prices in China, prices in America, prices in Europe – is always and everywhere the result of an increase in buying power – that is, an increase in a quantitative measure of general money power – an increase in the quantity of money – which is in excess of the concurrent increase in the new production of goods and services. 

Big, inflation-causing increases in the quantity of money in modern societies is almost always the result of conscious policy actions directed and controlled by political actors, who use this “paper buying power” to gain immediate political ends: Buy votes, employ as temporary “cures” for recessions, and to create a short-lived illusion of good times. 

Some politicians may be more to blame than others, but almost all are guilty of taking the easy way out of inflation, sometimes by creating even more excess money, rather than by a quick, even harsh but necessary policy of shrinking of the money supply. But alas, one way or another, the real quantity of money will be pushed down, by natural market actions that are painful for a long time, or by restrictive policy actions, which inflict sharp, politically unpalatable immediate distress. More on that below. 

In a flexible, modestly competitive society, increases in particular relative prices may be absorbed by downward pressure on other prices, by the appearance of goods and services that are or can become replacements and alternatives to the now more expensive good.  

For example, a price increase for gasoline may cause owners of trucking companies to lower the price they can afford to pay to truck drivers or cause these owners to switch to electric trucks. Shippers may choose to move goods by railroad instead of trucks, and sellers of online goods may cut back on offers of “free” delivery. 

The common idea that individual price hikes are always and only “passed on” to (in this example) buyers of truck-shipped goods is a possible outcome, but by no means is it the only possible case.

The monopoly power that might allow some players (let’s say power in a truck-driver labor union) in our running example to avoid the impact of higher gas prices will only increase the downward price pressure on players who lack monopoly power, perhaps on-contract truck repair mechanics or itinerant sellers of truck parts. 

In contrast, a big increase in the quantity of money in excess of the “needs of trade” must increase prices. That is, the extra money will be spent in a vain attempt on the part of buyers to acquire more goods. 

Since all goods have already been allocated because the previous quantity of money was “just right” to make a market allocation, new money raises prices in the ensuing struggle to re-allocate the existing distribution. The theoretical exception is the special case where, all across the economy, both buyers and sellers begin to hoard up (and so “freeze up”) the surplus buying power in the form of money kept idle and never spent. 

Such behavior is unlikely, and contrary to normal, habitual spending practices. It may even be irrational, since any person who first breaks away from this hoarding idea has an advantage over his neighbor, as by spending rather than holding money this active character can pile up for his personal benefit an undeserved quantity of goods and services well beyond the level that he has “earned” in the market. 

A critically important difference between inflation and relative price movements, the latter, for example, caused by a supply “kink,” is that inflation is semi-permanent in that prices will continue to rise, making existing money less valuable, until the “real” quantity of “real” money is back in line with the amount required to conduct real trade. 

In contrast, when supply lines are freed up, the temporary scarcity of goods caught up and “strangled” in the “kink” is overcome, the no-longer-scarce goods quantity returns to a normal level, and prices return to their previous relationships. Only then may inflation be termed “transitory.”

But today almost everywhere in the trading world, the quantity of money has risen far beyond the needs of trade, and it may be said more or less with certainty that this current inflation will go on for some time, at least long enough for money to become so cheapened in terms of the value of any one unit of value, any one dollar, any one yuan, any one euro, that the real aggregate value of all the money that is “out there” falls to where its real quantity is once again appropriate to what is needed, no more, no less. 

Let us get back to the politicians: in China and in America for example. There is enough blame to go around, but each has something different to regret.  

American Democrats and Republicans both added fuel to the blazing monetary excess that had been ongoing since the anti-monetarist policy of zero interest rates was promoted by New Keynesian Professor Ben S Bernanke (Princeton, Brookings Institution, 14th chairman of the Board of Governors of the Federal Reserve system and incredibly enough, named in 2009 by Time magazine as Person of the Year). 

Anna Schwartz, co-author with Professor Milton Friedman (both monetarist proponents of the ideas in this essay), said Bernanke should never have been reappointed to head the Fed.  (See a letter to The New York Times titled “Man without a plan,” July 25, 2009.)

Why? Because Bernanke actually implemented his idea that interest rates during bad times should drop to near zero combined with his (incredible) essay saying the economic problem of modern times was disinflation (see his November 21, 2002, speech as a governor of the Fed Board, titled “Deflation – making sure ‘it’ doesn’t happen here”). 

Bernanke, along with other New Keynesians, greatly feared (of all things) falling prices. In addition, Bernanke seemed self-serving, as later shown by his claim in his 2015 book that only (his) Fed easy-money policies prevented in 2008 an “economic catastrophe greater than the Great Depression”). 

Whatever may be the reasons for it, New Keynesianism helped central gankers everywhere to abandon monetarism, forget their obligation to stand guard against inflation and think paper money was a good idea. Like so many politicians who ignore the laws of history, Chairman Bernanke said we were in a “new era” of “great moderation” and somehow the old rule that central bankers should, above all things, prevent inflation, was old thinking. 

What about China? At big-picture level, China has more than an inflation concern. Big-picture items include a gradual shift from export-led growth to a Chinese Dream, where domestic consumption will be fostered, even at the cost of slightly (it is hoped) reducing the growth rate.

It means a move away from a tight focus on pure production gains, and if the sophistication of consumer goods made at home is aimed at, it is in order to benefit foreign buyers, sometimes even though domestic workers likely need such benefits if they are to keep happy.

On the supply side, making the dream of happy workers come true might require less arduous working conditions, higher wages and reduced intensity on the work side of life.  Happy workers should not need to worry that inflation will take away wage gains. 

But on the money side of China’s economic life, all is not under control. Ongoing habits developed during the recent decades (China had a current-account surplus every year since 1994) mean that China has a long-run huge inflow of foreign money. If those funds are not somehow sterilized, but are allowed to enter the domestic economy, especially if domestic goods have been exported away, inflation gets imported as fast as goods go out.

However, big-picture ambitions, for example that the yuan becomes an international reserve currency, allowing China to send its excess domestic money abroad in exchange for hard goods imported so as to satisfy Chinese workers’ demand for good requires that China’s monetary authorities walk a tightrope, caution on one side, yet on the other side supporting more or less Wall Street–style open investment markets and transparent financial reporting at all levels. 

If inflation is going on outside of China at a faster rate than it does inside, it may be easier to sell Chinese products in foreign markets. But if that external inflation (as has been the case) occurs in commodity markets like energy, food and other raw materials (commodity inflation faced by Chinese manufacturers hovers at 9-10% a year), then imported inflation makes it hard for Chinese exporters to find profits abroad. 

My final observation goes like this: Both general true inflation and relative price rises where one good rises above another, where the bread-loaf price of oil goes up, are challenges that confront policy makers the world over. What citizens should demand of their leaders is a more forthright, more honest explanation of what is going on. 

Dangerous increases in the money supply, foolishly low official interest rates and prodigal government spending projects must be admitted to and renounced for the short-run foolhardiness that they represent. It will be a hard thing for voters to request, since it is the citizens whose desire for free stuff motivates officials to print paper money. 

In places like China where policymakers have significant power over events and circumstances, conflicts among and between national goals must be discussed openly, and shortcomings should be admitted to, if dreams of a more stable future are to come true.

Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Canada. He has served as visiting professor at the Board of Governors of the US Federal Reserve system, at the US Congress and as the chairman of the North American Studies program at McGill University and a professor in that university’s Economics Department.