The Perverse Side of Inflation
After writing my previous post, explaining what inflation is, I would like to add a couple of extra concepts around it, so you can have the full scope of what inflation means from a political standpoint.
Let’s summarize what we already know. Inflation means that over time prices rise, and you end up paying more for the same. This happens when the governments, through the central banks, print more currency and inject it into the system. So, in the end, you have more money chasing the same amount of goods, and inevitably, prices increase to compensate. Inflation is a consequence of a political decision.
Why does this happen, and Who benefits from it?
Let’s put ourselves in the shoes of the government of any country. Each year we would prepare a budget to address the year’s needs, in the same way a family would manage the monthly income to pay the expenses for that particular month. Now let’s imagine that we miscalculated the amount of money we need and need some extra. To cover that, we could issue new currency through our central bank to cover that deficit, and we would pay our bills, with the promise that we would repay that money later on with some interest.
Next year we end up in the same situation; we miscalculate. Still, we need to pay back the interest of the debt from last year, so naturally, our deficit would be bigger, so to cover the difference, we repeat the same move. You see where this is going, right? Each time we miscalculate our budget, we increase the money supply, causing inflation to rise. Because there is more currency in circulation, we end up having more money; therefore, it is easier for us to pay the debt we initially issued.
Let’s stop here for a second to reflect on this. If the future currency is less valuable, it will be easier to repay your debt later in the future; actually, the later, the better. Meaning that inflation favors the payback of that debt; therefore, governments do not have an incentive to get rid of the inflation by default. Quite the opposite, inflation is a tool to cover their mismanagement. If not well managed, this dynamic can cause a debt spiral where we might end up issuing new debt to repay the old one, creating a debt bomb and inflation in the process.
To wrap up, we could say that inflation surges when governments print more money to pay for their mismanagement. When prices increase, they realize that the situation helps them pay more easily what they owe, and because they cannot control themselves and adjust their expenses, they keep printing, dragging all of us into it. It is like having unlimited credit and passion for shopping, you borrow money for new clothes, and you end up borrowing more money to pay what you already owe. And that is how perverse the problem with inflation is, who has to solve it, is who creates it and who benefits from it.
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