Inflation – The Corrupted Thief PLR Ebook

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The Triangle Model

The three root causes of inflation, or what the Keynesian economist Robert J. Gordon termed the “triangle model,” are demand-pull inflation, cost-push inflation, and built-in inflation.

Demand-Pull Inflation

When the demand for goods and services rises faster than productive capacity, demand-pull inflation occurs. This type of inflation is due to an increase in the supply of fiat currency and cheap credit. As more money is put into circulation and is easily accessible, both demand and prices rise.

For instance, if demand rises by 5% while productive capacity is only growing by 3%, demand will outpace supply by 2%. With more money chasing fewer goods and services, prices will naturally rise.

Demand-pull inflation has occurred many times throughout history. An infamous example took place in the UK from 1986–1991 when inflation hiked 4.6 percentage points to a nine-year high of 7.6%, caused by demand-related factors including lower interest rates, rising house prices, decreased income tax rates, and high consumer confidence.

Cost-Push Inflation

When input costs for goods and services increase, such as wages or raw materials, costpush inflation occurs. As the cost of production rises, supply decreases because fewer goods and services are available. Because supply-side factors (e.g., higher wages and higher lumber prices) have changed and demand hasn’t, the producer will pass on the additional cost to consumers.

A notorious example of cost-push inflation took place in the early 1970s when the intergovernmental body known as the Organization of Petroleum Exporting Countries (OPEC) imposed higher prices on the oil market without any increase in demand, now known as the Oil Shock of 1973–1974. Though producers were earning higher profit margins in the short term, all sectors of the economy that relied on oil saw increased production costs. As a result, these parts of the economy that involve oil (e.g., transportation, plastics, construction) saw inflationary pressure on the prices of goods and services.

Built-In Inflation

When consumers expect inflation to keep rising, they demand higher wages. This demand results in an increase in the cost of production, which results in higher prices. A circular dependency can emerge whereby inflation spirals out of control, known as built-in inflation.

Lowest Common Denominator

Per figure 1, we can see changes in prices within various sectors in the US economy. Over the past 20 years, sectors with government intervention (education, housing, medicine) have seen prices soar.

Figure 1

We can also see in figure 1 that competitive markets with low involvement by the government (e.g., cell phone services, toys, and TVs) have seen prices fall over the past 21 years. Net-net, it appears there is a strong correlation between governmental intervention on markets and inflationary impacts.

What Are the Effects of Inflation?

Economists from the Austrian school, such as Murray N. Rothbard or Ludwig Von Mises, contend that inflation is not a rise in the general price level but rather an increase in the supply of money and bank credit relative to the volume of goods and services. As such, they argue that inflation is outright harmful because it depreciates the value of currency, raises the cost of living, imposes an implicit tax on the poorest class of people at a relatively higher rate than the tax on the richest class of people, devalues savings and thus disincentivizes future savings, redistributes wealth and income asymmetrically, incentivizes speculation and gambling, underestimates the antifragile mechanisms of a free market system, and corrupts the morals of both the public and private sectors.

Meanwhile, the Keynesian school defines inflation as an increase in the general price level caused by an increased money supply. Keynesian thinkers assert that inflation can yield a variety of positive and negative effects, including:

[Positive] Increase in labor supply —An economy operating below its production capacity has more unused labor and resources than can be used to increase business production (i.e., economic growth). With a surplus of readily available workers, hiring competition increases, and thus it becomes unnecessary for employers to “bid” for employees by offering higher wages. In times of high unemployment, wages typically remain stagnant, and no wage inflation (i.e., the rate of change in wages) occurs. When there’s low unemployment, the demand for labor exceeds the supply, and employers may need to pay higher wages to attract employees. Increasing wages forces employers to raise prices, causing further inflation.

[Positive] Increase in aggregate demand —Because more money in circulation may lead to more spending, it can positively impact the economy by increasing demand for goods and services. This rise in aggregate demand thereby triggers more production.

[Positive & Negative] Increase in value of scarce asset holdings / decline in value of fiat savings— Because a currency’s purchasing power falls when inflation rises, so will an individual’s wealth if it’s parked in cash. Therefore, demand for scarce assets (e.g., bitcoin, gold, real estate) will rise.

By way of example, gold prices grew +24% in 2009 on the back of the worst financial crisis since the Great Depression, as inflationary concerns caused investors to seek safe haven assets. However, the S&P 500 rallied +26% during the same period, outpacing gold by 2%.

Though it may seem like the ETF for the S&P 500 (SPX) was the better investment choice at the time, this does not account for the amount of risk involved with investing in either asset.7 Considering the S&P 500’s risk (volatility) relative to gold, it’s clear that gold offered a better risk-adjusted return (i.e., less prone to a sudden drop in value while having relatively large upside potential).

Figure 2 below provides a more contemporary example on the performance of fiat currencies and scarce assets in the face of inflation by displaying the real (inflation-adjusted) purchasing power of the USD,

EUR, and GBP in contrast with USD-denominated bitcoin price. Though there are some immaterial exceptions, it’s clear that major fiat currencies have steadily declined throughout the last 11 and a half years while bitcoin has inversely posted significant returns.

Other Details

- 1 Ebook (PDF, DOCX), 26 Pages
- 5 Ecovers (PNG, JPG, PSD)
- Year Released/Circulated: 2021
- File Size: 3,133 KB

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