The Definition of Inflation Is Incomplete

Today, mainstream economists hold the notion that inflation is an increase in the price of goods or services. The issue with this definition is that it fails to get to the cause of the increase.

For the past few years, Venezuela has been plagued by President Nicolás Maduro’s inflationist policies, which have caused a disastrous economic and political crisis that is ravaging the standard of living for its citizens to the point where hundreds of thousands are fleeing the country in hopes of survival. This year alone, the IMF expects Venezuela to reach an inflation rate of 10,000,000 percent.

Although Venezuela currently holds the largest oil reserve in the world, estimated at over 300 billion barrels of oil, it has become one of the worst countries to live in, ranking 179 out of 180—just ahead of North Korea with regard to economic freedom. What is interesting about this particular situation is that at one point in time, Venezuela was considered one of the most prosperous economies in Latin America.

How Did Venezuela Fall so Low? 

It was the fourth richest nation per capita in 1950. The country is now experiencing a disconnect between its abundance of natural resources and the desolate poverty sweeping its society. The question we must ask ourselves is how did this come about?

Venezuela’s main export for the past several decades has been oil. Today, it accounts for 98 percent of its revenues. Since 1976, the oil industry has been nationalized through the company PDVSA (Petróleos de Venezuela, S.A.) whereby the government controls the means of production.

Though private corporations are allowed to compete, they are severely penalized through taxation.

Though private corporations are allowed to compete, they are severely penalized through taxation. With a country heavily concentrated on oil exports and operated through a state-controlled monopoly, the sustainability of Venezuela’s public services is extremely dependent upon oil revenues.

The background of Venezuela’s present economic crisis stems from Maduro’s attempt to sustain Chávez’s previous socialist policies through monetary expansion following a massive collapse in the global demand for oil. When Maduro became president in 2013, Venezuela had already been struggling to support its public services and experienced 56.2 percent inflation for the year following a monetary expansion of 60 percent.

Maduro Ruined Their Economy

Within a matter of months of becoming president of Venezuela, Nicolás Maduro declared an economic war by imposing price controls and minimum wage increases, alleging that capitalists had been speculating on consumer goods, causing shortages for its citizens as a result of the increase in domestic goods and services.

Whenever politicians stand upon their lofty pulpits condemning businessmen for the increase in price of their goods and services, I am reminded of the wise words of Ludwig von Mises, who said,

The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.

Unfortunately, this wasn’t the only time Maduro would attempt to negate inflation through market intervention, as Venezuelan oil imports into the United States have faced a dramatic decline of -38 percent, from 811,000 barrels per day priced at $101.59 the month Maduro took office to 500,000 barrels per day priced at $45.68 by the end of 2018.

Figure 1 - Crude Oil Prices – January 2013 through March 2019 (Macrotrends)

With the decline in the price of oil the past several years, the revenues in Venezuela have not been enough to support Maduro’s social programs. To compensate for the decrease in revenues, the government has relied on the central bank’s printing press to help provide liquidity during the downturn in demand for oil, to help sustain Maduro’s social programs, and to monetize both the fiscal deficits and debt incurred by the state-operated oil monopoly PDVSA.

Out of Control Inflation 

In 2014, the money supply expanded even further by 76 percent, and inflation increased to 68.5 percent with GDP contracting by -3.9 percent. With the continued economic stress of public liabilities and weak demand for oil, Venezuela defaulted on its debt in 2017 after failing to make a $200 million coupon payment on its bonds. With further attempts to alleviate economic stress and to attempt to sustain its socialist programs through monetary expansion, inflation spiraled out of control, reaching a record level of 2,295,981 percent in 2018.

Today, mainstream economists hold the notion that inflation is an increase in the price of goods or services. The issue with this definition is that it fails to get to the cause of the increase. If we neglect the cause, then we may easily agree with any politician’s viewpoint that the solution to decreasing the cost is to target businesses through price controls, but that is a fallacious belief.

Inflation is the overextended issuance of money whose consequence leads to a generalized increase in the cost of goods or services.

When price controls are enforced to combat inflation, the only result we experience is a shortage of goods because the prices are artificially lower than what the market would price these goods, as is the case in Venezuela.

Inflation is the opposite of what we are told to believe. Inflation is the overextended issuance of money whose consequence leads to a generalized increase in the cost of goods or services. The increase in the supply of money is promulgated by the central bank, which in modern-day economies has a monopoly over the issuance of money.

Monetary Central Bank Policies

The central bank attempts to impose various monetary policies to help create economic growth and stability through the manipulation of interest rates by dictating what the supply of money should be. One facet of how the central bank controls the supply of money is through open market operations. This process is where the central bank either buys or sells government securities and attempts to raise or lower interest rates.

When the central bank attempts to pursue an inflationary policy, it will purchase government and other debt securities from a bank with money created out of thin air. The bank is then credited the amount of the purchase and has newly available credit ready to be lent out to consumers. With more readily available to be lent out, interest rates will lower and entice business owners and individuals to borrow more than they would before the central bank undertook the purchase of debt securities from the bank.

Individuals that take on this new money will begin to bid up prices of goods and services as a result of having more monetary units than before. This will create an environment stimulating an artificial demand where there is more money willing to be exchanged for goods and services than before.

When the supply of money is increased and the goods and services stay relatively the same, the cost of goods will go up as the value of each monetary unit decreases. With each monetary unit now worthless, individuals will invariably be able to buy fewer goods than before as a result of the expansion of money.

The decrease in value per each monetary unit is a benefit for a government heavily laden with debts, which is why they encourage such inflationary policies by the central bank. Hypothetically, if a government sold 10,000 bonds each at a face value of $1,000 ($10,000,000 in total) with a coupon rate of four percent, the interest payment would be $400,000 a year in total.

Inflation is a Hidden Tax 

If this same government experienced an average inflation rate of five percent for those 30 years within its country, each year the purchasing power of its bonds would be eroded by $500,000. Thus, when the bonds mature and it is time to repay, this government will repay with money worth much less than it was initially.

The practice of governments inflating their debt away has been characterized as a hidden tax upon its citizens by Ron Paul, the former US representative from Texas, who has long been a well-spoken advocate against central banking. While the debt becomes unnoticeably less cumbersome to carry for the government, the expense is paid by the civilians through the gradual decrease in purchasing power and an increase in the cost of living.

Understand that the next time you hear a politician complaining about the rise in prices of goods and services, there is a high chance they are the reason for that increase. Before we buy into what a politician says, let us remember that a monetary expansion by a central bank is merely an inflationary policy disguised as an attempt to promote economic growth.

Further Reading

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