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Introduction

What is inflation? In layman’s terms, it’s when your money doesn’t buy as much as it used to. Why does that happen? Sometimes price inflation is caused by a change in the normal supply/demand forces of the marketplace. For example, prices are likely to go up when:

•A natural disaster, such as a flood or drought, devastates food crops and fewer come to market;

•The cost of producing a product is increased (perhaps unions demand higher wages or costly environmental regulations are imposed) and the new higher costs are passed on to the consumer;

•The limited number of available tickets to a popular sporting or entertainment event gives rise to sidewalk scalpers.

On the demand side, it could be that:

•Government programs (Medicaid/Medicare) enhance consumers’ ability to pay for particular goods/services, thereby overwhelming the normal supply;

•Low interest rates encourage borrowing and spending for personal consumption or investment, thus increasing demand while the supply remains fairly constant.

These types of “inflation drivers” usually are short-lived—crop production returns to normal levels, the sporting event is over, interest rates eventually rise. Even when this type of inflation continues longer term, it tends to be focused on a particular area of the economy (health care, for example).

But there is another cause of inflation—and it is the subject of this report. This kind of inflation is related to the supply of money available. In essence, it occurs when too much money begins to circulate, lessening the value of money. In extreme cases (and there are notable historical examples), this “oversupply” can unleash a powerful inflationary trend called “hyperinflation.”

The birth of money

The best place to start in understanding the kind of inflation that’s related to money supply is to look at what “money” actually is.

The power to create money carries with it the power to nurture or destroy an economy. Yet, few of us understand the process by which governments create money, or how that process ties in with the debate over budget deficits and the risk of future inflation.

So let us go all the way back to the beginning—to the birth of money—then gradually add layers of complexity as we go along. Let’s begin with a hypothetical scenario. We’ll pretend you’re the proverbial Robinson Crusoe stranded on an isolated island. You don’t have any money, but that’s not a problem because:

1. A single individual doesn’t need any money. There is no one else to exchange anything with. You do the best you can to make what you need, and you consume it all yourself. It doesn’t get any simpler than this.

Now, let’s add another shipwrecked survivor to the local economy.

2. Two individuals don’t need any money. Assuming your new neighbor has his own share of island property and you have yours, you both will primarily be looking after your own needs. Still, one thing has changed—there is now the possibility that an occasional exchange might take place if you each produce a little more of something than you need at the moment.

Having a surplus isn’t enough, of course. Neither of you will willingly trade your surplus unless the other has something you want. Both of you must find the swap appealing if an exchange is to take place. It’s not human nature to trade the fruits of your labor for something you have no desire for just to please your neighbor.

To the contrary, you will most likely put in the extra work and make the trade—that is, make the effort and sacrifice—only when you believe you will ultimately get something you want in return. (This aspect of human nature is usually ignored by government planners and explains why many well-intentioned government programs are utter failures. But that’s another story!)

3. A small community doesn’t need money, but as it grows, money will inevitably develop to facilitate trading. Let’s switch scenarios to one imagined by the late investment analyst Harry Browne in his popular book of the early 1970s, How You Can Profit from the Coming Devaluation:

One day Jones the nail-maker walks into the store of Smith the furniture-maker: “Smith, I need a new workbench. I’ll give you 2,000 nails to make one for me.”

“Sorry,” says Smith, “I have all the nails I’ll need for a while. Those you gave me for the bed I made for you will last me for another six months. Come back and see me then.”

Determined not to be refused, Jones goes on, “But I need the workbench now! Look, you’re bound to use those nails eventually. But, even in the meantime, you can probably trade them to someone else for something you need. I’m always getting offers of trades from people wanting nails. They’re a lot easier to exchange than furniture.”

“You have a point there,” ponders Smith. “I do seem to have a lot of trouble exchanging king size beds for clothes. This way, I’d only use as many nails as I need for each purchase... Well, okay—I’ll try anything once.”

So he accepts the nails and makes the workbench for Jones. And then he goes out to find products for which he can exchange the nails. And, lo and behold, it works! He finds that trades are much easier to make.

As a result, he enjoys life a lot more with a few nails in his pocket. He can stop at a store and trade for anything he wants to—without having to arrange an elaborate, long-term furniture purchase with the storekeeper.

In fact, he merely points out to the merchant the advantages of nails as a trading medium in the same way that Jones pointed them out to him. And the final argument is that you can always use the nails sometime in the future; they won’t lose their value. And if you don’t use them, someone will.

In the months to follow, Jones the nail-maker notices a slow, steady increase in the demand for his product. Why? Because individuals, one at a time, are coming to see that it’s valuable to have a few extra nails on hand (in addition to those needed for construction purposes) to facilitate exchanges with others. Nails seem to most people to be an ideal trading medium.

Money is simply anything you accept in an exchange СКАЧАТЬ

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Introduction

The birth of money

The Prudent Investor's Guide to Owning Gold. Austin Ph.D Pryor
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