17 - Summary of Part 2

Introduction of Government

In order to survive, an individual must create value. In contrast, governments do not create value and in order to exist they must seize assets. Such seizure is called taxation and is always unpopular. A big problem arises for a government when it wants to spend more money than it has available. In this case it must impose additional taxes.

Inflation – a Hidden Tax

A government can tax the public without its knowledge through the process of “Inflation”. The government simply prints more money so that it might spend it. However, each new unit of money which is printed to fund government spending reduces the value of the preceding money units, thereby reducing the wealth of those who have worked hard to save or invest money beforehand.

Moving from Gold and Silver Money to Worthless Paper Money Substitutes

Before a government can successfully embark on an inflationary pathway, it must first seize a monopoly of the minting business, declare what is legal tender, and slice through the notion that gold and silver are money. Weights of gold and silver are replaced by a “national currency” name and the money supply is no longer related to the amount of gold and silver in society. Unfortunately for us, the proliferation of money substitutes and electronic banking in the twentieth century made it easy for governments to unshackle themselves from the discipline of the gold and silver money system.

The Onset of Inflation

Recently, between 1944 and 1971, the 44 major industrial nations agreed to fix their currencies at a certain price against a certain quantity of gold. The agreement was called Bretton Woods. However, following massive expenditure in the 1960's, in 1971 the U.S. suspended the convertibility of dollars into gold and by 1973 the major industrial countries agreed to end Bretton Woods and to let their currencies float freely against one another. There was then no correction mechanism in place to prevent economic excess.

Exponential Supply of Paper Money

As the requirement to peg their currencies to gold was lifted, countries began creating un-backed money substitutes at an unprecedented rate. Rather than pay for their purchases in gold, governments issued paper money (e.g. debt instruments such as bonds) as payment. Since there is no limit to the production of paper money, the supply of money has increased at an exponential rate since the early 70’s.

Where Does All the Paper Money Go?

The new money which is created disseminates throughout the economy in two ways: through national product transactions (goods and services) and through capital transactions (investments). The distribution of money demand between the two markets is not fixed and there is no dam between these markets – as money demand moves from one market to the other, prices must go down in the first and up in the second and vice versa.

Capital Markets Act as a Repository for Inflation

Our excess money feeds into the capital markets via savings accounts in banks or through investments. The significance of this is that the capital markets are a holding container for a later, devastating inflation. Despite government’s massive money printing appetite, we have not yet experienced dramatic increases in the cost of the essential items we need to survive, namely food, fuel and water. But if something were to cause the money sloshing around in the capital markets to feed into the national product pool, we would see almighty price rises and a dangerous scramble for life’s essentials.

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