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10 - Introducing Government, Spending & Inflation

The Introduction of Government

In order to survive, an individual must create value. This might be the production of food and shelter through his own toil, or it might be through the creation of something which is of value to others, which can be exchanged for the items he needs in order to live. Through his labour efforts an individual is in control of the wealth he amasses.

In contrast, a government does not create value. It has no products to sell or exchange and must therefore expropriate the assets of individuals in some way in order to exist. In barter economies, governments expropriate resources by seizing goods in kind. In a monetary economy they seize monetary assets and then use the money to acquire goods and services for government. Such seizure is called taxation.

The taxation the government levies takes on numerous forms: payroll tax, corporation tax, real estate tax, sales tax, and so on. These forms of tax are all known to the public and are visible, and irrespective of the form the taxation takes they are always unpopular. A big problem arises for a government when it wants to spend more money than it has available. If the existing taxes do not bring in enough receipts to fund the government’s needs, then the government must impose additional taxes.

Inflation – A Hidden Tax

New or increased taxes are difficult to apply due to the unfavourable response of the public. Instead the government must find a way of taxing the public without its knowledge - it does so through “Inflation”.

"Since those dim beginnings in the forests of the Stone Age, governments have been perpetually rediscovering first the splendors and later the woes of inflation. Each new government discoverer of the splendors seems to believe that no one has ever beheld such splendors before. Each new discoverer of the woes professes not to understand any connection with the earlier splendors. In the thousands of years of inflation's history, there has been nothing really new about inflation, and there still is not.3

Put simply, it is far easier for the government to print more money to pay for its needs than to raise taxes or balance its fiscal responsibilities. During election campaigns a politician will usually promise the world. So often, following their election into office, is the supply of money substitutes increased to pay for the earlier promises.

Inflation is the disease which follows that money printing. Each new unit of money which is printed to fund government spending reduces the value of all preceding units, causing the value of money to fall.

The expansion of the money in circulation, always led the way in the inflation. When it abated temporarily, the inflation abated temporarily. When it stopped permanently, the inflation stopped permanently. Nevertheless, the inflation is officially blamed on everything under the sun but the government's spending, its deficits, and its money issues.4

An Example: A New healthcare Bill

For example, the government wishes to pass a new health care bill which provides free healthcare to all of its citizens. If it cannot cover the cost of healthcare through existing taxes and the public will not accept a tax increase, the government can decide to pay for the bill through inflation. It will simply print the money out of thin air in order to cover the costs of healthcare. In this case the government gets what it wants - additional money to pay for healthcare. But money can never really be created out of thin air, it can merely be transferred from one place to another – from you to them. From the perspective of the public, it may appear that they now have free healthcare, provided by the government, but in fact the country’s citizens pay for their own healthcare, albeit indirectly, through a reduction in their wealth.

If this concept is not yet clear, try to think of it in the following way: assume that the money supply of this particular country is $1 trillion but the government plans to print another $1 trillion to pay for healthcare. We have already learned that an increase in the supply of money reduces the value of each money unit, albeit with a small delay in adjustment, so the doubling of the money supply halves the value of each unit and prices appear to double. Before the government starts spending the newly printed $1 trillion assume that the combined savings of the public will buy 600 billion loaves of bread. From the instant the government spending commences the additional money enters the economy and begins to filter its way to every corner of the country. As the new money feeds out into the economy the price of goods will begin to rise and will continue to do so until they have roughly doubled, fully reflecting the doubling of the money supply. The public will not realise until it is too late that their savings will only buy them 300 billion loaves of bread - their wealth has halved as the price of bread doubled.

Under a gold standard such government inflation is difficult to instigate. The money printing would quickly become apparent as the excess money substitutes in circulation would cause the price of gold to rise, signalling to the public that government spending was out of control. Realising these limitations, governments take a number of steps to ensure they have full control over money and thus full control of the inflation tax.

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