Inflation Revisited

 A problem good students have is that when they are discouraged from understanding something, they take the hint. I’m attempting to boil away some of the mystical malarkey around our everyday understanding of inflation. Don’t demand to understand or agree with every detail.

Inflation is a catchall for rising prices. I don’t have the prescription for rising prices. What I can do is categorize inflation first by currency and then by class.

Use of this generic term obscures the distinction between currency inflation, our currencies value against other currencies and domestic inflation when our prices increase but stay in range of other nations or the price of oil.

At this point there may be some free market(oxymoron) apologists who make their living prattling that currency inflation can be ignored:

-The market will adjust. Cheaper currency means greater competitiveness in the world markets. This will lead to innovation and growth in the cheaper country.

After which we all have a good laugh. Cheaper currency means that our assets, our capital goods, are also cheaper. Which means that foreign investors or speculators will swoop in and buy our factories, spouses, banks and take the earnings off to their own countries.

Foreign ownership doesn’t have to be bad, ask Jesse James. I remember a friend carrying on about Japanese investment in the US:

-They run their factories more efficiently. They pay benefits rather than salary.

-What’s the problem?

-You’ll never get into upper management.

Fear of foreign ownership and speculation is why we have central banks. The purpose of all these central banks is to maintain stability in the currency markets, or at least dampen gyration. The success of central banks can be measured by comparing world currency variation against the price of gold. If all currencies decline against gold in unison, we can still trade. The central banks do insider speculation to discourage outsider speculation.  At which point you may get some ingrates complaining that these banks exist only to support the status quo, bear in mind that status quo is also our employers.

Central banks have various official mechanisms for maintaining currency parity, or imbalance:

1.    Central banks have a discount window to loan money to registered banks ensuring that they won’t suffer temporary over drafts. Registered banks should take this rate to determine their risk of being overdrawn or defaulted on.

2.    Central banks insure deposits to their registered banks up to some amount.

3.    Central banks can audit their registered banks.

4.    Central banks can buy and sell their own, other currencies and gold.

5.    Central Banks can purchase both their own and foreign government debt.

These powers give central banks the implicit ability to participate in bail outs and take overs. This may all sound collegial and powerful to you until government treasuries hold auctions to sell securities supporting their debt.

While central banks and associated agencies can purchase these securities the debt of most countries reaches a point where individuals must participate or the debt sells below its asking price offering a greater yield. Rather than sell debt below its face value government treasuries raise the interest offered. In either case the central bank had best raise the discount rate charged its registered banks or those banks will be making free money, borrowing from the discount window to buy treasuries. Central banks are supposed to support themselves.

There may still be some among the economic apologists fulminating against government debt. Debt is central to capitalism. European expansion is a consequence of the Fuggers legalizing interest. The problem isn’t debt; it’s how the money is invested.

Call it capitalism or whatever you want, we need to plan, we need return on investment, we need to organize work and we must have a valuation of the consequence. Finance gives us a means of assessing risk reward. At some point it comes down to someone saying:

-You want to bet?

Within domestic inflation there is also a distinction between capital and wage inflation. If those terms annoy you substitute investment and consumer inflation. There are five US government agencies that restrict wage inflation:

1.    Department of Immigration and Naturalization identifies the undocumented that set the base rate for salaries.

2.    Taxation (IRS) favors investment over income.

3.    Department of Labor constrains union organizing.

4.    Department of Commerce (Trade) allows imports or encourages smuggling.

5.    When the central bank, the Federal Reserve for us, raises interest it curbs new investment which competes on wages.

These constraints on wage inflation increase capital inflation. Increasing interest reduces competition in general. The check on capital inflation is market disaster. Investors buying treasuries concern themselves with wage inflation. Capital inflation raises prices when it achieves monopoly. Investment can lower prices in a competitive environment. Sometimes investment can create a competitive environment, thwarting monopoly.

The Fed bouncing the interest rate caused the crash of 1929. Since then, the Fed is expected to behave in a measured and considerate way. It is hoped that the Fed will stay ahead of wage inflation. The fear is that the Fed will get caught in a game of chase, losing investor confidence.

Economists justify their existence by referring to the velocity of money. Take away the boilerplate and this is used to justify holding down wages. The velocity of money is defined as the putative total transactions in a country divided by the putative total amount of money. It makes sense that when people get paid more, they will indulge in more transactions benefitting more people. What is lost is that without investment the price of goods will increase.

Contrast the velocity of money from wage inflation with the multiplier from capital inflation. The multiplier is when financial instruments are themselves financed. If everyone must put down 20% borrowing from each other the multiplier on the original asset is 5. Usually, the down is less than 20%. I’ll put multiplier against velocity any day. At least until the original loan is paid off. If the loan is defaulted and the asset can be seized this could lead to further financial stratagems.

Which brings us to the question of national default. Never loan to kings. Our constitution was written to allow taxation of liquor which was used to pay for financing from the Dutch. Jefferson negotiated US debt forgiveness from Napolean who had nominal ownership. Jackson demanded payment to the US in gold crashing our markets. Grant kept US from paying our debt in silver, as did McKinley. Under Nixon the US went off gold and onto oil, which was an abrogation of our debt agreement.

Wage inflation has a direct upward impact on treasury interest. Capital inflation should lower treasury interest over time. As capital accumulates it competes for investment opportunity. In a stable environment this competition should lower the acceptable collective rate of return. As Piketty explains in such static times wealth is dynastic, compounding is paramount, marriage and inheritance rule.

Some of these investment opportunities are illusory:

1.    Governments guarantee a rate of return then undercut this rate by creating more currency. 

2.    Council of Institutional Investors gives a list of dual class publicly traded companies that cannot be taken over such as Meta. As of February 2026, there were 414 such stocks. Some of these quasi-public stocks are in indexes.

3.    Private Equity can refuse withdrawals. There is no requirement that private equity be equitable about who gets to withdraw.

4.    The petrodollar is based on oil. When oil declines, the dollar declines.

When a bubble pops, central banks and governments can ameliorate the crisis by giving money to the failing companies. This is accompanied by harsh words and strict admonitions against recurrence. If the disaster is extreme enough wage earners may receive subsidies from governments. The wage earner subsidies are usually criticized as inflationary.