Inflation has a mathematical limit

Money is upstream of any human event bar none.

Short of returning to barter with the ramifications that would entail, there is no alternative to the use of money.

However, since the advent of modern times (since the 1600s that is) we’ve gradually moved towards a more pervasive use of a variety of money called Fiat. Fiat money is merely a tool for exchange, it is a vehicle. Fiat money is not wealth in and of itself. Fiat money is only something you can exchange for wealth.

If you had one million Zimbabwe dollars in a bank account in 2000 and left it there untouched, today that money couldn’t even buy a tomato … if you found a tomato to buy in Zimbabwe that is.

If you had one million Italian Liras in a bank account in 1999 and left it there untouched, in 2000 you would have received five hundred Euros in exchange for your deposit. Although better off than in Zimbabwe, you would have immediately realized that five hundred Euros allowed you to buy only half of what the Lira did.

If you held one million Pesos in an Argentine bank in 2000 and did nothing with that money, by 2002 your savings would have allowed you to buy only one quarter of what you could buy originally.

In the past four hundred years, fiat currencies have come and gone with amazing regularity. From the French Assignat to the American Continental to the German Mark fiat money will disappear. It can self destruct as was the case for the Continental or the Zimbabwe dollar or it can voluntarily be withdrawn before obliteration by the monetary authorities as was the case for the French Franc and the Italian Lira.

So, fiat money is only a vehicle. You better not believe it is wealth.

Money is the life blood of any and all human endeavors bar none. It is the medium that allows human activity to take place at many levels and betwixt several parties simultaneously. Not that there is anything wrong with barter of course. It is just that the dynamic of exchange brought about by barter cannot even approximate the depth and complexity that money permits.

At this point, you may think that the crux of the science of economics and finance would be to devise ways to preserve the purchasing power of a currency… and you would be spectacularly wrong.

The reason we’ve moved from value based currencies to fiat money is because the institution of power within a society must be free to manipulate the currency in order to pursue what is perceived to be their “legitimate” raison d’etat . It cannot be otherwise. If that were not so, then we could make do with some type of currency that derives its value directly from the underlying economy. In a metal monetary system for example, the monetary base can only be expanded by employing people, machinery and time in order to locate, extract, convey, refine and distribute more metal. Thus in a metal based monetary system, the monetary base can only be expanded by expanding the underlying economy. But a fiat monetary system has no similar material or temporal constraints because the money is created by political decree without any reference to the economy. Sure, politicians and bankers fall over each other to show that monetary policy is sensible and grounded but empirical evidence shows otherwise. A typical case of being better off by watching what they do rather than what they say.

Thus, although a fiat monetary system is more flexible and, in theory, more adaptable, when coupled with a “Democracy” the combination is certain to, eventually, obliterate the currency. Once again; there is no alternative to the logical conclusion of the combination of these two dynamics.

If you can get your head around the above, then it follows that not only is inflation necessarily exponential but it also has a mathematical limit. And here is why.

By adopting a fiat monetary system, a government implicitly chooses to artificially induce inflation into the system. Once you induce inflation the first time, you induce a rise in price level thereby inducing a rise in GDP. The amount of inflation induced the first time, will be modest compared to the gains in productivity and tangible wealth. However, as you push ever greater degrees of inflation into the system, inflation gradually becomes a greater component of GDP expansion. In so doing, you are compromising “real” GDP growth. Of course, the chances that in a “Democracy” the electorate or the politicians should advocate a reduction in spending (thus a reduction in credit creation and money supply) in anything is indeed as remote a probability as statistically possible. Therefore, the combination of fiat money and democracy will eventually obliterate a currency and, depending on other circumstances, will also bankrupt the state issuer of the reserve currency.

The problem arises by the fact that as the years go by, the inflation component of GDP growth increases till it overwhelms the number. Somewhere along the inflationary timeline, countries become “service” based economies.

Once you are a service based economy, you know that any let-up in inflation will spell doom for GDP growth.

This is the point at which government has a vested interest in closing an eye or two on practices that initially may be considered borderline legal.

Then at some point along the inflationary time line, closing both eyes on suspicious practices no longer suffices to ensure GDP growth. This is the point at which government has a vested interest in aiding and abetting blatantly illegal practices.

As of  July 2009, in the wake of the Western governments unilateral decision to buy into private enterprises in Europe and America to avoid the failure of insurance companies, banks, automobile manufacturers or finance companies; our governments unilateral decision to ride roughshod over some bond holders whilst favoring others in blatant contravention to the letter of the law; our governments tolerance of the by now discredited rating agencies that have been caught in flagrant and blatant conflict of interest; our governments explicit desire not to disclose how public funds are employed; our government tolerance of clearly larcenous practices as banks and insurance companies pay astronomical bonuses to their employees in the face of a crisis that is variously described as the worse since the Great Depression or worse since records in a particular sector began; our governments tolerance and reliance on a restricted number of finance professionals that hail from one of the largest finance houses on the planet to manage key positions in economics and finance….

…you get the drift…

Towards the end of the inflationary time line, economic activity no longer suffices to service debt; the point at which industrial capacity utilization is at an all time low; the point at which after an inexorable decline over 30 years the money multiplier has dropped below 1; the point at which after an inexorable decline over thirty years interest rates are at all time lows…. at that point, inducing more inflation may not help goose GDP growth any longer. If, at the same time, in an attempt to make up for lost revenue governments begin to not only print bonds but also print money to buy said bonds from themselves rather than from each other… at that point, deflation is virtually guaranteed… not only is deflation guaranteed but unlike a bout of deflation that may happen somewhere in the middle of the inflationary time line, deflation at the end of the inflationary time line will also destroy the currency.

If deflation has set in then the following is virtually guaranteed…

Credit implosion

Rising unemployment

Declining consumer expenditure

Declining asset values

Declining earnings

Tightening credit standards

Of course the above wouldn’t be so bad if it weren’t for one thing…

As more people lose their homes and their jobs and as governments must reduce spending on public programs, civil unrest is sure to follow. And if the condition persists, you can bet your bottom Dollar that governments will fall.

So, before that happens, those beacons of morality that are Western governments will very likely not step up to the plate to declare how things are really like. That is very improbable indeed. What Western governments will do on the other hand, is what they have always done in the past… engineer a war. If I am right, this next war coming up will be something to behold.

I say we’ll have us a global conflict by 2013 or 2015 latest.

Got bullion?

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One Response to “Inflation has a mathematical limit”

  1. Fraud reporting « Guido’s temple of the absurd Says:

    […] By guidoamm As shown here, here, here and in many other posts on my blog, in a fiat monetary system, inflation is the reason […]

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