Inflation, and Why You Should Care About It

When I speak to friends or family members about inflation, they seem to think of it as something that naturally happens. They shrug it off, recalling their first class during Economics 101 and they accept it as if it should surely happen like how the sun rises, or how we have to file our tax returns. Is that really the case, do we accept it as fact of life, one that has been happening since man started transacting with money instead of bartering?

How Banks Started

Gold and silver have been money for thousands of years, and they can never be printed nor conjured out of thin air. Paper money was invented to make it more convenient to buy goods, because carrying around gold coins and bars – especially to buy expensive goods - was physically exhausting and handling them makes you a target for thieves. The first paper money used were issued by banks, both in China and in medieval Europe (much earlier in China), which bankers handed to you after you store your gold or silver with them. These were actually letters of credit that allowed you to pay for things and carry/bear the ‘IOUs’ over large distances, without the hassle of carrying the precious metals. The bullion was left in bank houses all over the country, which meant that people then had accounts that allowed them to purchase goods from one place to another.

Withdrawal of the bullion rarely happened. When the first bankers realized that they can conjure up and print IOUs that were altogether worth more than the actual gold they store, then the idea of fractional reserve banking was born. Printing fiat currencies, be it by the government treasury or private banks authorized to print these notes, tempted the authorities to print more money than ever. It can be to build more bridges and palaces, finance wars or pay down debts (which they incurred by initially borrowing from the banks, after bankers gained control of a nation’s finances).

The Hidden Tax

Of course, there is no such thing as free lunch. Inflation is called the hidden tax, because every hundred dollar bill printed – which costs only a few dollars for a government to create – means more dollars added to the entire money supply and that you do not notice how it causes the general price levels to go up. However, it can be felt if you watch your budget or if your income does not increase more than the cost of goods, services, rent or the mortgage that you pay for.

The public does not realize or does not care that much that inflation is eating away at our purchasing power. Or that governments, since virtually none of the world currencies have not been fully backed or are redeemable by gold or silver for the past 40 – 50 years, have mostly caused and actually prefer an inflationary environment (most countries are net debtors, and weaker currencies mean that they can pay down debt faster with less valuable dollars). The last country to have their currency partially backed by gold was Switzerland, which had until 2000 Swiss Francs 40% backed by gold reserves.

Another form of this taxing by way of inflation that some people do not know about is seigniorage. Try taking coins out of your pocket. The metal content, which we can examine through our DUX Testing Program, costs only a small fraction of the stated face value. All governments practice this as a means of boosting revenue, and really to tax people.

During the time of the Roman Empire, a way for government officials to tax their citizens was by shaving off the edges of a silver denarius coin, before one can enter a public building or a house of worship. This is the reason why coins have ridges on their edges, so that one can initially check if the coin has been shaved off or filed.

To raise revenues, governments mainly do three things: A) raise taxes, B) borrow by selling bonds C) print more money at a faster rate than they did. Under normal circumstances, countries execute points A and B. However, at the current low interest rate environment with governments having bailed out financial institutions during the GFC in 2008, more countries have been ramping up printing of fiat currencies.

So the question is; which currencies do you trust?

Responsible governments balance their budget, record fiscal surpluses and are disciplined enough to only execute the three ways to raise revenue if situation requires.

As an example, the total value of all Singapore dollar notes and coins in circulation are fully backed by external assets. These can include physical gold and silver, foreign exchange such as time deposits and bank balances and other assets such as equities or bonds.

So what then happens if the citizenry lose confidence in their currency, due to the government having printed too much money?

On my next post, we will discuss the nature of hyperinflation and how it affects me and you.