What is Inflation?

After pondering the issue for sometime I was finally struck with the answer. It was during a conversation with a friend explaining him the ramifications of the financial system and where financial and physical assets play a role.

We will begin with the difference between commodities and money. We will then explain how they relate to each other.

The Difference Between Commodities and Money
Commodities are real things – they are actual wealth and are made of the stuff that we eat, build and travel with. Money by contrast derives itself from the physical asset and wealth represents, a credit for something real.

Over the course of a generation, the amount of credit will expand to accommodate business growth, borrowing for investment and for the sake of increasing the amount and efficiency of actual goods and services. This will then contract and will leave each own with his profit or loss.

The Credit Cycle
It is this ratio – goods to derived goods – that paint the economic picture of tomorrow. When the Dow is selling for an ounce of gold, one can be sure that the physical and fiscal assets have realigned. However, when the economy is flush with liquidity and the Dow is selling for 44 gold coins then the future, although it may contain more of an expansion, it is nonetheless bound for a retreat.

Inflation and Deflation
Now that we have these extremes, it is a simple matter of equalizing the ratios, an x-factor, that has yet to be either extended or narrowed. And there are two ways of this occurring.

The first is by raising the lower quotient (Commodities), this is what the investing public now refers to as “Inflation”. The second scenario is by a lowering of the higher quotient (Fiscal Assets).

Realize that the choice inherent to obtain the objective is a lesser of two evils. Either the holders of the physical will be happy and the holders of the financial assets unsettled (due to the fact that their goods now sell at a more expensive price). This is the “Inflation” we saw so vividly during the 1970s. The financial institutions aimed at increasing liquidity.

Or the holders of the financial assets will be, for lack of a better word “deflated” and the holders of physical assets content. This is “Deflation” by Keynesian definitions, that occurred during the debacle of the 1930s. Then the financial institutions allowed the liquidity to dry up itself.

Depression and Recession
Obviously the term Depression was provided for the latter, and the term Recession for the former since psychologically it is far more painful to lose $1000 than for your $1000 to be worth less, albeit with the same result – mediocrity of value.

In Summery
We now understand the difference between the common use of the terms “Inflation” and “Deflation” used to describe a nominal expansion and contraction of the money supply and the practical definition of those terms that relate primarily to the increasing spread between actual and monetary assets.

Inflation
According to its common and generally defined term Inflation refers solely to an increase in prices. The reason this description is so vague, is because the goods with one wishes to refer to as a guide may be relatively important to one individual but at the same time irrelevant to another. The proper term of Inflation refers not to the monetary price of goods but rather, more importantly, the ability to buy more goods at a better value. For example, if $100 now buys you 100 apples instead of 90, this would be an inflation of the credit supply.

Deflation
This categorize the opposite effect. The modern and widely used term Deflation refers to falling prices. While the proper and more appropriate term refers to falling valuations. – $100 buying you 90 apples instead of 100. This means that Inflation and Deflation in the modern sense refer only to prices which change daily as does the dollar, and is thus harder to grasp. The proper terms refers to value – the only reason money was created in the first place.

“The fools are those who know the price of everything and the value of nothing”

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