Inflation & Deflation Primer

A few facts about a complicated subject

I thought I'd toss off another quick post.

You probably already know what inflation is. It's when money becomes worth less over time (as opposed to hyperinflation where it becomes worthless). It's converse, of course, is deflation where money becomes more valuable over time. A dollar or yen in the future buys you more top ramen than it does today.

There's that duality principle again!

So the -flations are changes in the real purchasing power of money over time.

It's important to note that it’s not the amount of money in the economy that drives inflation. Rather, inflation is driven by the amount of spending.

This is an important distinction!

I think it's kind of counter-intuitive. If I inflate a balloon, it gets bigger. If I deflate it, I let the air out and it gets smaller. So you might infer that money becomes "bigger" with inflation—i.e. it buys more. But no, actually it buys less.

You can think of inflation as the money supply getting bigger. This means that each individual unit of money is worth less; that is, it purchases less of the goods and services available in the economy.

It's important to note that this is a ratio. If the amount of spending goes up, but the amount of goods and services to buy also goes up at the same time, it does not result in inflation. The numerator is the amount of money. The denominator is the amount of "stuff" in the economy for sale. If they both increase at the same rate, there is no inflation. That's another reason why it's not simply the amount of money in existence that drives inflation.

If the numerator (the amount of money) stays the same and the denominator (the amount of stuff to buy) goes down, that can also cause inflation.

What this means that if the amount of stuff to buy decreases for any reason—shortages, a sudden loss of industrial capacity, political chaos, broken supply chains, natural disasters, sabotage, etc.—this can also result in inflation, even without any increase in the supply of money. Thus, inflation can occur even without an increase in the money supply.

If the denominator (the size of the economy, usually expressed as GDP) gets bigger and the numerator does not adjust, then this can lead to deflation. In this case, there’s not enough money in existence for people to buy the all things that they want to buy and that people are willing and able to sell to them.

The thing is, there is no neutral effect of these things. Somebody always wins and somebody always loses—the duality principle in action. When you look at the financial history of United States, it's basically different interest groups fighting over whichever policy they think will help them the most. Some groups will want higher inflation. And others will want little to no inflation. Some—like consumers—may even desire deflation. Clearly they can’t all get what they want at the same time.

So, then, whom do these things help? And whom do they hurt?

Deflation helps the people who already have a lot of money and assets—the rich. That's because the money they have "stored up" in bank accounts and other fixed assets gains in value over time.

In other words, it primarily benefits existing wealth. "Dead" wealth; not "live" wealth.

Whom does inflation help? Inflation helps debtors, who are paying back a fixed amount of money that is worth less and less over the duration of the loan. Consequently, banks and bankers really hate inflation, because it erodes the real value of the loans on their books. They’re being paid back in increasingly worthless dollars.

In fact, if the money is losing it's value faster than the interest rate on a loan, it's known as inflating away the debt. Paying off your loan gets easier and easier over time, because the bank is eating the loss. That's another reason why bankers really hate inflation! Therefore, in order to keep the value of their loans high, bankers typically advocate for what’s called tight money—an atmosphere where inflation is low but not nonexistent (otherwise fewer people would take out loans).

Deflation especially hurts debtors, who have to pay back their loans with increasingly valuable dollars over time. That is, the real cost of the loan in dollars is going up.

So a thousand dollar loan taken out for, say, five years is much worse in an atmosphere of deflation. That's because, in five years time, a thousand dollars will be worth more than it is now, and you also have to pay interest on top of that.

Inflation privileges live wealth over dead wealth. You're much better off being a wage earner in a period of high inflation then someone living off of accumulated wealth and assets.

Put simply, high inflation erodes inequality. As Chamath Palihapitiya pointed out on Twitter, the highest inflation of the 1970s also coincided with the the smallest ever gap between rich and poor in the U.S. economy. As Joe Weisenthal noted, “The 40 year obsession with fighting inflation has been a disaster for the poor and fantastic for the wealthy.”

All the Boomers whining about the high inflation of the 1970s have it exactly backwards. High inflation made it easier to buy a house, because so much of the debt was eroded by inflation even taking into account the high interest rates at the time. Salaries also increased much faster than they do now thanks to high unionization rates and the emphasis on full employment. That is, their home loans were easier—not harder—to pay off than for subsequent generations. Yet they still like to complain about the high nominal interest rates in isolation from the other macroeconomic conditions at the time. That's just dumb and wrong. OK Boomer!

Given that, why are people so afraid of inflation?

When prices go up, people naturally react with fear. We each have a limited amount of money with which to buy resources. If we can't translate those cost increases into higher incomes, then we are obviously worse off. And we can't do that because of the power advantage that capital has over labor in the age of globalization. That's why certain sectors currently want to cut off aid to the unemployed. They want to cripple the ability of labor to bargain for higher wages in order to keep their profits high—that is, to make sure productivity gains accrue only to them, and not to America's workforce. This may finally be changing, but it’s too early to tell.

Inflation isn't a problem if incomes are rising along with the cost of items. If the cost of things goes up by five percent but your wages also go up by five percent, you're no better or worse off. If your income goes up by six percent, you’re actually better off. So rising costs (inflation) can’t be looked at in isolation. Purchasing power needs to be taken into account as well.

The thing is, real incomes haven't risen for over a generation. Productivity gains collectively generated by all workers in the economy have been almost entirely captured by the top .01 percent. That's why there are more billionaires than ever while more and more ordinary workers are struggling. This—and not inflation—is the real culprit behind falling living standards.

"Inflation trutherism" is a way of obscuring this fact. It claims that inflation is really super-high, it’s just that government is engaging in some kind of massive cover-up to hide this fact1. In my estimation, inflation trutherism was the beginning of conspiracy theories taking over our political discourse. The real purpose of inflation trutherism is to distract from forty-plus years of stagnant wages by putting the blame on "government money printing." This despite the fact that the vast majority of new money in the economy is generated through private loans taken out by the wealthy, corporations, and financial speculators.

Look around you. Take a look at our infrastructure—our roads, bridges, airports, canals, ports and transit hubs. Look at boarded up main streets and homeless encampments. Look at the mentally ill roaming our streets. Look at the lack of high-speed rail, high-speed internet and public transportation. Compare this with Europe or Asia. Does this look like a country where we've been spending way too much money the last forty years???

A historical digression

Prior to the Great Depression, both inflation and deflation were common. On first glance, we might think deflation is a desirable thing. After all, if our dollar buys more, then what's not to like?

That's what I used to think, too. But as I did more research, I realized the picture was far more murky and complicated than that.

The reason we think that deflation is such a good thing is because almost all of us reading this today are workers and consumers. We work for a paycheck and we go out and spend it. If your dollar buys more stuff, then that must be good, right?

But any real economy has more that just consumers. It also has producers. Usually businesses have to make upfront investments and sign multi-year contracts well in advance of actually producing anything. That becomes a lot harder if money is constantly gaining in value. They also have to take out bank loans. Paying back loans is a lot harder if money is gaining in value as I explained above.

Let's take the example of a garment factory. It has to lease space, purchase sewing machines, hire seamstresses, buy cloth, thread, thimbles and buttons from its suppliers, pay legal fees for incorporation—all before putting out a single dress or coat for sale.

The price they charge for the coat has to account for all the costs incurred—materials like fabric and thread, rent on the factory, the cost of equipment, legal and regulatory fees, wages for the workers—plus a markup for profit. In a scenario of falling prices, there is no way they will be able to do that. Deflation means that the price they paid for all those things six months ago or whenever was a lot higher in real terms than it is now. Because of that, they will not be able to recoup their incurred costs or pay their suppliers’ invoices, and will subsequently go bankrupt.

The quintessential example of this is farming. The way farming works today is basically the same way it worked thousands of years ago, and ever since. Because of the delayed nature of the enterprise, buying on credit has been an integral part of farming since Biblical times and even earlier. Being perennially in debt is simply the reality of life for the farmer, and always has been.2

At the initial start of the growing season, the farmer has no crop to sell, and so must purchase the items he or she needs on credit including seeds, equipment, fertilizer, labor, and so forth. At the end of the season, he or she will have a crop which they plan to sell for enough money to pay back whatever they borrowed at the start of the growing season, plus a little extra. They will also have to pay their laborers, and perhaps rent on the land if they do not own it.

If commodity prices are low and/or falling, (i.e. deflation) they will not be able to do that. They will not be able to recoup the costs of all the things they borrowed in order to produce that crop. In that case, they have only two options. They can either roll over the debt and hope for higher prices next season (in which case debts are cumulative), or they can throw in the towel and declare bankruptcy. Often this depends on the largesse of the creditor.

Of course, these aren't the only examples. In the real world, nearly every business has to make upfront investments, negotiate long-term contracts with terms ranging from months to years in the future, and take out loans that must be paid back (amortized) over some length of time.

So, for our hypothetical farmer or garment manufacturer, deflation is definitely not a good thing!

And this isn't hypothetical! Most of you probably know that in the nineteenth century, a large number of Americans were self-employed farmers, independent craftsmen and small businessmen. A lot more of us were producers back then. Deflation meant that struggling farms and businesses frequently went under causing those people to lose everything. Businesses could not sell their products for enough money to recoup their costs. Farmers could not sell commodities for enough money to pay back their loans. This happened pretty regularly. Many people lost their shirts and were utterly ruined. Some even became despondent and committed suicide.

If deflation hurt farmers and small businessmen, it helped bankers and money lenders. If money was scarce, then the price for it was high. The price of money is the interest rate. Therefore, "tight money" allowed banks to charge high interest rates on their loans.

High interest rates and deflation devastated American farmers and small businessmen all over the country throughout the nineteenth century. All of this has disappeared down the memory hole because we're not taught economic history anymore. Instead we're taught magical fairy stories of perfectly self-regulating markets and rational consumers. Propaganda.

Throughout the late nineteenth century, small farmers and businessmen were constantly pushing for higher and sustained inflation. They wanted the money supply to expand. That would lead to the higher commodity prices they needed to pay back their loans and make a profit. They also wanted interest rates to be lower so that it was easier to take out a mortgage to expand or buy things like seed and fertilizer on credit. Businessmen wanted to be able to sell their products and services for enough money to recoup their incurred costs.

They even formed political parties to advocate for this. The major brake on money creation back then was the Gold Standard. Some people wanted the government to issue fiat money as it had done during the Civil War—the Greenbacks—which had led to an economic boom. Others wanted money to based on both gold and silver rather than just gold—known as bimetallism.

Whatever their preferred method, higher inflation and an expanded money supply was the end goal for all of them. This was the basis of what's known to historians as the Populist Movement. The Populist Movement was primarily made up of rural farmers, independent craftsmen and small businessmen, especially those who lived in the American heartland. They were opposed primarily by bankers, and also big corporate monopolies.

The point is that inflation and deflation both helps some people and hurts others at the same time. There is no neutral scenario. Whichever one you prefer depends on where you fit in the economy.

Back to Today

Fast forward to today. During the nineteenth century, prices were far more unstable than they are now. When averaged out over a long period of time, inflation was indeed lower, but this obscured the wild price oscillations in between.

Some bad-faith actors like to cherry-pick prices from two different random points in time—twenty years apart, say—to argue out that prices remained the same and therefore there was effectively no inflation before about 1900. But, as the journalist and historian William Grieder pointed out, that’s the same as saying that because a plane starts and lands on the ground, it was never in the air. In between those two points, prices swung rapidly between periods of inflation and deflation, helping some people and hurting others. It was not the magical paradise for the common man depicted by libertarians like Ron Paul.

In modern times we traded off this volatility for higher—but stable—inflation. This stability makes it easier to plan for the long term.

Why is a small amount of inflation important? A few reasons.

One is that if money is increasing in value by doing absolutely nothing with it, then there is no motivation to invest it. Sure, you may still invest if you find some killer business opportunity. But, for the most part, it's much harder to get investment money flowing to productive enterprises in the macroeconomy when there's deflationary pressure.

The more important one is that when loans are taken out, the loan amount itself is created by the bank as brand new money, but not the interest. Therefore, the money required to pay the interest has to be created via ongoing economic expansion, meaning that the money supply naturally tends to increase over time. Otherwise it becomes a zero-sum game for existing dollars—to pay back loans with interest, some other economic enterprise will have to be cannibalized. This is simply baked into how capitalism works. If you don’t like that, you don’t like capitalism, and—last time I checked—libertarians tend to be very fond of capitalism

This predisposes the economy under capitalism toward permanent growth. That's a major issue to be sure, but it’s not one we're going to be able to tackle in this short post.

Right now you're hearing a lot of scare stories about inflation. A lot of this is clearly grandstanding for political purposes—a lot of people want to scare the Biden administration away from investing in the economy, just as they've managed to do for every presidential administration since Reagan.

But the fact is, the reason inflation is so high at this moment is because it fell off a cliff last year. You see, there was a global pandemic. People stayed home and demand evaporated practically overnight like a rain puddle in the noonday sunshine. A lot of productive capacity went into mothballs. Now demand is suddenly coming back, and supply cannot keep up. That is a temporary condition not caused by, for example, spending on infrastructure proposed by the Biden administration, which has not even started yet.

Because prices are compared to what they were at this same time last year—during the initial onslaught of the pandemic, mind you—the headline inflation rate will be high. That doesn't mean inflation is higher than it would have been had we not all went into lockdown for the last year or so. This chart helps explain make the point:

The other salient factor is supply chain disruptions. Recall the denominator in the ratio above. Supply chain problems have been well documented, for example, with computer chips and lumber. Both of these are very costly right now, pushing inflation measures higher. And sabotage is clearly behind the current spike in gasoline prices. I'm sure by now you've heard about the ransomware attack on the major pipeline supplying the U.S. Southeast and Mid-Atlantic coast.

These things happen. They will need to be solved, but it will take time. There are also things we are legitimately running short of because we live on a finite planet. That’s an important issue to be sure, but it's a much bigger issue than inflation and macroeconomics. Austerity and lack of government investment are not going to fix those issues.

But..but..but…what about housing, health care and education costs??? And why are certain things excluded from the calculations? Isn't that cheating? Isn't this all a big conspiracy by the evil government to make things look better than they actually are? Won't “Money Printer Go Brrrr" lead to hyperinflation any day now and destroy the American economy causing catastrophic economic collapse—cats and dogs living together; mass hysteria???

Well, no. But I've rattled on too long already. Those will have to be topics for another time.


What is true is that there are several different methods of calculating inflation. Some may be more accurate or informative than others—it's a totally valid debate. But what these "inflation truther" sites like Shadow Stats do is deliberately use methods which make inflation look as high as possible and claim that only they have the capital-T "Truth" and the government is deliberately "cooking the books" for nefarious purposes. This talk was rife in the early 2000s and plenty of “useful idiots” continue to propagate it today. It's pretty easy to see how we can get from that to Covid denialism, anti-vax conspiracies and stolen elections.


This is a major problem with the "money starting as barter" hypothesis. How do you barter with something you don't have yet? There's far more evidence that money originally started as credit that eventually became generally transferable among the community. Sometimes these loans were denominated in real, tangible objects; sometimes not. We have plenty of these loans written out on clay tablets. Michael Hudson has written about this extensively.