Myth: Inflation Is A Bad Thing

Since Uncle Tom's Cabin debuted in 1914, the American Dollar has lost the overwhelming majority of its purchasing power. Alongside 5 cent movie tickets, the America of 1914 saw milk at eight cents a quart and flour at 3 cents a pound. This represents an inflation rate approaching 2,000% for the intervening 93 year period -- meaning that were one to find a dollar bill from 1914, its buying power today would be just 0.0005% of its real value when it was printed. By all accounts, this is a staggering drop in value and Gold Standard advocates point to it as a ready and obvious example of the dangers of a fiat currency.

But then again, who keeps 93 year old money around anyway?

The key assumption is all of this debate is that inflation is a bad thing. It is not. Inflationary pressures spur economic growth, encourage investment, and allow for the massive development, infrastructure, and expansion that the United States has enjoyed since 1914. Alongside inflation comes growth, and without this companion, the scales seem unbalanced indeed.

Inflation creates, in a word, risk. The sequestration of capital is a risk-free enterprise in a world with no inflation. Inflation deters hording and encourages the rapid deployment of that capital. As inflationary pressures increase, so also does the velocity of money which itself relates directly to the propensity of an economy to both consume and invest. The converse is also true, as inflationary pressures approach zero individuals are more likely to horde capital than they are to invest it. This results in deflationary pressures which themselves reinforce the impetus to horde.

Inflation and deflation are both natural aspects of market economics, and though inflation is exacerbated somewhat by the dominance of a fiat currency, it is not eliminated in its absence. The Federal Reserve, created in the early 20^th century, serves and served to regulate and to some degree mitigate the fluctuations of international monetary markets. Though the Fed was created to help defend the US Dollar on the international stage, it proved unequal to the task after the collapse of the stock market in 1929.

In the aftermath of the 1929 collapse, a banking crisis struck the United States. With a run on the banks came a halt to lending. The money supply, tied firmly to the price of gold, dried up and massive deflation set in. Prices dropped and profits and wages drooped with them. As Jeffry Frieden explains in Global Capitalism, the Federal Reserve's hands were tied:

Governments searching for alternatives to deflationary paralysis and financial ruin ran into an apparently immovable international object, gold. Attempts to halt deflation and raise prices were blocked by government commitments to the gold values of their currencies. As two economic historians put it, the gold standard's "rhetoric was deflation and its mentality was one of inaction."

While gold standard economies experience constant oscillation between inflation and deflation, resulting in long term stability but short term immobility, fiat based systems experience deflation only under very unusual circumstances but retain extensive flexibility as a consequence. As a result fiat based systems, though subject to the hypothetical malice and incompetence of government, are better prepared to to maximize growth and innovation, spur investment, and generate wealth. Moreover, it is through the ebb and flow of this constant inflation that fiat currencies are regulated and through this constant inflationary pressure that their economies grow. As Berry Eichengreen, economist and historian, wrote in Golden Fetters:

The gold standard is the key to understanding the Depression. The gold standard of the 1920s set the stage of the Depression of the 1930s by heightening the fragility of the international financial system. The gold standard was the mechanism transmitting the destabilizing impulse from the United States to the rest of the world. The gold standard magnified that initial destabilizing shock. It was the principal obstacle to offsetting action. It was the binding constraint preventing policymakers from averting the failure of banks and containing the spread of financial panic. For all these reasons, the international gold standard was a central factor in the worldwide Depression. Recovery proved possible, for these same reasons, only after abandoning the gold standard