Inflation: It’s Complicated

“The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” Vladimir Lenin

Inflation is one of those things that everyone thinks they understand but few can define precisely. Today, it’s commonly used to describe rising prices—the cost of groceries, gas, or just about anything creeping higher over time. Ask the average person, and they might shrug and say, “Inflation just happens.” But this wasn’t always how we understood it.

A century ago, the Federal Reserve—and economists at large—defined inflation differently. Back then, it referred not to rising prices but to an expansion of the money supply. Price increases, if they occurred, were considered the result of inflation, not inflation itself. This might seem like semantics, but the distinction is significant because it changes how we perceive the phenomenon. A rise in prices feels like a natural, almost inevitable occurrence in a growing economy. But inflation, as originally defined, was a monetary policy action—central banks creating money faster than the economy produces goods and services, or what is often referred to as printing money.

Over time, the shift in meaning wasn’t accidental. Framing inflation as a noun—a general increase in prices—rather than as a monetary phenomenon takes policymakers off the hook. Rising prices start to look like a natural or even healthy sign of economic growth. And when inflation is viewed as inevitable, it feels less like the Fed’s monetary chicanery and more like the price of progress. But beneath the surface lies a more devious scheme: encouraging us to spend today and devalue yesterday’s debts.

Consider the incentives at play. If you believe prices will be higher tomorrow, you’re more likely to buy that house, car, or washing machine today. Central bankers welcome this because it keeps money flowing through the economy. Meanwhile, inflation’s devious second effect is eroding the real value of debt. Uncle Sam currently owes $36 trillion, a number that is projected to increase $2 trillion/year over the coming decade. By making those dollars worth a little less over time, inflation works like a slow, silent debt reduction plan—one that doesn’t require cutting budgets or raising taxes. It’s a win-win for the big players, though not always for the rest of us.

We measure inflation in several ways, each with its own quirks and limitations. The most common yardstick is the Consumer Price Index, or CPI, which tracks the average price changes for a basket of goods and services over time. It’s a useful measure but not without flaws. For one, it doesn’t necessarily reflect your personal experience, so your perception (of price changes) may be vastly different than the headline number reported.

Inflation doesn’t treat everyone or everything equally. For asset owners, it can feel like a tailwind. Real estate, stocks, and even gold tend to rise in nominal value during inflationary periods. If you own things that hold or increase their worth as the dollar weakens, you might even cheer a little. On the flip side, liabilities—like debt—become easier to bear. Borrow $100,000 today, and in ten years, you’re repaying it with devalued dollars. For governments swimming in debt, this is a feature, not a bug.

But for the average person, inflation often feels more like a tax. Your paycheck might grow, but if your grocery bill grows faster, you’re losing ground. And unlike most taxes, inflation doesn’t require legislative approval. It works in the background, quietly eroding purchasing power and transferring value from savers to borrowers.

The Fed’s current inflation target is 2%, however, the latest Bureau of Labor Statistics CPI report indicates prices have increased 2.7% over the past year. Consider this; one of the primary definitions of a proper medium of exchange (money) is that it is a store of value; meaning your money should have roughly the same purchasing power in the future as it does today. But even if the Fed ultimately achieves its goal of 2% inflation, over the course of ten years a dollar is worth just 80-cents, hence the notion that inflation is simply an implicit tax.

It’s important to understand that inflation doesn’t create wealth. Rather, it increases the supply of money without a corresponding increase in output. Printing more money simply spreads the same amount of economic value over a larger pool of dollars. Wealth comes from innovation and the associated increase in productivity/output—building more/better products, innovating, and growing the economy. Inflation is just the illusion of prosperity, a reshuffling of the deck that usually leaves the middle and lower classes holding fewer high cards.

The way we talk about inflation today obscures its true nature. It’s not just some natural byproduct of economic growth but a deliberate ploy used by policymakers to encourage spending and manage debt. A century ago, even the Federal Reserve would have called it what it is: inflating the money supply. Perhaps it’s time to revisit that definition.

Mark Lazar, MBA
CERTIFIED FINANCIAL PLANNER™
wasatchfinance.com