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Lucas Kandia's avatar

"Dad, how does inflation work?" asked my child of 23 the other day.

I gazed over at him as we drove through traffic. He held my gaze, and I sensed he really wanted to know this time. Not a Google answer, but something he could relate to. So I did my best to emulate Bill Bonner/Joel Bowman, two people I hold in high regard for having great insight and ability to wade through the bulls*it and make this all make sense to us.

"To inflate, means to make bigger than originally, in terms of size or volume. Take for example a balloon. When it sits there, inert and deflated, it doesn't really do anything. If you were a bug, you could alight it, and it would just lie there. No danger to you, or itself.

Now fill it full of air, and suddenly it reach lofty heights. Unfortunately, as with anything that goes up, it eventually will come down. Sometimes gradually, and sometimes, if it pops, catastrophically. And the alighted bug, would plummet to the earth along with it.

The economies of the world are like that balloon. You never want to inflate an economy, or make it larger than it really is, for the danger lies in bringing it back to normal size. No one in history (so far) has been able to do that. At least not without bloodshed and pain. Let me explain.

First of all, life is a game of supply and demand. In order to play, there is a simple rule. You work. You get paid. You demand something from a supplier. You give them $1 and they give you $1 worth of goods. You go back to work, to continue the cycle. You supply something that the world needs. The world repays you in dollars so you can go get what you need. In a perfect world (no such thing), the dollars even out in the game of supply and demand.

Let's break this down to a super simple example.

3 people. A Farmer, a Baker and an Accountant.

The farmer grows wheat. He then sells 2 units of wheat to the baker. For $2.

The baker makes bread. He then sells 1 unit of bread to the farmer and 1 unit of bread to the accountant. For $1 each. Total $2.

The accountant does books. He does the farmers books for $1 and the baker's books for $1. Total $2.

In this super simple example, total money is $6. No inflation. Just a supply and demand economy.

Now let's inflate this scenario by bringing in a 4th person. Someone who does NOT work. But has gotten FREE money from the government. Via a loan from the bank at 0% or a stimmie cheque. They come with $2 they borrowed or got for nothing. They turn to the baker and say that they would like to buy a loaf of bread. But the farmer wants to buy some bread too. As does the accountant. Faced with 3 people who all want a loaf of bread, but only 2 loaves to sell, he raises his prices. He sets the price of a loaf of bread at $2. The person with the free money gladly pays the $2 as he is hungry. The farmer and the accountant have to go back to work as they do not have enough money.

What happened?

Total money supply was increased by 33%. Whereas money supply was $6, it is now $8. But total work output, never changed. It was still 6 hrs of labor producing $6 of money supply. The printed money inflated the money supply, in turn causing prices to inflate or rise, based on supply and demand."

"So how do we fix the problem?" my son asked.

"Remove the fake money."

"How do we do that?"

"Two things.

Stop printing money. That one should be obvious.

The less obvious is to raise interest rates. Why?

If they remain at, or near 0%, everyone borrows money and prices sky rocket. Make it harder to borrow and a lot of those that did borrow money, will not be able to make their payments. Others that want to borrow won't be able to do so with high interest rates. Both won't have money to buy that loaf of bread. The price of bread will stop rising, as there will only be working people buying that bread. The ones that made their money honestly.

In other words, take free money (both printed and borrowed) out of the equation. And bring sanity back" I said.

"Is it possible?" he asked with a tremor of excitement in his voice.

"Anything is possible, but more than likely, those at the trough, the ones that have been voted in to make the hard decisions, will stay feeding until the last possible second. They'll keep interest rates artificially low as long as they can, kicking the can of responsibility (increasing interest rates) down the road for someone else to fix. And then run to the hills when the revolution comes."

"So there is a lot to look forward to" he said with a chuckle.

"A lot" I said smiling back.

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Molly K.'s avatar

Is it possible to put the Fed and the majority of our political leaders in the same position as Marie Antoinette October 16, 1793?

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