Inflation is Theft! Why Inflation is Far Worse Than Taxation
The popular conception of a powerful State is one that can arbitrarily confiscate our wealth and ignore individual rights of private property. This wealth confiscation may occur through taxation of our wealth, backed up by the threat and execution of violent force by the agents of the State. In conceptualizing checks and balances on a powerful and overreaching state, one of the founding principles of America is to be a government of the people, for the people, and by the people where there is no “Taxation Without Representation.”
Even if taxation occurs only with elected representation with the full blessings and consent of those governed, there still remains the reality that those in power can formulate policy to spend those taxes frivolously through loose fiscal policy, such as a larger welfare state, expansive foreign policy, and military adventurism. This taxation and the spending of our wealth are explicit, easily identifiable, and causes great emotion. Thus, it is easy to change
Protectionism, Politics & Economic turmoil | Data Driven Investor
A hefty 400+ point reversal in the U.S. Equities yesterday has flashed a warning sign for things to come. The markets…
But why is there so little attention paid to inflation? Especially since this inflation may have far more devastating effects on our personal wealth than any taxation passed by the Legislature and signed into law by the Executive?
Why We Do Not Fear Inflation
The reason that inflation is mostly ignored is that it’s not intuitively felt, maybe counterintuitive, and doesn’t make for a great dramatic rallying cry as “Taxation is Theft!”
Inflation is Not Intuitively Felt
An immediate rise in taxes is felt viscerally since citizens can actually see the money go away and feel the negative emotions. In contrast, a higher rate of inflation or even the very existence of inflation is not intuitively felt. Although we can understand inflation intellectually with the aid of mathematical tools, we do not actually feel it and thus it is not a prominent high-priority concern. This is similar to why we do not intuitively grasp most probabilistic or statistical concepts such as expectation and variance and must have mathematical formulation to contextualize it.
Let’s consider an example where we own an asset that returns 4% annually.
- If inflation is also 4% with no income tax, then it is equivalent to a 100% tax in a time period where inflation is 0%.
- If inflation is instead 5% on that same asset yielding 4%, then it is equivalent to an income tax of 125% during a period where inflation is 0%
Obviously, an explicit 50% income tax rate is outrageous, and 125% even more so. But we would hardly notice it if it arose from an inflation rate that was running at 125% of the yield of the asset.
“The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital.”
— Warren Buffett
Inflation is Counterintuitive
What does it mean that the value of each dollar, or any other unit of wealth, only slightly decreases in value in the short term, but cumulatively decreases dramatically over the long term?
Human thought processes tend to be linear in scale and our senses are logarithmic in nature.
Indeed, if we consider increasing some quantity by a specified increment 30 times, it’s intuitive that there’s 30 times more. But if it’s 30 doublings instead, it is not intuitive and instead alarming that we find it becomes over a billion.
Human sensory experience works on large differences. The intensity of noise is measured by Decibels on a logarithmic scale, meaning that we need variations separated by factors on the order of “ten” to even notice much difference.
Inflation is hard to think about and even harder to “feel” since it involves much smaller quantities than even linear, let alone logarithmic spanning multiple orders of magnitude.
Inflation Is Not Dramatic
We tend to personify and visualize as evil those forces that may hurt our personal livelihoods. What could be more nefarious than someone taking away our wealth by armed force? Especially when that has drastic implications for our futures and our children’s future?
If taxation is like a menacing posse of the state brandishing firearms knocking at your front door at high noon demanding and confiscating your property, inflation is like a thief in the night that furtively takes a bit of everything that you own in such a way that you don’t even notice, nor even feel bad about even if you do notice.
Different types of Inflation
The standard way that inflation is measured is via taking a standardized weighted average of a basket of consumer goods and services such as food and transportation to calculate the Consumer Price Index (CPI). The changes in the CPI in some defined time period, usually a year, is then used as a proxy for the inflation of the time period. This makes intuitive sense since if you can buy one sandwich now with $5, but you need $10 to buy the same sandwich in a future time, then there was 100% inflation over that time period since you need twice as many units of wealth. Equivalently, we can say that the same $5 can only buy half a sandwich in the future.
In periods of high inflation, those with fixed income, much like salaried workers, will get hit harder since the same unit of wealth has less purchasing power.
Asset Price Inflation
Another way that is less standard is to measure inflation through “asset” prices, in contrast to how many dollars are required to purchase a weighted basket of goods. Since January of 2012, the aggregate price to earnings ratio of the SP500 index has gone from 15 to 23, a 53% increase. This is equivalent to the price of those assets appreciating by 53%. Whether that asset truly appreciated by the same 53% in “value” is questionable.
In contrast to standard inflation, asset price inflation is beneficial to the owners of those assets, but sets up systemic risks across the greater economy when those assets are too far overpriced and veer too far away from intrinsic value.
Inflation and Broader Society
For the poor and/or those with fixed income and no assets, inflation hurts them greatly since the fixed cash they have can buy less and they tend not to own assets and thus cannot benefit from the appreciation of those assets.
For the wealthy, things are less grim. They do get whacked by standard inflation on their cash and cash-like assets, but since most of their wealth is locked up in assets, they benefit more from the inflation of those assets.
Thus, the poor get hit harder by explicit taxation as well as implicit inflation. The wealthy in contrast do well even with higher taxes since their assets are subject to capital gains taxes. Although the wealthy do not get whacked as much by standard inflation, they do bear a burden of increasing more probable and severe losses through bubbles created from asset price inflation.
Thus, inflation should not be viewed as a socioeconomic class issue or partisan political ideological issue, since all parties are subject to the evils of inflation just the same.
Inflation and Political Ideology
The economic Right may pride itself on both fiscal and monetary restraint. Indeed, there’s morality in the temperate values and actions associated with frugality, saving, minimal or no debt, and investing for the future.
“A penny saved is a penny earned.”
— Benjamin Franklin
However, these temperate values may be irrelevant if inflation is high since:
- High inflation incentivizes neither frugality nor saving since the money you hold is decreasing in worth, so you might as well exchange money in the present for consumption instead.
- High inflation benefits debt holders of a fixed-rate interest debt and incentives increased debt and hurt lenders, since paying off a fixed-rate debt later will be with less valuable money.
- High inflation leads to increasingly higher interest rates and this does not incentivize borrowing money to finance greater investment since it is more expensive to finance that investment and the returns on the investment may not match the utility of simply consuming that capital right away.
“A man might as well consume his capital as invest it.”
— Milton Friedman
Thus the usual concern of the economic Left’s about inequality that’s usually countered by the economic Right’s argument that excess capital may be used to invest and benefit all may be irrelevant in a period of high inflation since investment is not incentivized. Furthermore, the Right’s view that the Left is frivolously spending immediately instead of investing for the future may be countered by the Left’s argument that it’s actually irrelevant anyways since they are equivalent.
Although it is true that inflation may lead to higher wages that may lead to increased spending, leading to aggregate growth and an expansion of the macroeconomy, the question may be how much of this is indeed real growth, for how long is it sustainable, and what are the implications when it even stops and reverses or even slows down?
No Inflation Without Representation
There’s much attention in properly ensuring representation for explicit and easier-to-understand taxation, but yet there is no representation for more hidden and difficult-to-understand inflation.
Not only is inflation determined by the unelected and appointed members of the monetary policy-making, there is no accountability for those at the Federal Reserve who determine monetary policy in setting the target rate of inflation, controlling the prevailing interests rates (via the Federal Funds rate), controlling the money supply, and perform open market operations to round out the final gaps to reach these goals.
What is the answer to this? I do not know the answer, but it would appear it starts with awareness of how specialized unelected government bureaucrats hold so much power over the people in their ability to modify monetary policy and affect inflation.
True Rallying Cry Uniting Left and Right
On this particular issue of inflation, citizens across the entire political spectrum ranging the economic Left and Right can agree on one thing.
“Inflation is Theft!”