Wealth

Part 17 - Inflation and deflation

 https://www.youtube.com/watch?v=-zkADfv0boQ 

Inflation is a general rise in prices so that a unit of currency buys fewer goods and services over a period of time. In other words, it is a reduction in the purchasing power of money. 

The opposite of inflation is deflation; a sustained decrease in the general price level of goods and services. Low or moderate inflation may be caused by fluctuations in the supply and demand for goods and services, such as changes in the price of some crops cause by severe weather.

Very high rates of inflation and hyperinflation are typically caused by an excessive growth of the money supply and can cause harmful dislocations in an economy. Wages become inadequate to buy food for example and money becomes less and less valuable.

A sustained period of inflation is caused by money supply growing at a rate faster than the rate of economic growth.

The negative effects of inflation;- discourage savings as people expect prices to increase in the future (so money is quickly used to buy and hoard food) and loaning money at a rate lower than the rate of inflation means the loan will not be fully paid back in real terms.

The positive effects of inflation include;- borrowed money will be paid back with less valuable currency, investments in real assets like houses and shares in companies tend to increase with the rate of inflation (or better), reduced unemployment as wages are effectively reduced. 

The negative effects of deflation include falling real wages but the positive effect is that prices tend to fall as business try to increase business activity. Workers may find that they are able to buy more with smaller wages. 

In the USA between 1873 and 1879, wages dropped substantially while real national product growth rose. So, despite the recession, workers experienced an increase in real wages (most things cost much less).

One of the earliest recorded problems with prolonged economic deflation was the decline of the Roman empire. This was partially caused by a reduction in the money supply (resulting from the massive export of gold and silver to pay for Chinese silks). Less money circulating caused an economic contraction. The effect was prolonged because it primarily affected trade while much of the economy, still operating on the barter system, was less affected.

During the first 3 centuries CE, both the size and the silver content of the Roman denarius decreased. Originally, the coin contained about 4.5 grams of almost pure silver. During the Julio-Claudian dynasty, this was reduced to about 4 grams of silver, and again reduced to 3.8 grams under Nero. By the late third century, the denarius was debased to the point that it contained only about 2% silver.

Today, money has little intrinsic value. There is no gold in coins and, in 1967, the Bank of Canada reduced the silver content of 25 cent coins from 80% to 50% when the value of the silver made the coins worth more than 25 cents. When the price of nickel and copper became too expensive for small coins, mints started using steel plated with nickel, brass or copper or simply withdrew the smaller coins, like the one cent Canadian coin, from circulation.

Central banks try to maintain a low and steady rate of inflation to maintain economic growth and full employment and to reduce the severity of economic recessions. They control the value of a currency by keeping the amount of currency in circulation growing at a rate slightly higher than the rate of inflation, primarily by adjusting the interest rate the central government is willing to pay on short term loans, by buying or issuing bonds and by adjusting the reserves required by commercial banks.

Francisco Pizarro, a Spanish conquistador, who led the Spanish conquest of Peru in 1532, found large quantities of gold, most of which was shipped to Spain, inadvertently triggering severe monetary inflation. Almost overnight, Spain became very rich and quickly paid off its debts and began financing a series of religious wars. The king of Spain, Phillip II, used the new found wealth to buy an armada of 130 ships and attempted to invade England in 1588. The gold also allowed the Spanish to buy an unprecedented quantity of goods from Europe and China. This probably caused the high world inflation of the 16th century. The rapid increase in the money supply (then silver and gold) chasing a fixed amount of goods was a classic cause of monetary inflation. Prices in Spain rose 300 percent between 1500 and 1600. Spanish exports became uncompetitive in Europe and instead, the wealthy Spanish imported goods from abroad. 

 The gold severely inhibited economic development and when the supply of gold was reduced, Spain went into a long period of economic decline.

By contrast, Britain, gained just enough gold from privateers, like the national hero Francis Drake, for Queen Elizabeth to pay off the UK national debt and finance a rapid expansion in naval technology. The influx of gold rapidly increased economic activity in Britain triggering an early start to the Industrial revolution.

https://www.youtube.com/watch?v=ah9i3R9pRpg