Sunday, February 20, 2011

Inflationism and Social Unrest

A correlation may not necessarily imply a causal link. If a correlation between two variables exists, this does not necessarily suggest that one is caused by the other. However, scientific investigations of consecutive events are often conducted (and tend to be warranted) when one particular event occurs after another particular event on a routine basis. It is upon this notion of suspicious regularity that political authorities ought to scrutinize the conspicuous correlation between inflationism and social unrest.

Fortunately, there's already a theory behind the two. Inflationism, the practice of deliberately expanding the money supply, does just that; it causes the money supply to increase. If the supply of money increases, then the marginal utility of people's cash balances will decline. If the marginal utility of cash balances falls, then the subjective appraisal, by both buyers and sellers, of money and, therefore, the price of money, i.e, the purchasing power of money, will fall as well.

If the purchasing power of money falls, or to put it alternatively, if the array of prices rises on a macroeconomic level (known as price inflation), then social unrest will very likely ensue, particularly since among the prices that rise as a result of inflationism are those prices for goods the demand for which is quite inelastic. The demand for a good is inelastic if a change in the price of the good in question produces only negligible changes in the quantity of the good demanded. Naturally, goods that experience an inelastic demand are labeled as goods of necessity, i.e., goods that consumers consider rather compulsory for their well-being (this is reflected by the fact that people will continue to buy similar quantities of these goods even when the prices of these goods rise).

Perhaps the most sought after good of necessity is food, for obvious reasons. Inflationism causes the array of food prices to rise as well as the prices of all other goods. However, food is a good of necessity, hence the demand for it is highly inelastic. Thus, when food prices rise, the quantity of food demanded remains relatively stable; people don't just curtail or halt their purchases of food when food prices rise since food is a vital good. In the face of rising food prices, people maintain a relatively similar spending pattern, but the price increases inevitably lead to social agitation.

Assume that prior to a bout of inflationism, the price of corn is 25 monetary units per sack (25mu/sack). Moreover, assume that Mohammed the farmer requires 5 sacks of corn per day to feed his family and his animals. This means that his daily expenditure on corn is 25mu(5 sacks) = 125mu. Now assume that Mohammed's government adopts an inflationist monetary policy, where the price of corn rises to 40mu/sack. Since corn is a staple of most societies, it is considered a good of necessity and, ergo, the demand for it is inelastic. As a result, Mohammed will now have to pay 40mu/sack, but since his demand for corn is inelastic, he will either maintain his prior spending pattern or modify just slightly. So now his daily expenditure on corn will be something like 40mu(5 sacks) = 200mu. Mohammed's costs have risen by 75mu, so he loses 75 mu that he could have allocated towards the purchasing of other goods. Furthermore, since inflationism doesn't cause uniform macroeconomic price increases, its very likely that Mohammed's costs will rise while his revenue from whatever he does will remain stagnant.

The probability that this state of affairs will aggravate Mohammed, along with his farmer and merchant buddies who have been similarly screwed by inflationism, is very high. Once the inflationism is severe enough, Mohammed and his neighborhood may very well partake in an uprising against the government. If its Mohammed's government that's responsible for the inflationism, then the popular revolt may successfully lead to the removal of the current government, the confinement of its central bankers to a single cellblock, and the establishment of a new, anti-inflationist government. However, the rebellion will most likely be futile if the inflationism is propagated by a foreign government.

Tragically, this is the case today. The prices of not just food but of assets in general from commodities to financial securities have been rising for almost 6 months at a steady pace. In particular, those foods that people desperately require, corn and wheat, have risen significantly, contributing to social upheavals in Egypt and India, among other places. The statistics, while a dream come true for commodity producers and speculators, have been particularly bleak for commodity consumers.

All of this information and the methodology behind the indices are provided by the Food and Agriculture Organization of the United Nations.

Unsurprisingly, much of the culpability for global price inflation unmistakably lies with central banks such as the Federal Reserve who, in an attempt to assist their respective economies in coping with the 2008-2009 economic contraction, have introduced trillions in currency ex nihilo into the global economy by purchasing government debt instruments. Because of such central "banking", accompanied by bad weather and ethanol subsidies, the concept of food security, in an age of mass production, has arisen. In addition, resulting social uproars have threatened food supplies which have caused further price increases. If policymakers want to maintain food security they had better reconsider the arguments behind inflationism.


  1. Michael, the issues that you address are ones that need attention, for our own personal safety, if for no other reason. Your excellent post raises several questions for me. I apologize for lumping them all together in one comment.

    I agree that a decline in economic wellbeing can bring about social unrest. However, I am uncomfortable in comparing Mohammad’s economy with our own. No other economy compares with the complexity and interdependence of the U.S. It is possible that certain kinds of economic shocks could disrupt oil and transportation or the digital communication that we rely upon. A marginal decline in food shipments could cause more damage and social unrest than an increase in prices for Americans.

    My next area of concern is the comparison between prices in 2008 and today. Those very concerned about inflation today have not given any explanation regarding the commodity prices in 2008 through today. In 2008, there was some pointing at the higher prices, but nothing like the clamor today. While it is true that many countries have expanded their money supplies, there are other factors that need to be included in the analysis. For example, what happens to international commodity prices when a larger proportion of the world’s population is becoming prosperous? We have at least a couple very large countries finally enjoying real economic growth. Would not their new, increased demand for commodities tend to cause prices to rise? Would that trend tend to happen when many of those commodities have various restrictions on production? In other words, inflation will cause prices to rise, especially at the point at which the inflation is introduced into an economy. But not all increases in prices are the result of inflation.

    Finally, while I am on record as being worried about the catastrophic effects of the manipulation of our money supply, I think that there is more reason to be immediately concerned about the amazingly rapid expansion of public debt in the U.S. The Treasury’s debt could lead to price inflation (and I agree that we are seeing asset inflation), but the stress on our capital markets and immediate decline in our standard of living has the potential for a significant depression.

  2. You've raised many valid questions. I don't argue that monetary inflation is the exclusive catalyst behind our global price inflation, but its certainly a contributing cause that, unlike bad weather or foreign rebellions, is within our purview, hence we can put an end to it. I'm not particularly frightened of hyperinflation, but I'm concerned with the fact that monetary inflation via government credit expansion will cause further contractions in the future.