The consequences of inflation, generally higher prices, are known to most everyone. Most people think that the higher prices are the inflation but as the first sentence indicates the higher prices are just a symptom. There has to be something to drive prices higher. That something is an increase in the supply of money. People who receive this new money first benefit but those who do not only see the rise in prices. That is why the source of our inequality problem is inflation and not, as those on the left believe, a tax code that is not sufficiently progressive. In this article by Bart Fuller at Mises.org, Fuller explains inflation using an auction at a child’s birthday party:

As always, at any auction, the bidding was lively and competitive, even with play money. Cousins were battling for the same candy bar or box of sparklers. In-laws were bidding against each other for gift cards and treats. Everyone was having a good time.

Once people started winning some of their bids though, there was a change. Invariably, someone would win an item or two and then have only a few play dollars left. So few, that the amount they had left was now worthless for any further use in the auction. Once this point was reached the person would decide they had better things to do. Before leaving however, they would offer their small amount of leftover money to someone else. This started a secondary auction — the new auction being one in which the remaining active bidders vied for the unwanted play money of the people leaving.

Engagement in this second auction occurred each time someone left the primary auction with the departing player giving the money to whomever they liked. The winners of this new money suddenly had more purchasing power than those who were not as fortunate, leaving the less fortunate in the lurch as they were consistently outbid for the remaining items by the new-money bidders. For the sake of argument, let’s say these winners received a “liquidity infusion.”

As time went on, this process only got worse. There was a greater and greater disparity between those who had money and those who did not. In fact, it was possible for those who had all of their original money and had been saving it for a certain item, to lose their bid to someone else who had spent the original money, but also received a “liquidity infusion.” Those with new money were able to bid up the prices of the remaining items and crowd out the people who had not received a new liquidity infusion.

In the real world, it is the Fed  providing the liquidity infusion and the banking system is the beneficiary. This bailout has been sold as a way to bail out Main Street but nothing could be further from the truth. This bailout will benefit the bankers and the wealthy because they will be the ones who receive the “liquidity injection”.

The recent actions of the Fed are an attempt to avoid deflation. Bernanke seems to accept Milton Friedman’s analysis that the major culprit in extending the Depression was the contraction of the money supply in the early 30s. While it is true that deflation was a major factor at the beginning of the Depression, it was the policies of FDR that really extended the Depression into a decade long event. Today’s Fed is avoiding the mistakes of the 1930s Fed; it is still to be seen whether the next administration, whoever it is, will avoid the mistakes of FDR.

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