Inflation in Modern Economics and Historical Price Revolutions

“The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.” ~ Ludwig von Mises

Who’s making policy today? Let’s agree that semantics do matter; let’s also imagine for a moment that the word “inflation” only describes an increase in the money supply. Then let’s bend an ear to the latest choice of words.

“Inflationary pressures have been a feature of the major industrial economies in recent times,” said Gordon Brown, the UK finance minister this week.

“Inflation has risen not just in this country but in most of the major countries,” said his political partner and rival, Tony Blair – the UK prime minister – earlier this year.

“Inflation rates have been pushed upwards across oil-importing countries,” noted José Manuel González-Páramo, an executive of the European Central Bank (ECB) at a seminar in Helsinki last month.

“How should central banks react?” asked the ECB man. And what about the rest of us?

The same pattern that David Hackett Fischer found in the Medieval Price Revolution of the 13th century – a pattern of higher price levels preceding a determined attempt to increase the money supply – was also identified in the Price Revolutions of the 16th and then 18th centuries. Steadily rising prices for basic foodstuffs are recorded long before new sources of gold and silver were first tapped.

The Price Revolution of the 16th century, says Hackett Fischer’s research, actually began as early as 1480 – “many years before American silver and gold arrived in Europe. In England and Germany, prices nearly doubled during the half century before American silver could have had a significant effect on their economies.”

Whatever the initial cause of rising prices – and Hackett Fischer cites population growth in all four of the Price Revolutions he identified between the 13th and 20th centuries – observing the age-old response of human nature to higher prices reveals the true problem of modern central banking. For both the policy wonks themselves and for anyone trying to invest profitably under their fiat money dominion, the natural response to rising prices is actually a search for fresh supplies of cash.

Older, more studied and apparently wiser today, mankind of course knows to meet higher prices with higher interest rates instead. Pace this week’s mini-China shock to the Shenzen and global stock markets, tighter reserve ratios are also expected in the commercial banking sector. That should decrease the multiplier effect, or so theory says, thus reducing the availability and growth of credit.

When rising prices become clear in the data, rising interest rates are sure to follow. The supply of money must be restricted, not increased.

But that’s not quite what happens.

In the compact and compressed little Price Revolution we’ve experienced so far in the 21st century, global interest rates slowly began turning higher in late 2003. The Bank of England moved first, followed a year later by the Fed…then the ECB in Frankfurt…and finally the Swiss National Bank and the zero-rate crazy Bank of Japan. Yet the global money supply has by no measure decreased.

The broad supply of Sterling has risen at a double-digit rate annually for the past two years; M3 in the United States is now estimated by John Williams’ ShadowStats to be growing at nearly 12% year on year; Eurozone money supply is growing at 10% per year, the fastest rate since 1990.

Let’s give the Fed, ECB and Bank of England their heads, and imagine that they actually want rising rates to counter rising prices by restricting money-supply growth. It simply hasn’t worked over the last 12 months and more.

Could it be – shhhhhh – that modern central banking is impotent in the face of a genuine and sustained rise in living costs? Are the wonks undone by the rest of us – and most especially the commercial banks – scrabbling in the dirt for fresh supplies of money to overcome the loss of purchasing power that higher prices produce? Or will it take a surprise and shocking increase in interest rates, a hike up to double-digits throughout the industrialized world, to cut money supply growth and so cut the rate of inflation in prices?

“In cultural terms,” writes Hackett Fischer of the 13th century gold and silver seekers, “their actions helped individuals and institutions to cope with high prices, but had the collective effect of driving prices higher.”

High prices demanded more money; more money led to increased prices. If you ever thought today’s rising cost of living would somehow slow down by itself, you failed to account for human nature.

Adrian Ash
for Markets and Money

Editor’s Note: City correspondent for Markets and Money in London, Adrian Ash is head of gold investment research at – giving you direct access to the current gold price, investment gold, vaulted in Zurich, and low-cost gold investing.

Adrian Ash

City correspondent for Markets and Money in London and formerly head of editorial at Fleet Street Publications Ltd, Adrian Ash has been studying and writing about the investment markets for the last 9 years. He is now head of research at BullionVault - giving you direct access to investment gold, vaulted in Zurich, on US$3 spreads and 0.8% dealing fees.

Adrian Ash

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I would like to know what $250 back in 1975 would be worth today in 2007 in Australia

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