What even is inflation?

“Inflation is an increase in the quantity of money and credit. Its chief consequence is rising prices. Therefore, inflation—if we misuse the term to mean the rising prices themselves—is caused solely by printing more money. For this the government’s monetary policies are entirely responsible.”

— Henry Hazlitt, Economics in One Lesson

“Inflation is not a natural disaster or a disease that strikes a nation; it is a policy of the government, and the only way to stop it is for the government to stop inflating.”

— Murray Rothbard, What Has Government Done to Our Money?

If someone were to ask me to point out the single most destructive action a government can do short of slavery and war towards it’s own population, I would have to say Inflation.

Inflation is the main reason why you work so much and it feels like you’re not making any progress. It is an insidious form of taxation that can be levied at the discretion of the Central Bank, and it disproportionately affects the lower class.

When I studied economics, I first learned about supply and demand, and how prices adjust to equilibrate these 2 forces. Prices going up and down is a natural consequence of the market. Nothing to see here. But what in the f… is happening when all prices go up at the same time?

Productivity and Prices

Do prices tend to go up or down?

If you were born within the last 50 years, you’d be excused for thinking prices sometimes go down, but in general, they definitely do go up all the time. But sir, let me tell you what: prices tend to go down.

That is because, every year, new advances in technology help us improve our collective productivity. The more productive we are, the more we can produce with the same amount of labor. This is true for most markets. Sure, there will always be unexpected events that cause either an increase in demand or a shortage of supply in the market. But that is not what we are talking about here.

Case Studies: Increase in Demand or Diminished Supply

Before saying how things can go wrong, we must first say how they can ever go right.

In a market economy, things are often connected in very subtle and indirect ways. What does the price of cow feed have to do with the price of pizza? Well, cows are a higher-order product in the making of pizza.

The relationships between prices are often way more obscure than this. But the important point to remember here is that fluctuations in supply and demand are always happening, and these problems contain within themselves the seeds of their solutions.

Let’s see how prices behave in 2 different scenarios.

Case Study: Increase in demand for memory (RAM sticks)

With the advent of LLMs in recent years, one of a computer’s most common components has skyrocketed in price: memory sticks.

RAM is a way computers make operations faster. Data Centers are making a lot of calculations, and having more fast memory available can make them significantly faster. Which means you can do more calculations in less time.

But these memory sticks are also a component of every computer. So, because the demand for them has increased, due primarily to the surge in Data Centers that are being built, you should see them go up in price.

And you should also expect to see every computer, including personal notebooks, going up in prices. Nevertheless, these effects will affect every other price in different magnitudes (e.g., the price of onions should not change because of the change in RAM prices).

Case Study: Shortage in the supply of Oil

Some price fluctuations have much wider-ranging effects on the economy. Often, when there is a War in the Middle East, you’ll see the price of oil go up due to the disruption in the supply chain.

Those types of supply shocks can have a much wider effect because a commodity like oil is (in a very indirect way) a higher-order product of a lot of other items.

Even so, prices will change in different magnitudes. The price of gas is expected to be impacted much more than the price of silicon chips.

The interesting thing about all this is how these circumstances are temporary.

Within a capitalist system, every time there is an increase in price, that signals to entrepreneurs that there is an opportunity to make more money if they invest in solving those issues.

The Fracking Example

People have been experimenting with new ways of drilling oil for years. The first commercial Frack was tried as early as 1949, but it was an economic failure due to the cost of making such a contraption work.

Fracking is significantly more expensive than “conventional” drilling. Throughout the early 2000s, oil prices began a steady climb. When oil sat around 20-30 a barrel in the 90s, fracking was a laboratory experiment that lost money. When prices soared toward 100-140 a barrel in 2008, the math suddenly worked. Companies could spend 5-10 million on a single well and still turn a profit.

The breakeven price for fracking in 2008 was between 70-90 per barrel. At anything less than that, the operators would lose money. Today, technology has improved so much that fracking operations can break even when oil is at 40-50 a barrel - something that would have been impossible during the initial boom.

In short, higher prices invite competition, competition invites technological advances, which improves productivity, and productivity brings prices down.

Tip: Valuing Cyclical Commodities Stocks

Many commodities, like oil, minerals, and others, are considered “cyclical businesses”. That means that they go through phases of expansion and contraction that are related to the rise and fall of their respective commodity prices.

If the price of Oil rises, an oil company like Occidental Petroleum would have higher profits, which would invite competition. Many competitors do not possess the expertise that Oxy has in drilling for oil; therefore, they have lower margins.

When analyzing stocks in cyclical commodities, it is worth spending some time finding out their “breakeven” point. A company with a lower breakeven point is almost certainly a “better” company than an alternative with a much higher breakeven point. They can survive a bigger crunch in contraction periods and have better profit margins during expansions.

All else being equal, the lower the breakeven point, the better the opportunity.

Advances in technology are not a given; things can go badly wrong in a society leading to regressions in technology, but that is usually the exception. It usually takes major events, like wars (or the burning of Alexandria’s library).

The point can be derived more rigorously from first principles - that’s what we have economic books for - but the principle stands. People react to incentives, and the incentives are for opportunities to be explored over time, increasing productivity and leading to price decreases across the economy.

If that is the case, what is happening that we see prices going up all the time?

Inflating the Monetary Base

We’ve established how things can ever “go right” in an economy, and how prices are signals that tell entrepreneurs where to deploy their resources to explore inefficiencies.

Now, we shall explore how inflation is a very different phenomenon, and what impacts it brings to the market.

To understand what inflation really does, imagine a simple economy where gold coins represent all the money in circulation. The coins don’t have intrinsic value — they’re just a way to express how much you value each product relative to the others:

What Inflation is Not (or: How They Lie to You)

According to the economic organization