Why prices increase

By MT Webmaster Last updated Feb 12, 2014

Everything has a history. Even inflation has a history. So maybe you can read the very brief history of inflation in the extracts below and familiarise yourself with the subject before you engage in any further debates on the matter.

NO HOLDS BARRED

Raja Petra Kamarudin

We have been hearing a lot of talk about the increase in the prices of goods and services in Malaysia and, of course, all this has been blamed on Prime Minister Najib Tun Razak. What most people do not seem to understand is the reason why prices increase.

That is actually the same debate we are having in the UK and this may have an affect on how people will be voting in the next general election that is going to be held next year.

It is most interesting to know that China not only invented paper and began using paper long before the rest of the world even knew what paper was (well, as the Chinese always proudly tell us, China has a history of 5,000 years and were already civilised while Europe was still in the Dark Ages), but even more interesting is the fact that China also invented paper money and, with that, they invented inflation as well.

Is that not a very interesting piece of knowledge to have?

Opposite to inflation would be zero-inflation or deflation. Some people might think that this is better but imagine buying a house for RM1 million and ten years later (after paying interest on the loan you took to buy the house) your house is still worth only RM1 million or worse, just RM800,000. You would be happier if your RM1 million house is worth RM2.5 million ten years later.

Well, that is a very high inflation rate indeed but then you will be very happy when that happens. However, inflation can hurt you as well as help you profit on the property that you bought ten years ago. And this is what we are experiencing today in Malaysia.

So what do we do then? Maybe we can ask Anwar Ibrahim since he was once Malaysia’s Finance Minister. I doubt, however, that he has an answer to that question, as there are some things that are totally beyond our control.

In the meantime, it is more convenient to blame Najib even though if Anwar were the Prime Minister we would most likely be seeing the same thing happening unless Anwar is going to abolish paper money and we revert to gold coins for currency.

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The term ‘inflation’ originally referred to increases in the amount of money in circulation, and some economists still use the word in this way. However, most economists today use the term ‘inflation’ to refer to a rise in the price level. An increase in the money supply may be called monetary inflation, to distinguish it from rising prices, which may also for clarity be called ‘price inflation’. Economists generally agree that in the long run, inflation is caused by increases in the money supply.

Michael F. Bryan, On the Origin and Evolution of the Word “Inflation”

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Most frequently, the term ‘inflation’ refers to a rise in a broad price index representing the overall price level for goods and services in the economy. The Consumer Price Index (CPI), the Personal Consumption Expenditures Price Index (PCEPI) and the GDP deflator are some examples of broad price indices. However, ‘inflation’ may also be used to describe a rising price level within a narrower set of assets, goods or services within the economy, such as commodities (including food, fuel, metals), tangible assets (such as real estate), financial assets (such as stocks, bonds), services (such as entertainment and health care), or labour.

The Reuters-CRB Index (CCI), the Producer Price Index, and Employment Cost Index (ECI) are examples of narrow price indices used to measure price inflation in particular sectors of the economy. Core inflation is a measure of inflation for a subset of consumer prices that excludes food and energy prices, which rise and fall more than other prices in the short term. The Federal Reserve Board pays particular attention to the core inflation rate to get a better estimate of long-term future inflation trends overall.

Kiley, Michael J. (2008). “Estimating the common trend rate of inflation for consumer prices and consumer prices excluding food and energy prices” (PDF). Finance and Economic Discussion Series (Federal Reserve Board).

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The Song Dynasty of China were the first to introduce the practice of printing paper money in order to create fiat currency during the 11th century and, according to Daniel Headrick, “paper money allowed governments to spend far more than they received in taxes… in wartime, and the Song were often at war, such deficit spending caused runaway inflation.”

Daniel R. Headrick (1 April 2009). Technology: A World History. Oxford University Press. p. 85.

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The problem of paper money inflation continued after the Song Dynasty. Peter Bernholz writes that, “from then on, nearly every Chinese dynasty up to the Ming began by issuing some stable and convertible paper money and ended with pronounced inflation caused by circulating ever increasing amounts of paper notes to finance budget deficits.”

Peter Bernholz (2003). Monetary Regimes and Inflation: History, Economic and Political Relationships. Edward Elgar Publishing. pp. 53–55.

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During the Mongol Yuan Dynasty, the government spent a great deal of money fighting costly wars, and reacted by printing more, leading to inflation. The problem of inflation became so severe that the people stopped using paper money, which they saw as ‘worthless paper’. Fearing the inflation that plagued the Yuan dynasty, the Ming Dynasty initially rejected the use of paper money, using only copper coins. The dynasty did not issue paper currency until 1375.

Paul S. Ropp (9 July 2010). China in World History. Oxford University Press. p. 82.

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By the nineteenth century, economists categorised three separate factors that cause a rise or fall in the price of goods: a change in the value or production costs of the good, a change in the price of money which then was usually a fluctuation in the commodity price of the metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency.

Following the proliferation of private banknote currency printed during the American Civil War, the term ‘inflation’ started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable banknotes outstripped the quantity of metal available for their redemption. At that time, the term inflation referred to the devaluation of the currency, and not to a rise in the price of goods.

Michael F. Bryan, “On the Origin and Evolution of the Word ‘Inflation’

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This relationship between the over-supply of banknotes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate what effect a currency devaluation (later termed monetary inflation) has on the price of goods (later termed price inflation, and eventually just inflation).

Mark Blaug, “Economic Theory in Retrospect”, pg. 129: “…this was the cause of inflation, or, to use the language of the day, ‘the depreciation of banknotes.'”