This year, Namibians felt the full force of
higher inflation again for the first time in quite a while. Inflation hovered
about 3% to 3.3% for most of 2015, before spiking up to an average of 6.5% for
the first half of the year. Inflation has become a relative constant in modern
times, with most economies and central bank targeting a modest but positive
inflation target. But inflation is also the scourge of the working class,
reflecting in higher and higher prices that leave most people complaining when
it suddenly increases, like it did in Namibia this year.
Inflation is now a fact of life, almost as
certain as death and taxes, and while the concept of inflation (prices go up)
seems simple, there is a lot hidden behind such a simple concept. Inflation, in
fact, exists because we developed the concept of currency. Before the invention
of currency, or money, the economy operated as a barter system.
Imagine Joe, the cattle farmer. He has bred
quite a herd of cattle, but a family cannot live of cattle alone. He has to
take his cattle to the market to get his mealie meal and mahangu from those
farmers. But exchanging one cattle each to Paulus the mahangu farmer and Tomas
the maize farmer would give him way more mahangu and maize meal he could store
or use, as cattle is worth much more. And what if Paulus and Thomas already
have enough cattle to slaughter for their families? They might not want another
cattle, leaving Joe up a creek without a paddle.
This, obviously, would not do. It makes
running any sort of business nearly untenable. So early societies developed a
method that would ease trade – a store of value for your goods. Beads, ivory
and metals were thus used to denote a certain amount of goods – an early form
of money. These goods were used because they were rare, and not easily created
from scratch. But these first currencies led to the first fraud as well. Fake
ivory and beads meant that metals gained the upper hand, and metal began to be
weighed, and stamped into coins.
With Archimedes’ discovery of the principle
that bears his name, coins could reliably be valued, even if they were shaved,
or otherwise debased or tampered with. Economies developed around a
tri-metallic system, with gold, silver and copper coins, in decreasing order of
value. And here the first vestiges of inflation cropped up. It was suddenly
quite profitable to mine gold, silver and copper, since you could then create
your own money, and buy goods with it. But since you could potentially mine
more gold than the other sectors of the economy produced goods, the value of
gold coins would decrease. If there were, for example, 10 000 gold coins
in circulation, and 10 000 cattle, each head of cattle would cost 1 gold
coin (in our hypothetical 2 good economy). But if someone now mined another
5 000 gold coins this year, but only 2 000 cattle were born, suddenly
you had 15 000 gold coins with only 12 000 cattle, and each head of
cattle would now cost 1.25 gold coins – 25% inflation in the price!
So metallic currency had a built-in
inflation driver – production of the metal. This became especially prevalent in
what was called the Price Revolution during the 15th to 17th
century in Europe. With the Spanish treasure fleet returning from the new
world, the supply of gold and silver increased dramatically, resulting in
prices increasing sixfold over 150 years. But it also had another downside –
weight and storage. Wholesalers could take in a large amount of coins, which
make for a tempting target. Transporting it makes for an even more tempting
target. A solution was required.
The invention of the printing press made a
solution possible. First invented in China by Pi Sheng in the 11th
century, it also allowed for the first paper currency. This revolutionised
trading, as the hard metals could now be stored in a secure place (say, a bank)
and the paper was notes that delineated the currency stored there to be
retrieved after trading, should a trader so wish. By the time Johannes
Gutenberg introduced the printing press in Europe, paper notes followed in its
wake.
But paper notes had a downside. Since these
notes could be produced cheaply and easily, there was nothing stopping those
with vaults of gold to issue more paper notes than they had available. And
similar to how additional gold would cause inflation, so too would additional
paper. After such an occurrence, people would rush to convert their paper to
gold, causing a bank run, and more often than not, a bank would collapse,
ruining those who did not redeem first.
As I’ve noted in an earlier Theory of
Interest, it was one of these that granted central banks the responsibility to
maintain a currency’s stability, after a run on the Bank of England in 1797. Thereafter,
central banks started to stop allowing paper money to be redeemed for gold in
their vaults. But most countries still backed the currencies with gold in their
central banks, if only because foreign exchange between currencies would be
settled in gold.
This resulted in some stability to currencies,
but ultimately, the era of international trade showed the cracks in this
system. With each currency backed by gold, debtor and creditor nations started
causing rather large gold debts to be incurred between them, sometimes
threatening a nations local gold reserves. When this occurred in the US in
1971, President Richard Nixon unilaterally suspended the US Dollar’s link to
gold, and most nations followed.
Now every nation trades based on paper
currency, backed by the credit of their nation. But governments still control
the rate of fiat money (as it is now called) production. And this still creates
inflationary pressure on currencies. Should a government spend (create money)
too much while the economy slows, inflation is sure to spike up. When this is
not brought under control, as was the case in Zimbabwe, hyperinflation can be
created.
This, of course, is not the whole story
behind inflation, but it is why inflation can exist in our modern economies.
Hopefully, though, it does give some insight into why Namibia’s government
budget was cut, in line with slower growth forecasts alongside higher
inflation. While government decisions may sometimes appear opaque, with a
little history and insight, much can become clear to almost every citizen.
No comments:
Post a Comment