I understand the bad effects of inflation. But, let's ignore them for now.
My question is. why is it that inflation cannot continue for ever ? In other words, the governments all over the world, keep printing money for ever. I have read that "this is not sustainable" and at some point, it will lead to disaster. What's the reasoning behind that ?
I have also read that the dollar has lost 96% of it's value over the last 100 years and is now worth 4 cents. Why can't it continue for another for another 100 years by which time, the dollar will be worth 0.04 cents ? Why would something that worked for 100 years lead to a recession or depression ? Why can't the fed inflate the economy of all the problems that it faces ?
(again, not looking for the negative effects of inflation, just as to why people think this is not sustainable)
Continuous inflation - increasing the money supply - doesn't generate true wealth, only more money. Over time, the increased quantity of money leads to a decrease in the purchasing power of money and corresponding increases in prices and wages. Inflation is in effect a windfall for the people who get the new money earlier, and a theft from those who don't. Inflation increases time preferences - people want to spend their money on things now instead of saving the money. People are encouraged to borrow money because their debts will, over time, shrink in relevance. People become debtors and wastrels. Inflation artificially distorts the economy. IMHO none of these effects are disastrous, but they are harmful.
But excessive inflation can be disastrous. Injecting money into the economy through offers of cheap credit leads to malinvestments (people are willing to invest at lower ROI's than would naturally be acceptable), credit bubbles, and boom and bust cycles. Bailing out irresponsible financial institutions encourages the kind of financial fiascos we've seen with junk bonds and sub-prime loans. Inflating the national debt away undermines confidence in our bonds and currency and is an added tax that impoverishes the citizenry. If sufficiently severe, these situations can lead to a failed currency, a total economic collapse, famine, insurrection, etc. Take a look at what is happening in Zimbabwe, for example: http://www.nytimes.com/2006/05/02/world/africa/02zimbabwe.html?ex=1304222400&en=e4f95916b4e5d098&ei=5088&partner=rssnyt&emc=rss
There is no long term limit.
There is no right or wrong amount of money. The economy would operate the same if the money supply was half, or double. The effects come from the change in the amount, as mises said, the money does enter the economy at every place at once. It enters at certain points, like banks, creating a redistribution of wealth.
Our current situation is unsustainable because the inflation is stealing the savings of the nations that prop up the dollar. Inflation gives them incentive to sell their dollars.
This reminds me a bit of Silvio Gesells idea of "free money" instead of inflation, money would have to renewed and this renewal would require a payment. They tried something like that in Woergl and at some other places in the thirties: Here is what Gesell http://www.systemfehler.de/en/neo/ - It sounds a bit Keynesian.
Junk bonds, sub-prime crisis, dot-com bubble: none of these caused the economic system to collapse. In fact, the Fed is solving these problems with more inflation.
I am trying to understand HOW this will lead to a "total economic collapse" and HOW it manifests itself .
I understand the "failed currency" part. Hyperinflation can lead to people rejecting the currency outright. But, that can happen if the money supply is growing at more than 100% and there is no limit on government spending.
So, my feeling is this system will continue for ever. Sure, everyone else will gradually sell dollar and dollar will be continously depreciated and even might stop being the reserve currency of the world. But, in spite of that, the current system of inflation could still be in place 100 years from now. What's there to stop it ?
Think of it in the pure sense. All goods and services are paid for with other goods and services. Money just facilitates barter, so go back to a model of a barter society where inflation would technically be someone tricking others into believing he is paying for something when he really isn't. Say he issues IOUs, promises of work to be done or goods to be given in exchange for goods and services he has already received. He dates all the IOUs to come due a year from his first exchange, and people trust him for whatever reason. Then he skips town and everyone but him is poorer for it. If he tried to do it continuously eventually people would realize he either couldn't or wasn't going to make good on most if not all of his promises. They'd realize his IOUs are worthless and stop accepting them. Say someone with an IOU for a supply of grain and a cow thought they were going to have some nice bread and steak coming their way soon, so they spent their time and energy on growing hemp for fabric for some new clothing. Now they're short food and have to sell the hemp, which may or not be made into shirts but certainly wasn't the best way to spend their time and resources. And then of course they may not be able to sell the hemp, in which case the wealth that was being created is just lost. Poof, gone.
So you see the person who issued the IOUs, and anyone he decides to include in his scheme, gets nice and rich while everyone else gets poor and mislead as to what they should be doing with their time and resouces. For those who banked on the IOUs satisfying their demands for this or that and who then allocated resources elsewhere, they now need to sell what they've got right then at market if possible or just give up and lose all that productive effort. If the IOU issuer is the King or the government in some other form and declares themselves immune from any attempt to reclaim what is essentially stolen property, the general public is jolly well screwed.
That's why it's unsustainable. Because you can't keep that kind of thing going on forever. The IOU issuer can certainly do a lot to keep conning people for as long as possible. But eventually people catch on and stop taking the IOUs, in which case the con artist has to actually do something productive (derregulation and spending cuts), steal real goods from others elsewhere to satisfy those who realized they were being conned to shore up their confidence for a while and keep them accepting the IOUs (various forms of imperialism, monetary and direct invasion and occupation), or just bash the actual victims on their heads and tell them to deal with it because might makes right, in which case they'll get by as best they can while still dealing with the con (tyranny at home). Which they'll likely do through the development of black markets. Ever wonder why black markets develop so often in totalitarian states? It's just the market working to correct the corruption of the monetary and trade system in such countries, people finally saying, "to hell with the worthless promises and IOUs, give me something real and I'll reciprocate."
AustralianEconomist: So, my feeling is this system will continue for ever. Sure, everyone else will gradually sell dollar and dollar will be continously depreciated and even might stop being the reserve currency of the world. But, in spite of that, the current system of inflation could still be in place 100 years from now. What's there to stop it ?
It could. But if the dollar loses acceptance globally it will be under extreme pressures with in the States. Large corporations will use as little as possible.
A sell off would likely not be gradual. It would be a dollar panic, as everyone seeks to sell off their dollars before their values hit bottom.
A constant inflation the money supply, say at 5% a year, is perfectly sustainable. However a permanent economic boom through inflation cannot be sustained, because it requires accelerating the rate of inflation. This rate will eventually go up to infinity and the money will lose all value.
Ultimately a central bank that wishes to save its currency must stop the acceleration of inflation and restore to loan market to equilibrium, which is inevitably followed by an economic crash and liquidation of bad debts.
The fallacies of intellectual communism, a compilation - On the nature of power
Thank you very much for your replies. Appreciate your time and effort.
Unceasing inflation creates difficulty for entrepreneurs to accomplish economic calculation. Input prices and output prices share a distinct relationship. When these are constantly changing at different rates, it leads to economic errors.
The eventual result of unceasing inflation is economic destruction.