Hello. I would like to ask for the help and explanation of this seemingly easy question about inflation. As Peter Schiff states it, inflation by it's internal meaning is the physical expanding of money supply in economy by whirling the printing press. According to this meaning, "when inflation is present in a recession, prices may go up (if the printing is fast enough), stay flat, or fall than they would have with no inflation".
How do prices stay the same or even fall with expansion of money supply? What is the logic and mathematics behind it? Sorry for my narrow-mindedness.
Hope for explanation!
Thank you!
Price increases are not linear and they depend on a huge number of variables.
In a traditional bust, prices of a given asset drop because of 1) decreased demand because of reduced economical activity (less loans, factories closing down etc) 2) the need to eliminate large excess stocks built in expectation of even higher future prices. Prices drop until they reach a level the free market is willing to liquidate them, then stabilize, and as soon as the situation starts getting back to normal, climb again.
An inflationary period following a bust, however, adds a number of variables which break the traditional deflating price structure. A sharp drop in interest rates may lead to a lending and borrowing frenzy which fuels further demand, in fact reinflating the bubble or at least halting the liquidation process. Also, ever since the futures market was expanded in the '70s to include financial products and not just physical agricultural and mining commodities (which had to be delivered when contracts came due), an inflationary period will (as proven by experience) fuel a purely speculative bubble which in turn will drive prices up and break the demand/supply pricing structure. In short prices are not affected by traditional mechanisms, but by a vast financial casino built on cheap credit.
A good example is provided by the Second Oil Crisis, which sent fuel prices skyrocketing in face of decreasing demand worldwide. While gasoline and diesel fuel consumption in the US, Japan and Europe tumbled because of sky high prices (China's economy was still a very minor factor), oil prices boomed. This crisis did not end because OPEC opened the spigots, but because Volcker increased rates by 8% overnight and without warning. With credit now very expensive, the financial gamblers were effectively sent into full retreat mode. It was a shape of things to come.
Right now, with speculators assured central banks will continue providing them with cheap credit, prices fluctuations are not the symptoms of demand and supply, but highly dependent on the same variables as pure gambling. Good proof is provided by what happened in the first quarter of 2012: despite an equal level of supply and a sharp drop in oil consumption worldwide, oil prices stayed extremely high. The casino was as busy as usual and hence it was business as usual. Right now oil prices are dropping not because of excess supply and/or decreased demand but because somebody hit the "sell oil futures" button generating a frenzy of selling. Oil will rebound as soon as somebody hits the "buy oil futures" button. Again, pure gambling.
I hope this didn't confuse you.
One simple way is this. (It's not the only nor the major one, it's just the simplest to understand)
With the exception of time, labor and land factors, costs tend to fall due to technology making things cheaper to produce and transport.
Market competition forces producers to sell at prices close to their marginal costs. So, lower prices are the expected effect of technological advances.
So if you inflate the money supply, that creates some pressure for higher prices, but that might not be enough to offset the already present tendency for lower prices. It's aggregate effect might be not enough to prevent prices from falling in the absolute level. They still fall, but less rapidly.
Thank you very much for this thorough explanation - it is very helpful! Sorry, I clicked on "verify" by chance and have no idea what it is for.
What he means is that there are other changes in the world besides inflation that also have an effect on prices.
So prices can't fall because of inflation. But they can fall in spite of inflation due to all those other changes influencing prices. It's just that they would have fallen even more had there been no inflation, or in case of rising prices risen less.
Note that mainstream economists use "inflation" to refer to rising prices and "monetary inflation" to increases in the money supply. Austrians call rising prices "price inflation" or just "rising prices" and an increase in the money supply simply "inflation".