How Inflation Robs Some & Enriches Others: Getting It Right

Today on Facebook I saw a picture of three grocery carts. The first was full of groceries, the next was less full, and the last one was almost empty. The three pictures were supposed to represent the buying power of the dollar and show how the Federal Reserve has robbed us of our buying power.

It is true that the value of the dollar has been degraded. But that kind of illustration is flawed. The fact that a dollar buys less than it used to doesn’t automatically mean that we can’t afford as much stuff. Back when the dollar was worth more people didn’t make as high an income measured in those dollars. One could reasonably wonder, if incomes increased in dollar amounts as the dollar lost value, if wage earners have lost any buying power at all.

It is true that certain people have been robbed by the declining value of the dollar, but we need to be careful to explain how it was done.

When the Federal Reserve puts new money into the economy, eventually the value of the dollar will adjust so that prices and wages go up to account for the greater quantity of money. But this process is not automatic. Some people get the money first. As they suddenly have more money to spend, other people who trade with those people find that there seems to be an increasing demand for their products and services. They adjust their prices upward to avoid running out of inventory and begin increasing orders in order to have more products to meet the growing demand.

This causes a chain reaction in the economy. As people increase their prices and think they are making a greater profit, they eventually notice that the prices of all other products and services are rising. Eventually, wages and prices will adjust. Perhaps a yearly income will have the same buying power as it did before—though some industries might get permanently changed in the process.

The most important thing to remember is that those people who get the new money first and spend it before other people in society adjust their prices are the winners in the inflation game. Likewise, those people who get the new money last are the losers. By the time their wages to up, they are simply catching up with the cost of living because prices everywhere have already risen.

So, central-bank-caused inflation tends to make the rich richer—the ones who are closest to the financial system—and the poor poorer. Warren Buffet makes millions every day thanks to quantitative easing while you struggle to afford groceries.