It changes by the day, but Iran’s currency - the rial - is falling. This is inflation. The value of money declines such that holders of it can exchange it for fewer and fewer goods and services.
Something similar, but exponentially worse, is happening in Venezuela. A recent article in the Wall Street Journal indicated inflation of 13,000% due to a plummeting Bolivar. If Iran’s economy is down, Venezuela’s is collapsing.
The suffering taking place in both countries rates prominent mention in consideration of the modern view of inflation promoted by the biggest employer of economists in the world: the Federal Reserve. According to the credentialed in its employ, economic growth causes inflation. Yes, more people working and prospering supposedly has a downside. According to the Fed, the downside is inflation.
Except that the Fed’s view of inflation is 100% backwards. Crucial here is that it’s backwards in countless ways. Inflation is always and everywhere a function of a declining currency. It’s not a growth phenomenon as the Fed suggests. Fed economists would be wise to visit Iran and Venezuela to understand that inflation has nothing to do with prosperity.
That economists at the Fed believe growth causes inflation is yet another reminder of the central bank’s onrushing irrelevance. If an entity so full of the confused were actually powerful, this sad truth would reveal itself through persistent economic contraction. That the U.S. economy is the world’s most dynamic is loud evidence that the mindless interventions foisted on the economy from the central bank don’t mean too much.
The Fed’s incorrect inflation definition is rooted in a triple falsehood born of the easily disprovable view inside the bank that consumption drives economic growth. What a laugh. Implicit there is that Venezuela and Iran are booming. That’s the case because the citizens in each country have endless consumptive desires. They’re human after all, and as humans our desire to consume is limitless.
Missed by the Fed’s deep thinkers is that consumption springs from production. Always. It’s an effect of growth, at best. Iranians and Venezuelans can’t consume very much precisely because they’re not producing very much.
Fed economists think abundant consumption causes inflation, but then we can once again only consume insofar as we produce first. As such, demand always matches supply. There’s no inflationary impact to speak of.
After that, it should be noted that implicit in the Fed’s confused models is that the U.S. is an economic island with limited labor and production capacity. Except that it isn’t. While the Fed models “output gaps” in terms of labor and capacity that are supposedly limited by the number of workers and factories stateside, real people in the real U.S. economy properly operate as though those models don’t exist. Lest we forget, the best U.S. companies access the world’s labor and factory capacity to create their goods and services. There are so many examples, but Nike manufactures more shoes in China than anywhere else. It doesn’t manufacture any of its shoes in the U.S.
Back to a reality that plainly doesn’t intrude on the economists at the Federal Reserve, investment is what powers economic growth. The latter is a statement of the obvious. While the desire to consume is a given, our ability to consume is limited by our ability to produce. Production is what enables consumption, and the latter is an effect of investment.
Investment is what enables the individuals who comprise the economy to produce more and more with less and less. Applied to labor and capacity shortages, it's the growth itself wrought by investment that shrinks the need for labor (think automation) to produce for our myriad wants and needs. Economic growth doesn't cause labor and capacity shortages as Fed economists believe; rather it mitigates them.
Important here is that investment in production enhancements and inputs is what brings the price of everything down. Lest we forget, the prosaic ball-point pen used to cost $15. Nowadays a box of 60 goes for $7. The latter describes the price evolution of nearly every consumer good. Thanks to feverish investment, the cost of everything is frequently in decline.
The above speaks to the genius of economic growth. It’s an effect of investment simply because the investment is what enhances the productivity of the individuals who comprise what we call an “economy.” The more investment there is, the more knowledge and progress there is. And the more that prices decline thanks to greater understanding of how to produce more and more at lower and lower prices.
It’s sad that something so obvious must be repeated so regularly, but the surest sign of booming economic growth is falling prices. Conversely, rising prices are the surest sign of a lack of economic growth given the high odds of – you guessed it – inflation. When a currency is in decline, investment naturally plummets. It does for obvious reasons. Investors are less likely to invest if returns are going to come back in a cheaper currency. So with investment dormant, or actually contracting, the capital necessary for production enhancements disappears.
The truth can’t be repeated enough. Inflation has always and everywhere correlated with slow economic growth precisely because inflation is an effect of a falling currency that logically correlates with reduced investment. The situations in Iran and Venezuela loudly support this basic truth. Sad is that economists at the Fed are still hung up on a modern definition of inflation that could have only been divined by economists, and that has nothing to do with reality.