Inflation, is the simple answer. But what causes this? Why couldn’t society just keep on keeping on with prices? Examples, a $0.25 for a candy bar, $0.75 for a fast food burger, $30k for a home etc. It worked then, so why not now, why not just agree to lower the prices of everything?
In: Economics
A while ago economists decided that it’s good for currencies to devalue over the long term –
1. It encourages people to invest money in the economy to generate interest rather than just keeping a pile of money under their bed. This helps the overall economy grow.
2. Wages should grow as the currency value falls. This helps to redistribute money to working people compared to those who hoard wealth.
Now, you’ll probably notice that #2 hasn’t really been happening. Which is why inflation is considered by most to be a bad thing.
Also 1960 there were 179 million Americans vs 330 Million in 2020.
Economics of scale just mean there is more $$ out there in circulation because the increase of participants.
Well first, there were far fewer people in 1964 compared to today and far less stuff available to buy. But you could almost say that this is irrelevant for most stuff.
The GDP per capita in the USA in 1964 was approx $3,500 and the price of bread was $0.20. You could say that the productive capacity of the USA measured in bread in 1964 is 17,500 loaves of bread per person.
The GDP per capita in the USA in 2024 is approx $80,000 and the price of bread is around $2. Using the same approach the productive capacity in the US is 40,000 loaves of bread per person.
I don’t know about you but 40,000 seems a lot larger than 17,500. The problem, of course, is that we have more people, who can build more stuff and as productive capacity (and therefore income) increases, we can also afford a larger variety of stuff. Some stuff we become a lot more efficient at producing more of and the price relative to income falls. Some stuff is more limited (for example land) and therefore prices tend to stay fairly flat relative to income.
Home prices for rose from an average of $20,000 to $400,000 from 1964 to 2024 and average rents increased from under $100 to over $2,000. These tend to track income levels over time.
But the data on food, for example, shows some interesting trends. A broad measure of food prices from around 1960s to 2020s indicates that food price index rises by nearly 10x whereas production has risen by nearly 20x. In that same period caloric intake has increased by nearly 25%.
In fact, by nearly every measure, one would prefer to be in 2024 rather than 1964. This doesn’t even count for variety of goods available and consumed. (no PC, internet, mobile phones, video games, etc in 1964) Inflation from the mid 1990s to 2023 (excepting 2022) have been BELOW the average in the last century for the US. The problem appears to be that it has been so low for so long that most anyone under 40 years old today would have NEVER experienced inflation close to the century average. This makes it hard to process when 2022 hits.
Let’s say you are holding an item, we’ll call it X.
You are trying to sell it for whatever maximum price you can get.
There are four people standing around and each is holding $1 in their hand.
What is the marshmallow worth?
Well, it’s worth a dollar, because no matter who you sell it to, they only have a dollar.
Now let’s say one of those individuals has a money tree, and can pluck more dollars off the tree, and can offer you more $. They can effectively outbid everyone for your marshmallow, and the price at which you sell it will be determined by some equilibrium value between you and that person.
But now let’s say two out of the four people have a money tree, and both can pluck dollars off the tree. What is the price of your marshmallow now?
It now becomes a bidding war between the two, and whoever bids most will win.
Inflation occurs because you have too many bidders for an item, and can drive the price up as they are bidding against each other.
Inflation would normally be kept in check by some balance between supply and demand.
For example, when you had the only marshmallow and there were two people with money trees, the price of the marshmallow would be whoever bid highest between the two, and from there, whether or not you accept the price. You can always ask for more.
But wait…just as one bidder offers so much over the other person, and you are about to accept or counteroffer that highest bid….SOMEONE ELSE WALKS IN WITH ANOTHER MARSHMALLOW! Guess what happens then.
So what has happened over time is that the amount of X that we buy/consume, has been outstripped by the amount of $$ that is being plucked from the money tree. More buyers than sellers. Bam! Inflation.
There are other factors that can apply, but this is the ELI5 version.
If you have the world’s only remaining Michael Jordan card, it would be very valuable and you would be rich. If they started reprinting 100 million identical cards, it would not be worth anything.
>why not just agree to lower the prices of everything
Related to the example, it’s like asking everyone to destroy their copy of their Michael Jordan card so that it would be very valuable for the last person who holds onto it. As you can imagine, it is very hard to convince the government to “unprint” the dollars that caused the inflation.
There are more dollars than there used to be. The central bank prints money to pay for government expenditures but every dollar they create out of thin air devalues all dollars. It takes more dollars to buy the same amount of goods and services. That is inflation. It literally means an increase in the money supply.
Another post is a good explanation of why it is optimal to have a small amount of inflation. This is an answer to a tangential question.
Nobody keeps money in dollars. Dollars are the price of things, they are not an investment.
Some prices go up, some go down. Aluminum used to be the highest priced metal.
When real estate and wages rise, the price of other things goes up too.
The dollar is a measure of relative value. It is not an investment. Who cares if a dollar bought more or less 60 years ago. How much of your net worth is in dollars? Whatever paper dollars is in your wallet. Even your bank deposit isn’t dollars, it is a loan to a bank. Dollars pay no interest.
People buy homes and get a mortgage and then are short (negative) dollars. When they buy a house with a mortgage, they have an asset (home) priced in dollars and owe dollars. They hope their home goes up, priced in dollars, relative to their loan which is fixed in dollars with an interest rate (unless it is a variable rate loan, of course).
Comparing the dollar (a price) to something priced in dollars like an asset like gold or real estate or wages doesn’t make any sense. One is a price and the other is priced. You can compare the price of wages vs. real estate vs. food but comparing the dollar? A dollar is a dollar. it’s like the kilogram for weight. You don’t compare kilograms to things that are weighed in kilograms.
It’s like saying:
“why was the kilogram so much more 60 years ago because now the average person weighs so much more in kilograms than they did back then”
In short, the money supply needs to expand for economic growth to occur. Inflation is no direct guarantee of growth, but deflation basically means the economy is already in inflation. A lot of people try to apply conventional wisdom about personal finance to national economies, but the principles don’t apply the same; for instance, people saving a ton of money is terrible for the economy. Similarly, public debt isn’t nearly as big a deal as private debt.
Why the fixation on numbers when the numbers aren’t real. There is a lot of pressure by everyone and every business to get more currency for whatever they do.
A dollar represents a tiny slice of the whole pie of stuff.
Over time, the size of the pie (amount of stuff) grew bigger. But so did the number of slices we cut it into (the total number of dollars).
We made enough slices that you need more slices to get the same stuff compared to the past.
Additionally, when the pie grows, it doesn’t just grow in candy bars, it also grows in MRI machines and tanks. So that certainly doesn’t help.
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