Money, part II

OK, and so I return from the heady excitement of a weekend’s rugby to the more confuzzling realities of base level economics- here comes the second (and hopefully final) part of my description of the precise way money works in the economic system. For those who haven’t read part one, do so (post before last), otherwise this will get confusing.

I must begin with a correction and apology for the end of the last post I did on this subject- towards the end, I began referring to the actual production of money & value in an economy as inflation, rather than what actually causes it- devaluing the effort inputted by the worker so as to create a profit margin for the company boss. This is very much NOT inflation- I was, once again, getting ahead of myself.

Just to clarify this, I thought I might begin on a slight tangent and define what inflation actually is. Inflation is the process of everything in an economy getting a little bit more expensive over time. Cat food, washing powder, the cost of your boss employing you (ie your salary)- over time, this all rises slowly, at a rate of a fer percent a year. This is why, if you read old books or hear people talking about days gone by, people seemed to be able to get things incredibly cheaply in the past. Case in point- when I was at primary school, my teacher used to tell us about this shop her son (several years older than us) used to go to to buy sweets. At this shop, there was a row of sweets worth a few pennies, ranging from 10 down to 1p in price. Nowadays if I go into my local newsagents, the cheapest sweet I could buy costs 12p, and most cost quite a bit more. Why? Inflation.

The reason I was getting inflation confused with the production of value (for want of a better term), is partly because it, superficially, appears to be the same basic idea. I mean, if everything’s worth more money, the value of everything must be going up, right? Wrong- remember that money is only an arbitrary construct to give us an idea of value. Everything might be getting slowly more expensive, yes- but everyone’s salary will also be increasing at, on average, the same rate. So, for example, while your groceries bill may be getting steadily more expensive as the years go by, it will still remain roughly the same proportion of what you earn (presuming you stay in roughly the same job), so will not actually be putting any greater strain on your bank account.

So why do we have inflation, then? Why do our economists and politicians always try to ensure a low,  steady rate of inflation is always ticking over? After all, hyperinflation like what occurred in Germany in the chaos after the First World War can devastate a country, and its economy ( I heard a story once of someone at the time whose coffee went up in price by a quarter in the time it took him to drink it). Simple answer- it promotes growth, and is inherently linked to the process of ‘creating value’.

To explain: imagine a company makes cars. Because there is a differential between how much the car’s value is increased by people working on it, and how much said people get paid, the head of the company makes money. This means he is able to go out and buy things from his friend’s company, who make motorbikes. This makes his friend some money, which he spends on something else, etc. etc. until eventually more people are able to buy the first guy’s cars. This increases the demand for his cars, and thus the price he can get away with charging for them (no.1 rule of economics- when demand exceeds supply, price goes up, and vice versa, because there will always be someone willing to pay a bit more to ensure he gets the car and the other guy doesn’t). This increases his turnover. At this point he thinks “hmm, I’ve got a bit more money now, so I’ll pay my workers more. That way, people will come to work for me, not the guy next door”. So he raises his wages. To combat this, the guy in the factory next door raises his wages so all his workers don’t leave him, and all the other factories do too. Thus everyone’s wages increase, all the prices increase and hey- inflation. Notice how this process has lead to more people buying things (in reality this  is not just the bosses who do this, but reality economics is heinously complicated), and thus growth. This is, therefore, the basic cycle of economic growth.

However, the same is not so true for hyperinflation- when inflation gets out of hand. Since inflation leads to everything being worth more money but having the same value, it, over time, leads to the gentle devaluation of currency. If this process happens too quickly, and money becomes rapidly worth less and less, everyone gets terrified of the economic situation and uncertainty (how would you feel if you had no idea how expensive the milk would be when you got to the supermarket, and had to carry a wheelbarrow full of notes to pay for it), so people stop buying things and the economy ceases to show any real growth. This is why the situation is so bad in countries like Zimbabwe at the moment, where a mixture of corruption in the political system and generalised chaos everywhere else has lead to idiotic economic policies that cause inflation to soar upwards just as the real economy plummets downhill. In summary, therefore, a low, steady rate of inflation is the best thing for all concerned.

Right, that’s inflation covered, now onto… ah, right, 950 words already. Damn, I really need to get less into this. Either that or economics has got to become a lot easier to explain. Either way, I’m probably going to need another post to actually make my point on this (yes, I did intend to make a point at the start of this but have got somewhat bogged down, it seems) if not more, so think I will sign off for tonight. Saturday’s post will contain the third instalment of what I hope ends up just being a trilogy of economics, and I may actually get round to going beyond an anatomical description. Although please- don’t hold me to that.

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