KARACHI: Inflation refers to an increase in the general price level. There are several causes of inflation: a rise in demand-demand pull inflation and a rise in cost-cost push inflation etc. But the most dangerous of these is the inflation caused by printing money in the view of monetarist which is a distinguished school of thought among economists.
Pakistan, like other economies, is largely suffering from this evil. It has been reported that the government has added Rs 127billion in March-April this year which is too much and should raise some red flags.
Let me explain this problem in detail
Previously, the world used to follow the gold-backed currency mechanism. In this mechanism, a country could issue only the amount of currency notes for which it has gold reserves backing the same. Hence, the value of paper currency was in some multiple related to the price of gold. This mechanism kept the money printing activity in check
The US for the first time broke this convention when President Nixon abolished this convention in 1971. He apparently was giving ear to a long given advice by John Maynard Keynes, founder of the Keynesian School of thought, that “government can also spend the money it doesn’t have”. Bear in mind that Keynes was only concerned about the short run (he used to say that we are all dead in the long run so why care for it) and he ignored long-run inflation from such government spending.
This action by the US president for the first time gave authority to the government and to the followers to print and spend money without any bounds. Henceforth, the government didn’t need to earn money or amass gold reserves. It could simply print new currency with ease to finance anything it required.
This means that currency in circulation increased without increase in assets in the economy thus bringing in a decline in value of the currency.
For a lay man I believe it is difficult to understand how printing money can have an impact on prices. After all the prices of cars, houses and vegetables etc are set by the people who don’t have any idea about this complicated mechanism. They set the price they like and that’s about it. To illustrate the impact of printing money on prices, let’s go through an extreme example.
Suppose, in a hypothetical closed economy, we have currency notes of Rs1,000 and we have nothing else but a car. Since these currency notes can only be used to buy this car in the economy (nothing else is there to buy), the value of this car is Rs1,000. Simple isn’t it? If the government in the post-Nixon-decision scenario prints notes of Rs500, increasing the total circulation in the economy to Rs1,500, whereas no other asset has been added, what will be the worth of this car now? It will be worth Rs1,500. The price of car increased by Rs500 not because of demand or cost, but by the increase in the amount of currency in circulation. This is how printing new currency causes the most dangerous and irreversible inflation.
Due to this excessive money printing, the rupee is losing value and we are becoming poorer each passing day. Several statistics can be presented in this respect. For example, in the 1950s 10 gram of gold was worth PKR 50/60 whereas now the same quantity amounts to Rs50,000. Rupee has lost its value almost a thousand times. Similar is the case with real estate. Every asset has multiplied in rupee terms and one of the main reasons, if not the only reason, is the uncontrolled printing of money by the government. This is the gravest reality of inflation. On the other hand, wages have not kept pace hence living standards or purchasing power of the people has been compromised.
There has to be a check on this money printing exercise and if we have checks in place they must be real. If this is not done, everyone who lives here in Pakistan, whose wealth is not increasing with the increase in rate of money printing, would be a net loser in this dirty game. Our future generations will be much poorer than us.
The writer is a translator of several books and a voracious reader on political and economic issues
Published in The Express Tribune, July 17th, 2017.