How Inflations and Gold Works

Inflation is a particular phenomena that involves the monetary process of the federal reserve. The federal reserve will increase the money supply and in turn more money will chasing few products. It, typically, manifests itself as higher consumer prices.

Many of the publication describing inflation are not useful or are just to abstract to follow. So I describe inflation, hopefully, in a friendly, less abstract and confusing way.

If I am to describe inflation it is best to start with a simple financial transaction; a transaction between a farmer and a baker.

Farmer selling roasted chickens is in need of fresh bread and a Baker selling fresh bread is in need of a roasted chicken decide to sell each other their best products.

After the transaction of a roasted chicken for a loaf of fresh bread, they both decide to get together next week for another transaction.

Again they meet the following week to buy their products, however, as they exchange their products the farmer is not satisfied, the fresh loafs of bread is now half molded. The farmer is in need of bread and notices that the other half of the loafs of bread are perfectly fine and eatable. The farmer decides he can take two half molded loafs of bread on the assumption that he can still exchange the roasted chicken for a whole loaf of bread.

On the fourth week, the two merchants meet for another transaction, and again the loafs of bread are further moldy. Moreover, the loafs of bread is now three quarters moldy. The farmer again renegotiates the terms and requires 4 of these loafs of bread to satisfy his need for a complete loaf of bread.

If you notice a common theme here is that the required loafs of bread increase over time. This is the essence of a product debasing or a product losing its purchasing power. The baker has to continue to increase the amount of loafs for the farmer to continue to get his value for the roasted chicken. When money supply increases and allowed to float in the economy, the value of the dollar debases; the same way the loafs of bread have debased. Just the same way as the more loafs of bread are required to buy the chicken, when the dollar debases, more dollars are need to buy the consumer item.

You might say that the dollar bill does not get moldy, but it does debase. The more the money supply is increased the more the dollar debases. It’s the same principle that governs most items in a financial transaction, the scarcer the item the more value it has — think rare collectable items, gold and other precious metals.

There is a misnomer when describing what the price of an item and the value of that item is. When I describing the value of the chicken compared to the bread loaf, the value of the chicken remained but the value of the bread depreciates and the price of the chicken increased in comparison to loafs of bread. -- Price and value is not the same thing.

 

However, when we bring gold in this scheme, its value remain constant. Gold has always been  a good barometer in measuring inflation. Gold is a precious metal that cannot be created or printed; it can only be recovered through expensive mining. Displacing millions of tons of earth produces a relative small amount of gold, enough to repay operating cost and profit. The increasing in gold supply every year is on par with the increase in world population.