Price rise due to money-supply increases

In earlier days, when money was backed by a commodity, such as gold or silver, inflation took place in the form of currency debasement.

Debasement is the mixing of substandard metals with precious metals. Initially, the currency coins would masquerade as par value. But, it wouldn’t go on for long. Instead, citizens held on to pure gold and silver, and conducted transactions using the debased currency.

In modern days, governments have exclusive control of money supply, and it resorts to printing in order to meet expenditures. As more and more currency entered circulation, prices of goods went up.

This prompted governments to resort to price controls to reign in uncontrolled price rises. Such interventionism didn't end with a simple decree of fixing a cap on prices.

Intervention begets more intervention.

Here is a short story to illustrate this.

In 1701, the most deserving citizens of the Nianysnia, complained to its king that the price of their favourite staple bread had gone up considerably. This caused tremendous hardship to the men who had to work twice as hard. The women had to save more and feed the children less.

In the above setting, the just king decreed that the maximum price of bread shall be only one Gezuning. The king felt enthralled by his thoughtful action; now that the people could go to old times.

But what happened later on? Did the people of Nianysnia see any change?

People's love for bread knew no bounds now that the price has been brought down to one Gezuning. Those who previously avoided bread either because they had no taste for it or due to its price, now wanted to save money by shifting to the cheaper alternative. All the while, people praised their dear king for making this possible.

On the other hand,  marginal producers - those whose production costs were high - found the times changed.  Marginal producers were those who produced in small quantities and typically fulfilled the 'last ten percent' of the market demand. Whatever price was set by the markets earned them profits, albeit a sliver.  But, with the new price decreed, their days were numbered. One by one, they exited business.

Both - the increased demand and reduced supply - caused shortages of bread in the market.

Nianysnia, which was otherwise an abundant country, now had to contend with the unseemly sight of men queuing up in front of shops early in the morning. Once their time to leave for work arrived, their wives would swap places in the queue. Typically the wait would last for a couple of hours.

This caused many grievances. Not everyone got bread. Those who desperately needed it, and was even willing to pay a premium above market rate, had to go back disappointed. Their wives were upset, and the children would cry.

The king reflected on this. Before he had imposed price control, the prices were high, but at least enough bread was going around then. People's needs were met. Ironically, with price control he had intended to achieve equity, instead he had to contend with a market without enough supplies.

He was advised that the scarcity was because few families were hoarding up, causing uneven distribution among the populace. To address the matter, he recommended setting up a 'committee' for fair allocation.

As one would imagine, the committee struggled with the rules for fair allocation. They came up with a formulation that included criteria such as number of family members, number of children, number of children under 10 years and other esoteric criteria such as ratio between bread and potato each family typically consumed for dinner.

In order to alter rules in their favour, few families even formed associations to influence the committee members. Bribes were exchanged. The Bread Commissioner rose in importance to become part of the elite echelon of the society.

All this didn't alleviate the problems of the citizens. There was still scarcity. The scarcity was because total production had decreased. The advisor felt a little upset that his plans did not work. He stepped outside the palace and met few producers and listened to them. He found out that at one Gezuning there was no margin left for the producer. Even though the price had reduced, the raw materials required, that is wheat, had not reduced.

The producers lobbied the advisor for imposing a similar price cap on wheat growers, so that the former could earn some money.

The process was now familiar. Wheat prices were decreed. Bread producers were instantly relieved. But the advisor was waiting to see how things would evolve with the wheat growers, after the imposition of price ceiling.

As predicted, farmers were disappointed with the meagre earnings from fixed prices. They altered their plans and now produced less wheat and more potatoes; few did something entirely different - like grazing cows for a living.

The routine was becoming more predictable. The king set up a wheat committee. Again, the commissioner was a man with wide powers. A consultation paper by wheat industry was submitted to the commissioner. One of the suggestions for continued production of wheat was to lower the price of input fertilizers.

The commissioner constituted a cost-audit report to ascertain facts. Once the facts were established, he forwarded his suggestion to the king. The king thought that with another decree, all the problems would be wished away.

As you can now imagine, again, fertilizer producers began slowly exiting their businesses. Fertilizer producers produced fertilizers from raw material which were base-chemicals. The king's decree now must extend to producers of those base-chemicals.

By now, there was severe shortage of bread in the country. A sort of 'revolution' was building up.

Meanwhile, all those who exited the bread industry, were looking to cut their teeth in new lines of business, especially luxury products - items meant for the rich - where no king or queen would even bother.

Or so they thought.

The king found that entrepreneurs, labour and capital were moving to those industries which weren't 'public necessity'. He began imposing heavy tariffs, quantitative restrictions (quotas) and a cap on profits.

Industry suffered. Industrialists quietly began leaving Nianysnia. At least some of their incremental production shifted outside Nianysnia.

End of story.

What began as a price control of one item had spread its tentacles over large parts of the economy. In order to control retail sales price, every-stage higher-order production had to be brought under price control.

Where capital flight occurred, control of profits, wages and rent began. When all means of production were fully controlled by decree, there were no free markets left.

This was the dawn of socialism.

The lesson for citizens

Socialism rarely begins with an instantaneous takeover of all production means. It begins with minor interventions. These minor interventions, in order to be fully effective, needs to extend itself to more space and time in the economy.

The cause for alarm should be raised anytime when a government suggests 'a small intervention' as a panacea for something that appears as an injustice. That a 'wild-west' would prevail if not for government interference, is an accusation and a suggestion, that should be relegated to the times of the wild-west era itself.

The modern era is one of freedom, of a limited, constitutionally elected government that has defined roles. There are no kings who derive wisdom and power from God, nor are there 'little bureaucrats' who should consider themselves wiser than the citizens.

Public policy is effective when its citizens can discern between those that promote freedom and those that promote serfdom.  Only the citizens can prevent the gradual encroachment of intervention which ultimately culminate in full fledged socialism.

(In case you were wondering what happened to Nianysnia, it soon came under severe socialism. Yet, it was last seen unshackling itself from State-ownership, bureaucracy and making small steps towards free-market capitalism. However, it lost several decades to socialism during which the process of capital formation slowed down. Several countries, which where similarly placed as Nianysnia was when it had embarked on price control, were now several decades ahead in terms of prosperity. It's now time for Nianysnia to play catch-up.)