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The Truth About Hyperinflation And Price Controls

May 10, 2008
In our modern, pampered world, many people don't want to take care of themselves and are always whining for the government to "do something" about whatever it is that is causing discomfort in their situation.

Unfortunately for all of us, those cries for the government to "do something" do not fall on deaf ears. Politicians are always eager to buy more votes for themselves by "doing something" that gives the appearance that they are helping people.

When government response is applied to the field of economics and prices, just about every action the government takes is going to cause more pain and discomfort than it relieves.

The free market, with honest weights and measures, is the most efficient method available to humanity for providing the highest standard of living for the global population. Inevitably, if some outside force, such as government, interferes with the free market, it will cause everyone to experience a lower standard of living (with the possible exception of those who directly benefit by the government action, but even then, that is not always the case).

Prices are merely the free market's method of finding a balance between supply and demand.

Let's use an extreme example of prices for a new Lexus in order to understand the point. Suppose that the price to buy a new Lexus, in today's dollars, was only $10.00. Yes, ten dollars apiece. How many would you buy? I'd probably get 50. That would cost about $1,000.00. I would only be limited by the space it required to store them. Everyone would certainly want to buy more than just one, and many people would want dozens of them for that price.

It is easy to see that a low price will encourage great demand. The reverse of that is also true. If a new Lexus cost $50,000,000 each in today's dollars, the company would be able to very, very, very few of them. The exceedingly high price would greatly discourage demand.

If the price is too low, the result it that there is too much demand and the manufacturer can't keep up. If the price is too high, there is too little demand and the factory goes idle for long periods of time.

Prices too low will encourage too much demand, while prices too high will greatly curtail demand. This principle also applies to profit. If one company is making a high profit by manufacturing an item, other companies will see this and jump in to make a very similar product. This results in more competition and greater supply. The effect of an increase in supply will be a lowering of prices. That is how supply and demand interact with each other.

Price is like a thermostat that regulates demand and supply. If anyone forcibly plays with that thermostat, it is going to upset the balance of supply and demand.

What typically happens when the government gets involved with rising prices is that the central banks start the process by printing too much currency. In so doing, all the well connected insiders get to enjoy the fantastic benefits of the new money by the billions, while the common man doesn't. Instead, as this new money gets spread out into the economy, the value of the money gets diluted. It is like taking one gallon of milk, pouring it into two containers, and adding a half a gallon of water to each. Magic, presto! Now you have two gallons of milk.

Except that you don't. You simply have one gallon that has been watered down by 50%.

The central bank creates out of thin air new money by the billions. Once it is spent into the economy by those that receive it, the effects of that inflation are felt by the entire population several months later in the form of rising prices. As this process continues, at some point the public will cry out for the government to "do something".

And those wonderful politicians will indeed take some very visible actions by passing a price freeze law. This is price controls. The problem with this approach is that instead of creating price stability for the comfort of the population, it will heap more misery and a lower standard of living on the population.

The population yearns for relief from misery, and the government sends more misery as a result.

How so?

The answer lies in supply, demand, and profit. Let's go back to our example of the Lexus. Let's say that a new Lexus sells today for $50,000 dollars. Let's also say that it cost the company $40,000 to manufacturer it. As the central bank dilutes the value of the currency, the cost to buy that Lexus goes up to $60,000 and cost to produce it goes up to $50,000. More central bank dilution of the currency further dilutes the purchasing power and the cost to buy that Lexus goes up to $70,000 and cost to produce it goes up to $60,000.

This pattern of events continues until the cost to buy that Lexus goes up to $200,000 and cost to produce it goes up to $190,000. At that point the cries from the public are overwhelming and the government steps in to "do something" about the problem. Instead of doing what it should do and create an honest currency that cannot be diluted (which would supremely benefit the people and put an end to the well connected insiders stealing from the system for their own benefit by diluting the currency), the government institutes price freezes to halt the rising prices.

If the central bank continues to water down the currency by printing it and making it available to those few elites that have that privilege while price controls are in effect, it will bring about catastrophic results. Let's go back to the example of the Lexus. What if the value of money is further diluted so that the cost to buy that Lexus should be $220,000 and cost to make it is $205,000, but the government instituted price freezes and Lexus is only able to charge $200,000 due to the recently enacted price control laws? How long will Lexus continue to lose $5,000.00 per car they make? What if the central bank continues to water down the currency, and the cost for Lexus to make a car goes up to $225,000?

You may be wondering how the cost for the Lexus company could rise with price controls in effect? Well, Lexus doesn't buy all their materials in the country where the price controls have been enacted. Therefore, their costs can and do go up. The result is that at some point they will discontinue making their cars, or at a very minimum, stop selling their cars in the country where the price controls exist. No company can exist if it costs it more to make their product than the product can legally be sold for. Therefore the company will simply stop making and selling their product in the country with the price control laws.

With price control laws enacted and a continuing of currency dilution by the central bank, eventually most companies will not be able to function properly and will have to cease making and selling their product in the country with the price control laws. Taken to the extreme, the store shelves will become empty as no company will be making the items needed to restock the shelves.

This is not just some philosophical ivory tower theory. It is reality. Just look back at the Soviet Union a little over a decade ago. Yes, the official price of sausage may be $1.00 per pound, but if there is no sausage available, what good did the official price do? Did it make the people's lives any better? The grocery store shelves in the Soviet Union were always empty. People would wait in line for hours and even days for the chance to buy what little might become available. 5,000 people lined up to buy 6 chickens. Is that the type of situation that the government wants to create by "doing something"?

Price controls bring about shortages. Honest weights and measures that the elite cannot water down to their own advantage bring about price stability. We will all suffer from shortages when price control laws are passed and enforced.

Rather than cry for the government to"do something" as a nanny, Americans should demand the total elimination of the current dishonest financial system that only benefits the powerful insiders. Americans should demand that government enforce the Constitution, and re-institute and protect honest weights and measures for the benefit of the people, rather than prevent honest weights and measures for the benefit of the few well-connected insiders.

America needs to wake up before it is too late.
About the Author
J Stromsteen has many years experience in the finance, real estate, and insurance industry. Besides her own website, Cheap Auto Insurance, she contributes to the website Bush's Depression as well as first time home buyer to provide up to date information on the unfolding real estate and financial crisis.
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