Redistributing Wealth Through Inflation

Rongqing Dai, Ph.D.

Abstract

Inflation has become a scary term not only for ordinary people but also for the many economic professionals. While inflation is actually not only an inevitable fundamental element in the market economy, but also a key to understand many important economic phenomena that have been occurring for decades or even centuries around the world, there does not seem to be a consensus among the professional economic experts about the role of inflation, mainly because all the studies have been either empirical analyses, or mathematical modeling based on empirical observations and statistically processed empirical data, without solid persuasive dynamic reasoning, even though some meaningful conclusions have been drawn out of those empirical studies.

The mechanism of redistributing wealth through inflation in response to wealth increase has been utterly ignored by the professional body of economics. Unlike taxation and any other officially enforced order or private philanthropic activity to redistribute the social wealth, the redistribution of wealth increase through inflation happens naturally. In this article, the knowledge of that mechanism will be presented along with an in-depth analysis on the inflation related dynamics in the market economy in general.

 

Introduction

When a system of interest gets complicated, it would exhibit some macroscopic patterns of various statistical significances at its surface level. This applies to each logical layer of the system if we dig down to the dynamic causes that entail the surface patterns or look into the subsystems that compose the whole system, and thus could be viewed as an abstract self-similarity phenomenon. Although this universal self-similarity might sound too trivial to be qualified for the title of self-similarity, in comparison to things like Mandelbrot set with beautiful pictorial manifestations, it does have very realistic effect upon human practices in any area, by luring humans to work with superficial conclusions based on empirical data of certain statistical validity, without looking into the dynamic causes behind the observed phenomena. Depending upon the angle of observation as well as the relative depth and extensiveness of data collection, sometimes this approach could bring forth very profound insights of the subject, like what have happened in the field of physics, but sometimes it could end up with very partial or even erroneous conclusions.

The market economy is a typical complicated dynamic system for which people have been generally contented with empirical theories (or mathematical models based on empirical data) without understanding the more fundamental dynamic causes behind the scenes, which could sometimes lead to unsatisfactory or even disastrous economic consequences. Inflation is an economic subject which has confused the professional (academic, industrial, and governmental) community of economics since it became an issue that concerns this world long time ago. Although inflation is a fundamental factor in the market which sensitively affects the economic wellbeing of both individuals and the economy by and large, people in that professional community, who basically determines the economic status of this world, have been so far quite confused about the nature of inflation.

As for whether economic growth would cause inflation, some economists point out that inflation is not the result of economic growth, but the result of over growth beyond the capacity (Tejvan Pettinger, November 2017, Bill Conerly, May 2019), some others think that in the long run, inflation is positively related to economic growth in a bidirectional relationship (Jaganath Behera & Alok Kumar Mishra, 2017), while the proponents of the quantity theory tend to deny that economic growth would cause inflation at all (David R. Henderson, NOVEMBER/DECEMBER 1999, Frank Shostak, June 2018).

As for the impact of inflation upon economic growth, some point out that inflation would have negative impact on the economy in the long run (Jose De Gregorio, October 1991, Rosemary Emike Idalu, February 2015); some find that it depends on whether it is in a developed country or an undeveloped country (André Roncaglia de Carvalho, Rafael S. M. Ribeiro & André M. Marques, 2017); in the above mentioned literature of Jaganath Behera & Alok Kumar Mishra, based on data from India, the researchers find that as long as the inflation rate is under 4%, it will exerts a positive impact on economic growth, and many others also believe that as long as the inflation rate is under certain small cutoff value, e.g. 6% (MARC DAVIS, Updated Feb 9, 2019), 10% (Dr. Econ, June 1998), etc, it would not hurt the economic growth, but the renowned economist Robert Barro finds (Robert J. Barro, October 1995) that inflation would hurt the economic growth only if the inflation rate is higher than 40%, while some others consider “a little dose of inflation is absolutely essential” (Brian Milligan, January 2015), and thus we need “to bring inflation back to target whenever it threatens to rise too high or fall too low” (Peter Ireland, OCTOBER 2013).

Obviously, the reason for this lack of consensus among the professional economic experts about the inflation-related dynamics (such as the cause and the impact) in the economy is mainly because all the studies have been either empirical analyses, or mathematical modeling based on empirical observations and statistically processed empirical data, without solid persuasive philosophical reasoning, even though some meaningful conclusions have been drawn out of those studies of empirical nature.

A Natural Mechanism for Redistributing Wealth

As a matter of fact, in an economic system, inflation is a mechanism that would naturally redistribute the wealth (increase) created by a specific group of people to the rest of the society.

One typical example of how this redistribution mechanism functions is the role of inflation in the economic growth through exportation of goods and services, which actually offers a very convenient angle of view for understanding the economic booming of some previously economically backward countries such as South Korea, China, India, and so on. We might acquire a general picture of how inflation could help to move wealth between different social groups within a country and between different countries through a conceptual analysis with a hypothetical example.

Assume country A is an exportation-oriented country, and country B is an importation-oriented country, and at the beginning, the wealth of an average citizen of country A is much less than the wealth of an average citizen of country B, and thus an average citizen of country A would normally not consider to consume goods or services from country B, while an average citizen of country B would take the consumption of goods or services from country A, or a trip to country A, as a trivial matter.

Now assume manufacturers of type T products in country A make a huge amount of profit through their exportations to country B, and thus they start to spend a large amount of money in their own country A to buy goods and services, which would cause a sudden imbalance between the demand and supply of the relevant goods and services (in a general sense, including unmovable property). Accordingly, those who provide the goods and services in country A to those profitable manufacturers of type T products would increase their prices for the goods and services that they provide, while hiring more local people and ordering more raw materials to produce the relevant goods and services, which would further boost the prices in the market for much more types of goods and services. During this process, the income of the involved workers would also be increased accordingly because of the increase of the need for relevant skills, experiences, or simply handy labor in the market, the enhanced ability to compensate or the will to reward the good work of employees by the employers because of the improved business performances, as well as the demand of compensation increase by the employees and the government because of the increased living cost.

If the abovementioned process could last for a long period, the overall market prices of domestic supply of goods and services in country A would steadily increase, and by definition, inflation has occurred in country A because of the huge profit of the manufacturers of type T products from their exportations to country B.

Assume that through a period of time, the manufacturers of type T products in country A made 1 billion dollars from country B, and it would be equivalent to 10 billion units of their own currency; however, because of the inflation, when many of those people need to spend most of the money, the buying power of that amount of 10 billion units of their own currency might have become only half of its original worth. Obviously, because of the inflation, the actual domestic wealth accumulation of the manufacturers of type T products in country A could be much less than what they might have thought of when they originally gained the profit through their exportations (e.g. A person initially expected to purchase 100 acres of land, and but then found that he could only afford for 50 acres in the end).

However, from the stand point of view of the buyers in country B, those people from country A did gain 1 billion dollars from them. Then where did the rest of the wealth that was moved from country B to country A go? The answer is simple: it is redistributed to other people within country A, and the mechanism of fulfilling this redistribution is the (infamous) inflation. As the result of the inflation, not only would the general prices of goods and services of country A become closer to those of country B (or even supersede the prices in country B for some items), but also could come a rapid growth of general income level of ordinary citizens of country A.

In order to better understand this, let’s examine two ideal scenarios. First, in an extremely ideal situation, when the surface value of every single unit of the currency of country A magically doubles instantly everywhere in the system, including all the prices and all the numbers on every balance sheet (no matter in banks or in private households or any social entities or any single person’s financial records), then we won’t see any effect of inflation, as long as the exchange rates on the international market also adjust proportionally at the same time. Therefore, we might conclude that it is not the change of the surface value of the total amount of banknotes in the market, but the uneven change of the purchasing power within the economic system, that would cause the noticeable problem of inflation. Second, if those who boost the total buying power of the society by generating their own wealth increase would voluntarily share their wealth increase with the rest of the society, then the increased total buying power would not be reduced because of this voluntary sharing (suppose people would always quickly get into contractual cooperation whenever there is the need of more capital than they could offer by individuals); but on the other hand, a more rationally distribution of the total national wealth among business owners and skilled workers of versatile backgrounds could facilitate a more balanced nationwide economic development, which could not only help to bring forth a quick nationwide economic growth, but also to boost the wealth of average citizens in comparison to other countries, as long as their currency does not over devaluate in the international market (i.e. the exchange rate does not change too much).

Accordingly, if the market could be fine-tuned in such a way that the wealth increase in a specific group of the society would be quickly and rationally redistributed to the whole society, while that profitable group of people could still enjoy meaningful wealth increase for the needs of their personal life and the expansion of their businesses, then inflation might be a very useful tool for the economy; accordingly, as the result of the inflation in the above hypothetical example, not only would country A as a nation accumulate a huge amount of wealth in total, but also could its prices of goods and services become almost the same as those in country B, and thus a bit of saving would make its citizens not only able to consume goods and services from country B, but also able to travel to country B as tourists.

Typical real life examples that the above conceptual analysis might apply to could be the exportation of IT services from India to US, the exportation of toys, garments, and goods for convenience stores from China to US, and the exportation of electronic appliances from South Korea to US.

On the other hand, if there was no inflation in country A, which means the prices of domestic supplies of goods and services are all fixed, then the wealth increase of those manufacturers of type T products from their exportations would not depreciate as with inflation, but the increase of the income of most ordinary citizens because of the economic growth would be much slower. Although the market would still be boosted to certain extent because of the spending of those profitable manufacturers, a large amount of the increase of the total national wealth would stay in the hands of those manufacturers without being shared with other citizens in the nation. Consequently, this would worsen the social polarization. While people might be tempted to assume that the polarization effect could be offset by a special taxation policy to restrict the wealth accumulation by individual people, they would not be able to solve another even more serious problem caused by the fixed price policy as the means to avoid the inflation, which is the crippled demand and supply mechanism in the domestic market, let alone the worsened imbalance of the domestic economic development. This is because pricing is a very important determinant for the consumption of goods and services. When the total buying power increases, if the domestic prices are all fixed, then the increased total buying power might cause severe shortage of certain goods and services (as well as the possible abuse of certain natural resources), and the unnatural redistribution of the buying power among ordinary citizens by taking heavy taxes from the wealthy people would make this situation even worse.

Besides, as long as country A would stay in a market economy (instead of a planned economy), a forced redistribution of wealth through taxation from the wealthy to the poor could help the economy only if it is limited to certain extent, for otherwise it would hurt the reproduction capacity of manufacturers; therefore, even after the heavy taxation, a large amount of the wealth increase from the exportations would still be retained by those rich wealthy people, and the social polarization would still get worsened because of this.

Of course, the market economy is a complicated open dynamic system, and sometimes some previously hidden factors might come into play and thus smooth things out. But in general, as a natural wealth mover, inflation could serve to redistribute the wealth in a relatively smooth way without risking ruining the economy due to the possible negative effects of fixing the prices as mentioned above.

Now let’s take a look at what would happen to country B. Let’s assume that the currency of country B is not a hard currency to be accepted by other countries for international transactions, and thus people of country B need to use a currency of another country (e.g. US dollar) to buy goods and services from country A, then the importation from country A itself would reduce the national buying power of country B since it will reduce their total possession of the hard currency. In case the currency of country B itself is an internationally recognized hard currency, then importations would increase the debt of country B to country A.

Therefore, in this hypothetical example, inflation helps to change the worldwide wealth distribution among countries by redistributing the wealth increase within country A.

On the other hand, if the domestic production capacity of country A is weak, then in order to satisfy the increased domestic purchasing power as the result of exportation, some other people would import goods and services from some other countries (including country B), which will cause a reversed wealth movement out of country A. Therefore, a balanced economic growth in various areas of all sectors would be an important assurance to keep the wealth within a country.

Unlike taxation and any other officially enforced order or private philanthropic activity to redistribute the social wealth, the redistribution of wealth increase by inflation as discussed in the above hypothetic example happens naturally (without even being noticed by economic experts so far). Here I do not mean to promote inflation. We all know that inflation does hurt people (especially the poor people) and could have negative (or even disastrous) impact upon the economy if not being properly tamed, as I will discuss shortly. However, without the knowledge of the redistribution mechanism as discussed here, people would not really understand how inflation operates in the economy, which could logically entail that whatever measures taken to handle inflation might be quite haphazard.

As a last point for this section, I need to point out that although the analysis on the domestic wealth increase redistribution is conducted with a hypothetic example of exportation, the conclusion about the wealth redistribution mechanism of inflation applies to the redistribution of the wealth created in any other ways.

 

The Impact of Excessive Amount of Currency

The foreign hard currency usually needs to be exchanged back to the domestic currency for people to purchase in the domestic market of most countries. Therefore, in the above hypothetic example, the increase of the domestic buying power through the profit from exportation would most probably come with an increase of the total amount of the domestic currency in the market, after the exporters make exchange of the hard currency that they made from country B for the local currency of country A. Although this increase of currency would be the direct trigger of the inflation in the market, as analyzed above, it also meaningfully plays the role of redistributing the wealth increase. Unless the domestic consumption demand of those exporters much exceed the domestic production capacity of country A and there is no importation restriction for people to satisfy their needs by large scale importation, the wealth redistribution would most probably benefit the economy in general.

However, not all the increase of currency in the market would come naturally as in the above example during the economic growth. The supply of currency is often increased through the operation of various monetary policies. Obviously, there would be benefits for people to do so. Although the redistribution mechanism as discussed in this writing has never been aware of by the professional economic community before, the motivation behind the artificial increase of the amount of currency shares some similarity with it. The main difference is that the idea of the redistribution of wealth or the so-called redistribution of income in the mind of the professional economic community is the dilution of the income of labors instead of the capital owners. This is because the increase of the currency, which would always come in an uneven manner (Rongqing Dai, 2018), would increase the amount of cash in the hands of employers while the standard level of salary in the market would not increase proportionally in the same time, and thus the employers can hire more people at the same salary level with the same substantial value of capital. Similarly, since the market response to the increase of the total amount of cash is not even either, those who are at the upstream of the cascade of the injected cash would create new demand of the products with the old low prices, which could effectively boost the local production to certain extent.

Besides, even without international trading being involved, a rapid economic growth might also make an increase of the total amount of cash desirable. Here we might conceptually borrow the famous equation of the quantity theory MV = PQ (M is total amount of cash, V is the conceptual velocity of cash circulation, P is the average price, and Q is the total amount of products), which claims that the nominal total cost of products in the market would tend to match the nominal total buying power of the market. Although this equation has oversimplified the real market circulation, it conceptually reveals one aspect of the market circulation: if the general purchasing power stays low, then it could push the total nominal market value of products to stay low. In case there is a sudden jump of PQ because of a sudden increase of the products Q, it will require a much faster V if the total amount of cash M stays the same. However, it is much easier to inject more cash than to increase V, which reflects the structural quality of the economic system. But on the other hand, if the MV cannot match the incremented PQ (because of the stationary M and the slow increase of V), it will hinder the sales in the market and could stop the economy from a quick growth; when this gets serious, the manufacturers would have to lower down the prices because of their incapability of selling products, and the market would incur a deflation, and the economy might enter a recession. Therefore, a rapid economic growth could possibly create a natural demand of an increase of the total amount of cash in the market.

Ideally, after the extra amount of the cash is injected into the market, the production of the nation would be proportionally boosted and thus the market price increase due to the injection of the extra amount of cash would be cancelled out. In this case, the injection of the extra amount of cash would bring forth a nationwide real wealth increase without causing long term inflation, which would be the good intention of the policy makers. This ideal scenario is actually of realistic potential, or at least it is possible for a result that is close to this scenario to happen under certain idiosyncratic conditions. However, in most cases, as many believed, it would be more difficult to increase productivity than to increase the amount of the total cash in the market, and thus the injection of the extra cash would boost more percentage of total price than total productivity, which means that the inflation would happen as the result of the injection of cash by the central bank. Let’s borrow the quantity theory equation again: MV = PQ, which conceptually tells that if there is too much cash in the market and transactions for purchasing are active, then the price in general would increase if the total production stays the same. Nonetheless, even it would not follow the ideal inflation free scenario, the injection of the extra cash might still possibly boost the economy, and thus both the nationwide wealth and the average wealth of the working class would all increase in the end.

An important difference between the inflation caused by the injection of cash and the inflation as the direct response to natural wealth increase as in the above hypothetical example is that the former would have a bigger chance to create a real wealth increase for those on the upstream of the injected cash cascade than to cause a redistribution of wealth increase, as would naturally happen in the latter case. Consequently, the former might cause more wealth polarization than the latter.

The Negative Effect of Inflation

The unevenness in the wealth increase due to either the endogenous growth in the economic system or the injection of cash from outside determines that both the benefit of redistribution of wealth and the benefit of cascade cash flow would be neither seamless nor perfectly fluent, in the sense that not everyone in the society might get the redistributed wealth in the process, and some people might get the redistributed wealth very late. Therefore, even when the inflation is in the so-called healthy range, it could still be harmful to many people in the economic system. Accordingly, how to counteract against the non-seamless and non-fluent nature of the potential benefit of inflation should be something that the economic policy makers or economic scholars or philosophers need to be concerned with. Furthermore, the unevenness in the inflation related wealth increase could lead to a much more serious negative consequence if the injection induced inflation surpasses the boosted total production tremendously, which could cause a severe shortage of goods and services in the market, and when the situation goes out of control, it could crash the whole economic system as occasionally happened in the past.

A sophisticated knowledge about how inflation might benefit or impair the economic wellbeing of the citizens and the economy by and large, as discussed in this writing, might enable a more fine-tuned market arrangement. In terms of the natural endogenous wealth increase, as mentioned above, if the wealth redistribution mechanism of inflation could be geared properly, it could become a very useful way not only to facilitate a more balanced quick nationwide economic growth, but also to boost the wealth of average citizens in comparison to other countries, as long as the currency does not over devaluate in the international market (i.e. the exchange rate does not change too much). In terms of the injection of cash in response to the natural increase of the need of cash in the market, ideally, if we could make the increased amount of cash exactly match the increased demand for a smooth cash and material flow in the market, then we even would not need to worry about the issue of inflation; similarly, in case of an effort of proactive injection of cash in order to boost economic activity in the market, if it could result in a higher productivity that cancels out the previous short term price hike, then we would not have inflation issue either.

Although it is impossible in general for those ideal scenarios to become reality, knowing those ideals as a result of a better knowledge about the inflation related mechanisms in the economy would still make a huge difference compared to the relatively indiscriminate economic practices because of the ignorance of how inflation actually operates in the economy. It is like shooting a fast running rat when you see it, compared to shooting it when you don’t know where it is at all, even though in both cases you are not sure how to shoot it. As a matter of fact, the so-called scientific development is a process of approaching ideal goals step by step, and engineering is the craft of approximating ideals.

In terms of macroscopic policy making, a more fine-tuned market would definitely require a more skillful play of both the monetary policy and the social assistance measures or even some legislative action to force the skillfully fine play to happen.

 

A Further Remark

The confusion about the nature of inflation by the professional (academic, industrial, and state official) body of economics once again demonstrates the detrimental consequence of practices without seeking correct philosophical insights. One naïve or even harmful idea in this high tech era is that philosophy should be only the business of the so-called academic philosophers and the business of the academic philosophers should be only about the so-called confusing big questions or the categorization and introduction of the existing philosophical works by famous figures in the past.

It is true that mathematical formulation, lab experiments and field data collection, plus powerful calculation means could be very useful for acquiring philosophical comprehension about the issues in the world, but that does not mean we could replace philosophical contemplation about practical issues with mathematical formulation plus data collection and processing. Although the statistical approach is very handy and powerful for studying complicated systems, it also comes with a major defect in general that it highly depends on the size and the contents of sampling itself, and thus could easily miss some hidden behavior of the system.

In general, complicatedness could create a new phenomenal layer for which we might apply statistical analysis without heeding the dynamic causes behind; besides, at the surface level, complicated systems with very different backgrounds (e.g. a mechanical system vs an economic system) might exhibit very similar behaviors, and thus we might apply similar logical thinking to deal with them. But on the other hand, the study of superficial patterns of a complicated system without knowing detailed dynamic causes could also easily overlook some meaningful factors as in the case of inflation. Therefore, when it gets very complicated, it would be desirable to handle the system with much more fine-tuned philosophical thinking instead of basing our actions solely upon statistically averaged data.

In addition to discovering some details that would be missing in the empirical studies, logical philosophizing could also help to offer explanations to some results found in empirical (or empirically modeled) studies, while we cannot do the opposite. For example, the knowledge of the wealth redistribution mechanism of inflation could be comfortably used to explain why a rapid economic growth in a developing country could cause high inflation, but not reciprocally.

As a matter of fact, the more and more frequently exposed symptoms of blindness in both scientific and social practices indicate that, as the social dynamics including scientific and technological manipulation gets more and more complicated, human beings are being not only pushed to the era of 2^nd order philosophy to think beyond the traditional way of reasoning based on simple relationships of notions, but also naturally forced to a recurrence of the ancient practice of the all-around philosophy in every area of life, as what people did before the birth of the modern science, in the presence of the advanced scientific and technological facilities.

Unfortunately, the populace of this world is still not aware that the biggest threat to the future of this civilization is not the scientific impotence but rather the philosophical impotence, and our educational system and general social practices are still sprinting to the opposite direction against the abovementioned naturally demanded movement by the social dynamics itself. Today human beings are so burdened by all kinds of auxiliary formalities and professionally restraint standard ways of thinking without the capacity for advanced philosophizing. It has been a common thing that the academic professionals are incapable of comprehending writings or ideas that are not exactly in line with what they have been familiar with even if the contents are closely related to what they are doing daily. People who could survive the systematic selection of nowadays education and social competitions are simply incapable of doing all-around philosophizing in everyday issues. We just simply don’t have this type of training anywhere in this world, and this world would no doubt pay more and more prices for this collective global deficiency, as the social dynamics predictably getting more and more complicated.

We do urgently need a philosophical revival for the survival of human civilization, not from within the impotent professional system, but from the open society. We do need the support from the society for the effort of reviving the philosophical vitality in this world.

 

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