A Simpleton Explains Inflation

Inflation is classically defined as "more money chasing the same number of goods." Allow me to explain that in laymen terms using hypothetical and real world examples using inflation and deflation to make my points.

Remember when the Mazda Miata first came out? Everyone wanted one. The retail price was about $14K. There were few Miata's being delivered by Mazda. The buying public's desire to have a Miata now was more urgent than Mazda could meet. Buyers seeing a money making opportunity bought them up and resold them at a higher price than they paid for them. There was a huge waiting list at Mazda dealers for this cute little two seater and some hopeful buyers were willing to pay over retail to have one immediately, hence inflation of Miata prices set in because of more dollars chasing a finite number of available Miata's for purchase.

When there were say 2000 Miata's in dealer showrooms nationwide, but there were 5000 willing buyers who did not want to wait on the list, the price of Miata's skyrocketed. If I recall correctly some buyers paid up to about $17K to have one immediately. See? More dollars chasing a small and finite number of Miata's drove up the demand above supply, thus prices rose. Simple.

Another inflationary issue is the cost of production...either labor, materials, delivery or a combination of all three. Generally any rise in these costs is still driven by supply and demand. If no one wants to buy Whiplash Widgets then the price will decline, whereas if Whiplash makes the sure fire best widget on Earth the demand will be higher. If able to meet demand the price will remain relatively even. If demand stays high but Whiplash cannot meet demand the price will climb - inflation!

Housing prices remain low because there are more houses for sale than there are buyers for them. Before the bust when we were in the boom cycle, there were more buyers then there were houses to buy so builders' built and a glut occurred leading to the bust cycle. As long as there are empty houses waiting for buyers prices will remain lower than they were.

Now let's move to the danger of quantitative easing (QE) or "stimulus." This is little more than the injecting of money into the system to create economic activity. This will lead to inflation as it creates the situation of "more money chasing the same number of goods." In fact QE proves that despite the claims from some that "trickle down" does not work, QE is all trickle down. It's putting more dollars into the system. Those dollars move from consumer to manufacturers and retailers to employees and suppliers and ON PAPER that creates the appearance of more economic activity. And it is more economic activity and it is indeed "trickling" through the system, creating wealth on paper by the movement of money from one entity to another and so on.

By definition inflation will occur if more dollars chase the same number of goods.

Deflation is what our housing market is experiencing because there are more houses than buyers, and gasoline is causing inflation because demand is high but the threat of shortages due to unrest, etc., drives up the price. There are more than enough buyers for every gallon of gasoline, therefore prices will climb, and indeed they are. If every driver in the US parked their car for a month the price of gasoline would plummet - not arguing for such a possibility but merely pointing out how quick we'd see the result if it happened.

Inflation is as old as Man's first transaction. It happened in the barter system as well as the monetary system. It is the natural result of commerce be it money or barter; less of something but high demand will drive up the price whereas more of something or less demand will drive down prices. Truly, like water levels, they each seek their own level. Left to natural forces both conditions will alleviate themselves in time.