This is the fourth part in a series of articles that are meant to explain government finances and how they affect our investments.
This part will explain inflation in India in an easy way.
Reading the earlier articles in the sequence below will be very helpful.
- Fiscal deficit of India in plain English
- Government borrowing in India explained in plain English
- What do the RBI and the Batman movie have in common? – Quantitative easing in India by the Reserve Bank of India (RBI)
Summary of earlier articles
- The Government of India spends more than it earns leading to persistent fiscal deficits.
- It borrows from the market to feed expenditure which is greater than income.
- The market may by be unwilling to fund the government at lower rates of interest.
- The RBI engages in quantitative easing, creates money out of thin air, and purchases a portion of the government bonds in the market.
- The government is able to meet its borrowing needs using the RBI as a crutch.
More money, more problems, a thought experiment
Suppose there’s a country Imaginaria in which there are two people. Each of them owns a cycle. Suppose each of them has a Rs. 100/- note. So, two cycles and Rs. 200/- are present in this country’s economy. The price of each cycle should settle at Rs. 100/-
Suppose the central bank of Imaginaria introduces Rs. 50/- in the economy. Central banks can print money by virtue of sovereignty.
Now we have two cycles and Rs. 250/-.
Like water finds its level, the price of each cycle should settle at Rs. 125/-
Thought experiment conclusion
- The real assets in Imaginaria are the 2 cycles.
- The assets are unchanged
- Price increases because money supply increases.
The government lies to you
The Government of India and most other governments mislead their citizens.
While doing this, we must also control inflation. This would pose some difficulty because of a bad monsoon this year – Manmohan Singh, Independence day speech, 15 August 2012
Inflation at its current level is due to high rate of increase in prices of vegetables, pulses and edible oils – Minister of State for Ministry of Finance, Namo Narain Meena, 9 August 2012
…That in turn, to some extent at least, is a sign of growing prosperity of our country – Manhoman Singh, Prime Minister, 5 November 2011
Think for yourself
- This year we are expecting the real Indian economy to grow by 5.5% this year. But even today money supply is growing at 13-15% levels.
- OMOs add to money supply.
- Supply of goods and services do not grow by the same amount.
- Like the cycle example, prices increase because of the extra money.
When there are generalized increase in prices in the economy over the long-term it usually has got nothing to do with the nonsense that politicians will talk about. Take your pick from the usual excuses for not being able to control inflation.
- Bad monsoon
- Infrastructure bottlenecks
- Supply-side issues
- Low agricultural productivity in India
- Food prices are not coming down
- Rising crude oil
- Add your favourite reason from the newspapers here. I’m sure there are more that you have seen!
Another small thought experiment
Assume that the public has Rs. 100/- for living expenses. You buy 2 things, food and clothes worth Rs. 50 respectively, in a year. Say, food, the favourite target of the government, rises by Rs. 5/- to Rs. 55/-, it necessarily means you will have Rs. 45 or Rs. 5/- less to spend on clothes.
I accept that food prices increased over the last few years. Something else should have become cheaper. On the contrary all prices are going up.
And to counter our Prime Minister’s logic, prosperity has got nothing to with rising prices. It does not help if your salary increases and prices increase by the same. Prosperity is increase in real wealth not inflationary increase in wealth (Or as economists would call it, nominal wealth increase which is real wealth increase plus increase due to inflation)
Truths which the government does not want the citizens to know
- The RBI has overall control over the money supply in the country.
- OMOs inject money into the economy increasing money supply.
- The biggest truth is that inflation is not increase in prices, that’s what the government would like you to believe.
- Just like high body temperature is not the illness but rather a symptom of fever due to an infection, rising prices are an outcome of some action.
- The true definition of inflation is increase in money supply.
If you have seen the movie, “The Usual Suspects”, there is a fine dialogue by the character played by Kevin Spacey.
The greatest trick the Devil ever pulled was convincing the world he didn’t exist.
Don’t be fooled by the Government’s proclamations that they are trying their best to control inflation in India. If they wanted to they would have done it by now. The levers are in their hands.
In the next part I will explain how money supply inflation is actually daylight robbery by the Government. From whom you might ask? From the citizen’s pockets.
I hope this series of articles is useful to you. If there are any comments you would like to share please use the box below. The star rating system below also helps me improve my articles.
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The next article in this series on government finances and how they affect our investments has been posted at Capital Orbit.
Click here to read How inflation destroys your wealth, explained in plain English.