Oil and commodity prices are soaring. Inflation has reached a sixteen year high. As the thief who cries “Catch the thief!” the politicians are blaming it on everyone else, except their own policies. Economists are placing the blame on a food shortage. Everywhere, the effect is being confused with the cause.

Inflation is, and always is, an increase in the supply of paper money or bank credit. When there is more supply of money, people value the money less. This leads to a general increase in prices. An increase in supply of bank credit too would lead to the same.

When money is injected in this mode into the economy, it first reaches the people whom the governments pay. Let’s assume that these are the defense contractors or the farmers whom the government pays subsidies. Then, the money ripples out and spreads through out the entire economy. When it ripples out, the demand for the goods increase and hence, the prices rise.

Usually, when there is a budget deficit, the Reserve Bank of India purchases government securities, against which it creates checking deposits. This is how paper money is created. It should be kept in mind that budget deficits in itself are not inflationary. Budget deficits are not inflationary if they are financed by bonds sold to the public paid out of real savings.It certainly doesn’t mean that budget deficits financed in this manner doesn’t have harmful consequences. It hampers production and misallocates resources.Inflation can occur even if there is a budget surplus if there is an increase in money supply notwithstanding.

Governments usually inflate in order to buy armaments during a war period. They inflate in order to buy the votes of the public without their knowing it. They inflate in order to provide subsidies to certain political pressure groups. They inflate under the false belief that it would cure unemployment. Inflation is in fact a tax we pay irrespective of our income levels. It leads to reckless income redistribution in a wanton fashion. It discourages saving and encourages speculation. It wipes out morality.

Inflation would always end in a crisis and a depression and worse, people would then blame the depression on the inherent defects of capitalism. It is worth remembering that people blamed the great depression on the inherent defects of capitalism and that led to sweeping reforms that took people into a welfare state oriented society.

The only cure for inflation is to stop the expansion of money and credit. It is as simple as that. If we had instituted a gold standard, which means, if paper money was redeemable in gold on demand, it would have put an automatic rein on the extent over which they can inflate. It would have stopped inflation altogether. And this exactly is why they abandoned the gold standard. And this is why we badly need it.

Inflation derives from the doctrine that what we need is not a gold standard, but monetary management. Monetary management, but is a euphemism for government manipulation of money and credit, which is the root of inflation. It should be remembered that a century back, every economist of repute believed in a gold standard. It required decades of government propaganda and obfuscation to change the tide.

The gold standard was abolished only because it wouldn’t let them inflate when it seems to them that they should. On a gold standard, each money would be defined in terms of gold and all international currencies would be anchored to each other. It would put a stop to fluctuating exchange rates and would lead to a fixed exchange rate.

There are economists who believe that monetary management is needed and we should increase the money supply in relation to the increase in goods and services. They believe, otherwise, that it would lead to deflation and depression. The absurdity of the doctrine becomes clear when we think that how we would compare the increase in goods and services in relation to the increase in money supply. It is true that if let alone, the prices would fall every year, but that wouldn’t affect the profit margins. The total demand would be sufficient to buy the products at lower prices and there wouldn’t be a depression or unemployment.

It is also believed by some pseudo-economists that inflation would cure unemployment. But, the real effect of inflation is to hamper production and reduce employment. The only situation in which inflation would boost employment is when a deflation has occurred and the labor unions are not to use their power to raise wages. But, to say that inflation is a cure for unemployment is tantamount to saying more drugs is a cure for withdrawal symptoms.