What is a unit of account?
The measuring stick for economic value.
I am 5’11” tall, in today’s inches. With inflation—and without growing any taller—I can expect to measure 6’2” next year.
I am 220 pounds as of now. If my real weight stays the same, then I should be about 227 pounds in next year’s pounds, after adjusting for inflation.
To break the sound barrier today, you must be going 767 MPH. Next year it will probably require about 790 MPH—because inflation.
As of today, a rotisserie chicken is done when its internal temperature reaches 165 degrees Fahrenheit. Next year, bet on 170 degrees.
This year, each day is 24 hours long. Next year, each day is likely to be nearly an hour longer after inflation. With 365 days in a year (as of now…), that’s about 11 more days we’ll need to add to the calendar.
Etc, etc, etc.
Obviously, all of this is absurd. What is the point of measuring things if the measurements keep growing, even though there’s no actual change in the object being measured? What if this happened in real life? Strangely enough, that’s exactly how fiat money works.
Isn’t it strange that dollars have model years? Why? Is each new dollar-model-year an improvement on the last one? Are we getting more features with each successive release, like we do with new cars or smartphones? No. Each new version of the dollar always has less purchasing power than the last.
Why does this happen? What is it about the fiat dollar that we know it will be worth less tomorrow than it is today? To answer that, let’s think back to how we measure length.
Suppose I need to replace a broken window in my house. In order to buy the correct size to replace it, I must measure its length and width. The tape measure I use will show the length in inches or centimeters, depending on where I live. It will fit neatly into my pocket, so I can take it anywhere and enjoy accurate measurements. Because length is objective—a fact with a single correct value that exists independently of how you feel about it—each measurement can be independently verified by anybody else with their own tape measure.
Unlike the dimensions of the window, the value of the window is subjective. Since my window at home is broken—letting in wind, rain, and pests—my subjective value for a replacement window is relatively high. You, on the other hand, probably have no broken windows in your home, making a new window essentially worthless to you. Whereas I may be willing to shell out hundreds of dollars for a window, you probably wouldn’t want one even if it was given away for free. So, the value of a window is subjective to each of us based on a variety of factors like how many windows are available (supply), how much you need one (demand), and how much it costs relative to your available budget (affordability). There are other factors, but let’s leave them aside for simplicity.
The subjective nature of pricing makes it easy to overlook a critical factor: the size the measuring tool itself. While an entire tape measure can fit in your pocket, dollars are distributed unevenly throughout the world. No single person—with the possible exception of the leaders of the Federal Reserve—knows exactly how many dollars exist. All we know is how many we personally have, and that we always need more of them tomorrow to afford the same groceries we bought today.
But the size of the money supply is of paramount importance!
The number of total dollars in circulation—its market capitalization—determines the size of any individual slice of the economy. The more dollars there are in circulation, the less each individual dollar is worth.
If prices are subjective and nobody has any idea how many total dollars exist, how do we know that next year’s dollars will slice the economy into more and smaller slices? Because there is no constraint on fiat money that enforces its relative scarcity. If, for example, the number of dollars in circulation was limited according to the amount of gold held in Fort Knox, then it would be virtually impossible to grow the money supply at a pace faster than gold could be mined.
Without this constraint, the temptation to print new dollars, and paper over ever-increasing deficits, is too great for any government to resist over the long term. Each new dollar printed is a dollar stolen from the collective savings of the entire world. But because nobody’s dollar balance decreases, they never even notice the heist.
Imagine a measuring stick that keeps on cramming more and more markings into the same length, making each “inch” shorter over time. Fiat money is like a one-foot ruler that will span only six inches (in today’s inches) tomorrow.
"Inflation can be defined as _______"
For many years, the word inflation was not a statement about prices but a condition of paper money—a specific description of a monetary policy. Today, inflation is synonymous with a rise in prices, and its connection to money is often overlooked.