As we all know, inflation is the devaluation of the current medium of exchange. This means the loss of purchasing power of all current income and income saved from the past, such as savings, bonds, etc….

So when higher inflation begins, what would compel a person to continue holding this degrading wealth? I mean, once people realize that inflation will not stop anytime soon, they will see the value of their wealth degrading rapidly.

So what will people do?

The answer of course is spend. They will do anything in their power to get rid of their fiat money which is losing its value, and use it to buy things or invest in things which cannot be inflated at the whim of the government.

So what result will this have?

There are two problems I will mention. The first is something I will mention briefly because it is not the purpose of this article. It is the building of bubbles and false employment.

As people rush to ditch their degrading wealth, they will spend it on everything. They will invest it in areas which they normally would not invest in. They will buy things they don’t need. They will buy commodities.They will invest in unprofitable sectors, etc… Pretty much anything with real value and real practical uses. It is basically the same idea as the FED artificially lowering the interest rates. So this of course breeds false employment, malinvestments, etc…

So this leads me to my second point, the increased demand. As I mentioned before, people will consume much more when they expect continuous inflation. So the demand for goods and services will rapidly increase, but the potential output of the economy will not change (The only factors which can change the potential GDP or natural output are an increase in the labor force and/or technological advances).

Since the demand is increasing at such a high rate, the price level will also increase. More people will be borrowing from banks to consume, the marginal propensity to consume will increase, but the potential output will not increase.

And as I mentioned, people will be borrowing more from banks. Since banks loan out 90% of their reserves, this expands the money supply even farther. The exact formula is (1/.1)*deposits. This further expansion of the money supply results in more inflation. The excess inflation results in more consumption. Yet through all of this, productive capabilities will not increase, which also contributes to higher prices.

So the result is the inflationary spiral, which will continue until the whole system collapses or the government props up the prices and convinces consumers there will be no further inflation (which is impossible because inflation never stops in a fractional reserve system).

While people say the free market system is unrealistic, I would refute that by saying it is much more realistic than our current system which will inevitably bring economic collapse.

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