Chapter 9 - What is Inflation?

Along with the definitions of usury and money, the ‘Definition of Inflation’ has been modified over the years. Webster’s American Dictionary of the English Language, in 1864, defined inflation as:

“undue expansion or increase, from over-issue; -- said of currency.”

Samuel Johnson’s ‘A Dictionary of the English Language’, 1755, had this definition for inflation:

“The state of being swelled with wind; flatulence.”

In the Merriam-Webster second edition of its New International Dictionary in 1934 inflation is defined as:

“Disproportionate and relatively sharp and sudden increase in the quantity of money or credit, or both, relative to the amount of exchange business. Such increase may come as a result of unexpected additions to the supply of precious metals, as in the period following the Spanish conquests in Central and South America or the period following the opening up of large new gold deposits; or it may come in times of business activity by expansion of credit through the banks; or it may come in times of financial difficulty by governmental issues of paper money without adequate metallic reserve and without provisions for conversion into standard metallic money on demand. In accordance with the law of the quantity theory of money, inflation always produces a rise in the price level.”

Merriam-Webster’s Collegiate Dictionary, eleventh edition, 2003, inflation was redefined as:

“a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and service.”

The definition has changed from “an increase in the volume of money” to “an increase in price levels”. This leads to flawed thinking. It is the rise in the portion of the Money Supply that is not hoarded that makes the difference. I call this Circulating Money. This is poorly characterized by the figure for velocity. Price level inflation also occurs if there is an increase in velocity. If the Money Supply increases whilst velocity falls in proportion, then no price rises are likely to occur. It is not an increase in the total Money Supply that causes ‘price’ inflation, it is the increase in the volume of Circulating Money. (Or more rigorously: An increase in the volume of Circulating Money exceeding any rise in the availability of goods and services. {Demand is already factored into the concept of Circulating Money.})


This can be calculated by assuming that Circulating Money changes hands before one month. Velocity is the number of times money changes hands in one year, so a Velocity of one indicates that one-twelfth of the money changes hands each month. A Velocity of two indicates that one-sixth of the money changes hands each month. A velocity of twelve indicates that money is changing hands once a month on average.

Some people tell me that their money only lasts one week, in which case they have a Velocity of fifty-two. Some businesses have a big restock each week giving a velocity of fifty-two. The fruit vendor outside this Amritsar Hostel restocks his barrow each day suggesting a velocity of three hundred and sixty-five. I had problems deciding what time period to use. I decided on an arbitrary time of ‘one month’. This enabled calculations and added some realism to my study of Circulating Money and Hoarded Money.

 Velocity    ‘Circulating Money’ percentage 
 12  =  100% 
 10  =  83% 
 5  =  42% 
 3  =  25% 
 2  =  17% 
 1.5  =  12% 
 1  =  8% 
 0.75  =  6% 
 0.5  =  4% 
Hoarded money and velocity. Creative Commons Attribute - Andy Chalkley.

Talking Heads

Talking heads usually advise that the Money Supply should be increased to boost the economy. Increasing the velocity — by decreasing hoarding — will have a similar effect. Of interest, under the current Bank Credit regime, an increase in the Money Supply requires an increase in debt, which is good for the creditor’s bottom line. In reality, what is needed is an increase in Circulating Money. The increase in Circulating Money can either come from Hoarded Money converted to Circulating Money or it can come from fresh new money injected into the Money Supply in a specific manner to ensure that it becomes Circulating Money and is not appropriated by hoarders. Current methods used to boost the Money Supply, tend to add money to Hoarded Money and not Circulating Money.

Hoarded money and economic recovery. Creative Commons Attribute - Andy Chalkley.

Gold and Silver as Money

Where gold or silver have been used as money, it is their rarity and their desirable physical features that give them their initial value, but it is the citizens need to pay purchase goods and to pay taxes that gives money its value. If gold nuggets were found in every garden, gold could not be used as money. If society had a distaste for gold, it could not be used as money. If gold had a religious spell cast on it, it would become worthless in that area. It would be used as fishing weights. Part of the reason for the high value of gold is because it has a history of use as money and has the potential to be used as the medium for money. Part of the drop in the value of silver would be because it is less likely to be used as money. It is my view that if a metal commodity is required as a medium for money, then silver would be preferable, as it would be more difficult for the proponents of gold to monopolize the metal. We should not be deceived into thinking that silver and gold are precious because of some intrinsic characteristic. They have value because they retain the possibility of being used as money and they retain the reputation of being usable as money. That reputation comes from history and their relative lack of abundance. They only function as money when stamped, so they still need a government ‘Fiat’ upon them. So you might as well think of silver and gold as just a medium on which a convenient government stamp is embossed. This view would make them ‘Fiat Money’. Many years ago, in California at the height of the gold rush, so much human effort was put into gold mining that the Californians forgot to plant food. They nearly starved. The increased supply of gold depressed the value of the currency in a manner called inflation. Similar happened in Spain. Plundered gold was brought home to Spain in a manner that caused great inflation and the demise of the Spanish Empire. Gold flooded into Spain which wrought havoc with the Money Supply. The same gold slowly infused into Europe giving a steady and moderate increase in the Money Supply which raised Europe to the heights that it retains until today. Silver and gold can suffer the same abuse as paper Fiat Money.

A beautiful example of ‘demand maintaining a value’ of a commodity is the clever system employed in the diamond industry. Diamonds are comparatively plentiful, but, by restricting the supply of fresh diamonds to the market, the value of diamonds is maintained. Supply of diamonds is carefully matched to current demand which cleverly maintains their value at a much higher level than would naturally occur. Diamonds have little value until their supply is restricted to match demand.

The reason I talk about ‘money having no value to the creator’, is that its absence from the definition of money encourages the bizarre way we generate and manipulate money in modern times. I started my study of money when writing pamphlets for the ‘Occupy Wall Street’ movement. I had assumed that all money in Australia had been created by the Reserve Bank of Australia. You may have assumed this as well. Only a small amount of logic was needed to realize that I was entirely wrong. A quick look at the definition of Money Supply made it fairly obvious. The Money Supply, in its simplest form, includes Legal Tender (the orange part) and demand deposits in financial institutions (the green part). The Legal Tender is the money created by the Reserve Bank of Australia in the form of Cash Currency and is the orange part of the graph. The rest of the Money Supply is the Bank Credit in bank accounts which is commonly called money even though it did not originate from the reserve bank. This is the green part of the graph. It follows that only a very small portion of the Money Supply is in the form of cash created by the Reserve Bank of Australia. The biggest portion of the Money Supply is in the form of Bank Credit in bank accounts. The green part clearly never came from the Reserve Bank as the total Cash Currency ever produced by the Reserve Bank of Australia is $67 billion. [5]

Money Supply. Creative Commons Attribute - Andy Chalkley.

The Bank Credit is close to 95% of the Money Supply of the nation. This 95% is not cash, as this volume of cash was never created by the Reserve Bank of Australia. It cannot be turned into cash, as this volume of cash never existed. I shall call the money listed in bank accounts ‘Bank Credit’ to represent its nature. This Bank Credit is credit for an equivalent amount of currency (Legal Tender) to be paid to the client at some time in the future. It is the amount of currency that the bank promises to pay you, on request, in Legal Tender. Thus, it is a bookkeeping credit in a computer for that amount of currency. There is a regular transition of Bank Credit into cash and cash into Bank Credit. This convinces the citizens that their bank balances are convertible to government issued cash. There is not, and has never been, the volume of cash available, nor created, to match the total Bank Credit in bank accounts. Thus, the Bank Credit, as listed in bank accounts, did not come from the Reserve Bank of Australia. There is the question of whether it should be called ‘Money’ as it did not come from the government. A legal definition of money may be that which the government deems to be money. This means that Bank Credit is mere ‘credit’. The colloquial definition of money defines ‘anything that enables transactions’ to be money, so it is common to refer to Bank Credit as money.

In western nations, the ratio of Bank Credit to genuine government created currency, is between 12:1 and 30:1. [3] There is significantly more Bank Credit than there is real genuine ‘currency’. In the UK, there is 3% currency to 97% Bank Credit. [1] Worldwide, it is estimated that there is 8% currency to 92% Bank Credit. [2]

The omission of the concept that ‘money has no value to the creator’, is one of a few items that allows banks to create credits in bank accounts for money that never existed. Another item that allows the creation of money by account entries is the double entry book-keeping system where one account is credited whilst another is debited.

The money in bank accounts did not come from a central bank.

The money in bank accounts is ‘Credit’ for an equivalent amount of currency that was never created, does not exist and never existed. It is ‘Bank Credit’, often called ‘Commercial Bank Money’. It is a virtual substitute for Legal Tender.

At present, my thinking is that Bank Credit is not money. This is quite a conundrum. It is credit for money that does not exist. It is entirely different in character to physical currency. It is mathematical in nature which allows it to be negative whence it is called debt. It is fake money because it arrived with a baggage of debt that neutralizes its existence. The credit and debt live a different and separate existence but their joined origin destroys its ability to be controlled. Irrespective of whether Bank Credit should be considered as money, it is an entirely different beast to currency. It is doubtful whether it could be considered to be called Fiat Money. It gives Fiat Money a bad name.

Money is a human creation that enables exchange. For money to function, it must have a limited and controlled supply and must be universally accepted and trusted. Physical Money exists as currency which can be classified as Fiat Money or Commodity Money or Representative Money.

It can be Commodity Money, which can be anything from cows to shells to gold to silver. It can be Fiat Money, which something deemed to be money by a government. This is usually paper notes. These two are physical forms of money but both can be virtualized by entering credits in registers. Give the bank one thousand dollars in cash, and they write $1000 in a register and you now have $1000 Bank Credit. The $1000 cash walked out of the bank with the next client. The $1000 that was deposited does not represent $1000 sitting in a bank account, it represents $1000 that the bank promises to pay you at some time in the future. Your bank balance is effectively an IOU from the bank, informing you that the bank owes you a certain amount of Legal Tender. The bank account balance is merely a listing of how much Legal Tender the bank owes the account holder. This is very interesting because there never is or was that volume of Legal Tender in the nation. The system works because people don’t request their account balance to be converted to Legal Tender in large quantities.

Fiat Money

It is usually defined with a key statement:

Fiat Money is money, which is deemed Legal Tender by a government.

Although it sometimes has an extra part:

Fiat Money is money, which is deemed Legal Tender by a government, but is not backed by a physical commodity.

It may also have this extra component:

or is generally accepted for payment of debt.

When currency is physically made from silver or gold it is called Commodity Money. Where the currency represents a fixed amount of silver or gold, it is often called Representative Money. The terms are often mixed up. When paper notes are called Commodity Money, one has to be aware that it may be ‘fully backed’ by silver or gold or partially backed by silver or gold. Another author might call it Representative Money.

Fiat Money tends to get a lot of bad press. It is very easy to corrupt a Fiat Money system. It is also easy to corrupt a Commodity Money system and its hybrid Representative Money system.

However, the corruption occurs when substitutes for the Fiat/Commodity/Representative Money are created diluting the Fiat/Commodity/Representative Money. The Fiat/Commodity/Representative Money is the money created by the Central Bank as coins and notes. The orange part of our graphs.

In the above graphs, the orange part is the Fiat/Commodity/Representative Money. The green part is confusing. It did not come from the central bank. Very little Fiat/Commodity/Representative Money is held in the bank vaults. Only just enough is held to fill ATMs and most of that comes from daily deposits by retail businesses. In any economic crisis, this conversion ceases. The conversion of green to orange ceases.

I ask you: “Is the green part Fiat/Commodity/Representative Money?” I will even ask you: “Is the green part money?”

The Money Supply needs to increase slightly each year to match increased population, increased economic activity and cover for Hoarded Money. “Is it the green part or the orange part that increases?”

The government part increases slightly but it is the green part that covers most of the increase. So it is the expansion of Bank Credit that is the bulk of the Money Supply increase and the Bank Credit comes from loans from banks. Yet people blame the Fiat/Commodity/Representative Money for all manner of economic ills. Fiat Money, in particular, gets a bad rap for economic issues that it does not deserve. It is not the Fiat/Commodity/Representative origin of the money that is to blame but the corruption of the system by allowing Substitute Money, in the form of Bank Credit, to become so dominant. Substitute Money in the form of Bank Credit dominates our money system and constitutes about 95% of the money in circulation. [UK 97%, Australia 96.5%, USA 93%.]

It is Substitute Money that gives Fiat Money a bad name.

The annual increase of the Cash Currency in Australia was ~$4 billion [7] whereas the increase in the Broad Money was $127 billion. [6] Yet the blame for inflation goes to the government. The talking heads state that the central bank should be kept “independent from political interference.” Yet the government still gets the blame for economic ailments.

The banks cause the problems but the government gets the blame.

When it goes pear shaped, all sorts of interesting arguments surface, such as a return to the ‘gold standard’. Such a change takes us from a ‘debt-ridden Substitute Money system’ to another ‘debt-ridden Substitute Money system’.

Any money listed in a banking or financial institution is Bank Credit and only maintains its value whilst the financial institution remains solvent and continues trading. This credit is very much like mobile phone credit. Imagine you give $1000 cash to a large phone company to get $1000 on your account. The phone company has banked and spent the $1000 within a few days on wages and whatever else. You now have $1000 of credit on your card which is entirely virtual. You owe a friend $50 and you request the phone company to transfer $50 to your friend. The phone company adjusts the credit in these two accounts. It charges a 20c fee for doing so. You have thus cleared the debt to your friend and the phone company made 20c. The phone company gets clever and allows transfers to other phone companies. Similar amounts tend to be transferred between phone companies on a daily basis. So only a small imbalance occurs between the different phone companies. So they have mutual accounts with each other, in which they record the minor differences. The phone companies get clever and offer to lend you credit for a fee. They lend you $1000 of credit and you pay back $1100, a year later. Banks operate in this same manner. They transfer credit between clients and it has the same effect as paying with money. They are not transferring money, they are transferring ‘Credit’. The money has long gone.

Bank Credit satisfies the first item of the definition. Bank Credit allows transactions and does so exceedingly well. The definition of money is not worded to distinguish the essential difference with this fake form of money. Counterfeit money also satisfies the definition of money. The carton of beer often also satisfies the definition of money. The definition of money needs to be adjusted to recognize the issue of fake substitute money.

As time goes by, citizens start to rely on the availability of Bank Credit. When the Bank Credit is restricted and the Money Supply decreases, people blame the government and the Fiat Money system. It is not the government Fiat Money that is at fault. It is the lack of Substitute Money, in the form of Bank Credit, that is the problem. It is not the Fiat Money systems that collapse. It is the Substitute Money system acting as a parasite on the back of the Fiat Money system, that collapses. In past times, it was the ‘moneylenders’ that loaned at interest and they were thus called ‘Usurers’. These usurers loaned money, creating unpayable debt. The Usurers had their henchmen to enforce asset seizure or enslave the debtor or their children. Nowadays the servitude is not tolerated and the enforcement is done by the state on behalf of the moneylenders.

The old style enforcement is still found in local drug arrangements where drug users fall prey to their credit issuing drug suppliers, in the human trafficking in some parts of the sex industry and in some nations where employees are in unpayable debt situation to an employer. Very little is done to assist these victims of usury. In the local drug market, we actually criminalize the hapless victim.

Fiat Money

Fiat Money is money that is deemed Legal Tender by the government. Hopefully, I have demonstrated that this only includes the cash notes and coins produced by the central bank or the treasury. Hopefully, you now question whether Bank Credit is ‘Money’. Hopefully, you can argue against those that state that a Fiat Money system is a failure waiting to happen.

Corrupted Fiat Money systems

Some people state that the average life span of a Fiat Money system is 25 years. The average lifespan of a corrupted money system will be less than 25 years. The lifespan of an uncorrupted Fiat Money system is much longer. There are many Fiat Money systems that lasted centuries and often with minimal inflation, even when inflation was measured over decades or centuries. The Tally Stick system was designed to avoid corruption by the usurers. This system successfully curtailed the influence of the usurers for centuries until it fell prey of the usurers in its final years of use. The usual corruption occurs when credit is issued for the Fiat Money. This expands the Money Supply, often with very beneficial results. It also creates debt back to the usurers, payable in money. This may cause dispossession and worse for the desperate borrower. With larger quantities of this usurious debt, whole nations will suffer unpayable debt and become subject to unreasonable conditions demanded by the usurers. If the usurers withhold further credit, the government can be blackmailed into accepting conditions favorable to the lenders.

Please note that:

In days gone by, citizens were lured into debt through desperation or for business purposes and nations were lured into debt for war purposes. These days, people are lured into using the convenience of Bank Credit as a substitute for government Fiat Money. The citizens do not relate this to economic instability and the phenomenal build-up of debt.

Gold Backing

If the government claims that its money is backed by gold, the reality is: only some of its money is backed by gold and thus the money is closer to Fiat Money, than Commodity Money (often called Representative Money). If the government allows you to pay your taxes using Bank Credit from a bank account, it does not mean that the Bank Credit is Legal Tender.


To a citizen, the whole essence of money is that it can purchase goods. Citizens acquire money for no other reason. (They never wish to exchange it for gold. Gold is used for the purposes of scamming the money system system through hoarding.)

Regional Inflation

Inflation is usually measured as a general rise in prices across a whole nation. The region covered is the complete nation. Inflation is much more dynamic than this. It is possible for the inflation to be different in different regions of the nation. This would be influenced by the increase in the volume of money in a region which is influenced by how much money enters the region and how much money leaves the region. Let us consider an isolated state of a nation, far from the nation’s capital. ‘Money in’ depends upon federal government expenditure in the region, businesses that bring money into the region such as mail order firms and tourism and bank lending practices in the region. It is necessary to ensure there is adequate money in each and every region of a nation. Excessive money into any region or state will cause inflation specific to that state or region. Any regions or state starved of money will experience a local recession.

If one employment segment receives more money than others, the wages in that segment of the economy will rise. If there is a big boost in construction, construction wages will rise.

Around 95% of new money is created when banks create credit at the time of making a loan. Where this new money is spent will cause inflation in the areas to which it lends. If it lends vigorously into the housing market, house prices will rise. If it lends to stock market speculators, the stock market will rise. There can be unfortunate consequences for the participant when the banks cease lending into the sector. Study of one inflation figure is inadequate in the study of a modern economy. Inflation in all sectors is significant.

Lending for Trade in Existing Assets

Bank lending that was granted for the purchase of existing assets, whether they be real or virtual, does not augment the real economy, but contributes to selective asset inflation. This asset inflation is both unsustainable and prone to volatility.

Selective Inflation

Inflation is presented as a single figure and encompasses existing assets, new assets, new goods, and services. However, different items inflate at different rates for different reasons. The same item may have different inflation rates regionally. For an efficient economy, some knowledge of the numerous inflation rates is needed both on a regional and item basis.