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The rate of consumer price inflation edged upward at the end of 2009, following a rare episode of price deflation in the first half of the year. Overall, the annual average Consumer Price Index (CPI), before seasonal adjustment, actually fell by 0.42 percent from 2008 to 2009 (through November). This decrease mainly reflected sharply lower energy prices in the wake of the financial crisis and the global recession. Netting out volatile food and energy prices, inflation averaged a steady 1.7 percent throughout 2009.
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Deflation is unlikely to continue, if history is any guide. With a few exceptions, the price level has increased every year since World War II. Since 1913, the purchasing power of the dollar has fallen dramatically—according to the CPI statistics, by over 95 percent. That is the same year that Congress created the Federal Reserve System, which, as the nation’s central bank, is supposed to “fight” price inflation.
In our view, this long-term erosion in purchasing power is likely to continue as long as the United States retains a fiat currency. All the currencies of the world today are fiat currencies—that is, currencies that promise to pay nothing except more of the same currency and are legal tender (usable to extinguish debts and obligations) because their issuing governments say so. This system stands in sharp contrast to a gold standard, in which currencies are defined as or redeemable in specific weights of gold. Fiat currencies derive their value solely from a government fiat, or decree, that they are legal tender.
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This article is from the January issue of the Economic Bulletin.
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