(Mike Maharrey, Money Metals News Service) The Federal Reserve may finally have another scapegoat for the inflation it created – tariffs.
Two Fed officials recently warned about the possible inflationary consequences of President Trump’s aggressive tariff policies.
Of broad-based tariffs, Federal Reserve Bank of Boston President Susan Collins said, “one would expect to have an impact on prices,” and that “you actually would not only see increases in prices of final goods, but also a number of intermediate goods.”
Atlanta Fed President Raphael Bostic sounded a similar warning, saying his business contacts planned to pass tariff costs along to consumers. “The ultimate question about whether that is significantly inflationary depends on exactly how it plays out,” said.
Reuters summed up the situation, reporting, “Economists broadly expect the tariffs will push up inflation and depress growth, but are struggling to measure to what extent, given the fluidity of the situation.”
They’re Both Right and Wrong About Tariffs and Inflation
In one sense, Collins, Bostic, and others are correct.
Tariffs will raise prices.
But they are also wrong.
Tariffs don’t create “inflation” in the true sense of the word.
There is only one thing that causes the general price level to rise – money creation. As economist Milton Friedman once put it, “Inflation is always and everywhere a monetary phenomenon. It’s always and everywhere a result of too much money.”
The problem is in the imprecise definition of inflation used today.
When people talk about inflation in the mainstream, they generally just mean “rising prices.” Inflation was defined more precisely as an increase in the amount of money and credit in the economy, or more succinctly, an expansion in the money supply.
Economist Ludwig von Mises defined it this way in his essay “Inflation: An Unworkable Fiscal Policy“:
“Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check.”
A 1970s dictionary offered this definition of inflation:
“A sharp increase in the amount of money and credit causing advances in the price level.”
Notice in this definition that rising prices are the result of inflation – not inflation itself.
Economist Henry Hazlitt summed it up this way:
“Inflation is an increase in the quantity of money and credit. Its chief consequence is soaring prices. Therefore inflation … is caused solely by printing more money. For this the government’s monetary policies are entirely responsible.”
Of course, the government and its central bank would prefer you don’t realize they are causing prices to go up. That’s why they have conflated monetary inflation and price inflation. By defining “inflation” as rising prices (the consequences of their monetary inflation), they can blame price increases on other things, including greedy corporations, Vladimir Putin, and now Trump tariffs.
Mises recognized this propaganda ploy decades ago.
“People today use the term `inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation… As you cannot talk about something that has no name, you cannot fight it.
“Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar.”
The Tariff Effect
As I’ve already said, tariffs will cause some prices to rise. They might even cause a lot of prices to rise. But they won’t cause all prices to rise. That only happens with an increase in the money supply.
Unlike price increases due to an increase in the money supply, price hikes due to socks such as tariffs are balanced out by price decreases in other areas of the economy as people shift spending patterns.
Think about your own spending habits. If rising prices start to squeeze your budget, you will cut your spending in other areas to make ends meet. Let’s say the price of X goes up because of a tariff. If you can’t cut back on X or substitute something else, you’ll have to buy less Y to free up money in your budget. Lower demand for Y will cause its price to drop. In a stable money supply environment, some prices rise, and others fall, balancing out the general price level.
The only way you can keep buying the same amount of stuff in a rising price environment is to get more money. If you had a money printing press (like the Fed) you wouldn’t have to worry about rising prices. But you don’t, so you do. You make adjustments.
This reveals how monetary inflation works. More dollars chasing the same level of goods and services cause all prices to generally rise. Monetary inflation essentially raises the floor on prices, making all of them go up.
Imagine a land where green rocks served as money. In this economy, an apple costs 1 green rock. One day, somebody finds a massive stash of green rocks, doubling the supply. As the new rocks work through the economy, everybody has more so they can afford more apples. With the increase in demand, apple growers can double the price to two green rocks. Consumers are willing to pay it because have more green rocks. They can afford it. This same phenomenon will happen throughout the economy, causing the general price level to rise. In effect, the purchasing power of one green rock halved because there are twice as many green rocks.
So, while tariffs will put upward pressure on a lot of prices, they won’t impact all of them. It won’t cause “inflation.” The Federal Reserve does that by creating money and incentivizing debt.
But Powell & Company over at the Fed would sure like you to think tariffs are causing price inflation. That gets them off the hook and allows them to quietly keep creating inflation while pointing the finger of blame across the street at the White House.
Mike Maharrey is a journalist and market analyst for MoneyMetals.com with over a decade of experience in precious metals. He holds a BS in accounting from the University of Kentucky and a BA in journalism from the University of South Florida.
