Welcome to Finance and Fury. The idea for today’s episode came a series that I have been slowly working my way through – Black Sails – If you haven’t seen it, it’s about the golden age of piracy – weaving real historical figures into a fictional narrative – and it almost acts as a prelude to the book treasure island

  1. But one episode in this series got me thinking about inflation – as the show represents one very simplistic way to think of money supply growth leading to inflation – as a fictionalised historical way that inflation historically did occur –
    1. This issue with these historical examples is that they can be extrapolated to the modern day as a way to show that increases in the monetary supply leads directly to inflation – so I want to look at if this is really the case
  2. But we will also be looking at inflation in the context to piracy – as in the modern era we have a different age of piracy – with inflation being an indirect tax – as it does eat away your purchasing power – stealing away wealth from those that cannot match the pace that their money is eroded by

To start – Lets take a trip back in time – The Golden Age of Piracy is a common designation for the period between the 1650s and the 1730s, when piracy was a significant factor in the histories of the seas – particularly in the Caribbean

  1. The history of piracy is often subdivided into three periods – but we will be looking at the latter stages – as piracy really peaked in Caribbean around the post-Spanish Succession period (1715 to 1726) – this was when English and American sailors and privateers found themselves unemployed by the end of the War of the Spanish Succession and turned en masse to piracy in the Caribbean – it wasn’t solely isolated to this region but this is what we will be focusing on
    1. What is a Privateer – Essentially a private person – which in this case was a ship crewed by individuals that engages in maritime warfare under a commission of war
      1. This commission empowered the holder to carry on all forms of hostility permissible at sea by the usages of war – which included attacking foreign vessels and taking them as prizes, and taking prize crews as prisoners for exchange – the proceeds were divided by percentage between the privateer’s sponsors, shipowners, captains and crew
      2. So in essence – it was legalised piracy to help fight and fund a war – the nobility of each country engaged in a conflict would offer privateer status to raid and steal from the nation that they were at war with – so English sailors or even private individuals, if they had access to a ship could go out under the rule of law and seize another individuals property – as long as it belonged to someone who was a citizen of a nation they were at war with
  • So many English privateers came to being during this time period in an aim to make their fortunes by a means of stealing French or Spanish merchant ships and their cargo and crew
  1. Then all of a sudden – England signed a peace treaty with France and Spain in 1707 and told all of these people who were earning a living through plunder that they were now out of the job – with no other job prospects – many of these ship crews decided to just continue on – but this time they had a much larger customer base – as they decided to also hunt English, Dutch and Portuguese ships – which were previously their allies
  1. Now that we are caught up with the history – The show black sails is set in 1715 – and it uses some real events but does fictionalise these – where I am up to is all about the hunt for the Urca de Lima – a Spanish Treasure Fleet that was used to ship gold back to Spain that sunk off the modern day Florida coast – In the show the pirates recover this – in reality they never did
    1. This is a great example of an influx in the money supply leading to inflation – where all of a sudden all the pirates on the island have more money than they know what to do with – so they start spending like mad –
  2. There were unintended consequences of the mass wealth increase without the accompanying increase in output – purchasing power decreased
    1. $1 is no longer worth $1 – most of the inhabitants on the island had vast sums of money now – but when almost everyone has vast sums of money, that money starts to reduce its purchasing power –
      1. This has a deeper philosophical point that a free market solves over time – finding the price point for a transaction – where money is just the medium of exchange –
    2. For me to ask you to work for me for 1 hour – lets say its mowing a lawn – every one of you will have a different price point to take the job – if you earn $1k an hour as a Barrister/QC – you probably won’t do the job for $20 – but if you are a 12yo with $300 in savings – $20 for an hours work might sound pretty good – but let’s say everyone in the country all of a sudden was earning $1k an hour to work, I would need to pay $1k to have my lawn mown for 1 hour – to incentivise them to trade their time for the work required – this is what happened in the show – everyone was so rich they were having trouble finding people to do any work – This is the demand side of a transaction – if there is an equal distribution of wealth – and this is a large increase in the money base – unless supply can keep up we can see inflation
  3. The reverse is also true on the supply side – the market aims to solve a price point and tends to settle on a point based around demand at a certain price leading to the quantity supplied –
    1. If there was only one person with a lawnmower in the country and they charged $1k an hour to mow a lawn – then there may be demand for this by QCs who wanted their lawns mowed – as they trade 1 hour of their time for someone else’s – but this would be a monopoly by this one individual – so they could increase their price to where ever people were willing to pay – in a free market more people would start offering their services and undercut prices – if two people were now doing this role of cutting lawns – then the price may decline to $950 an hour – but if 100,000 are fulfilling this role, the prices may drop down to $20 an hour – if no monopoly is present
      1. What was different on the supply side to today when compared to Black Sails on the island of Nassau – there was more or less a monopoly of supply at the same time as a mass increase in the money supply – it was an island with limited labour and supply of good – If monopolies exist when an increase in the money supply then inflation can exist


Skipping forward to today – there are still pirates and inflation that are present in modern economies –

  1. Inflation today still occurs as we are seeing – and it is a decline in purchasing power – but is this decline due to an increase in the money supply or a decline in the amount of available goods –
  2. it comes down to where the money is going and who the loss of purchasing power affects the most – we will come back to this point towards the end of the episode

When looking at Inflation theory – Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

  1. This is part of the theory of Monetarism – the belief the money supply in each economy is the primary driver of economic factors – but Friedman’s works were conducted during the 1950s and 60s – prior to the current state of the monetary system – and globalisation with a mass increase in supply
    1. His theories totally make sense in a world where money has a backing and the increase of the money base can lead to inflation in a monopolistic world – or in a world where the supply of goods increases at a slower pace than the money supply – meaning that people can demand higher prices for goods
    2. Does this mean that the increase in the money supply over the last two years is what is driving inflation – In my view it doesn’t
    3. This is due to a number of factors, but first and foremost is that the vast majority of the monetary supply increase has not translated into consumption growth – in other words – when the money base increased by $1 – consumption did not increase by $1 – and this was due to, in most part, people not being the recipients of this increase in the money supply –
    4. If you look at the money supply increase – this has definitely impacted the prices of assets that this money is directed towards – property is one that most people would be familiar with –
      1. This is because buying a TV or a toaster is different to a property – most consumer purchases, if people can borrow more and demand higher prices soon see competition that drive prices back down – like people mowing a lawn – but property doesn’t see the same level of competition – land supply is limited and property is a heavily regulated commodity – so it isn’t like there are 30 producers out there that can just increase their production of TVs to meet the new demand in a few months – property is vastly different – not only in the production process but also in terms of how much money is being spent to purchase property and the competition – its not like there is only 1 toaster that 100 people are competing on and bidding up the price –
      2. This is where we see inflation on asset prices – people competing on say a good property in a desired location – nobody is down at the good guys or JBHIFI competing over TV and calling their broker to see if they can borrow an extra $30k to match the next winning bid
    5. This is where the vast majority of the increase in the money supply hasn’t gone into additional consumption – the government bonus payments mostly went into savings for pensioners as savings rates went from 5% in 2020 to 25% by mid 2020 – have come down but still sitting at 12%
  2. Beyond this – where did the money go? The vast majority of this over the past 15 years has been retained within the financial system – in the form of Government debts through QE initially and then redistributed depending on the repurchases of the investment firms government debts were purchased off by central banks – why would central banks just print more money and try to affect inflation?


Inflation in the modern era is actually part of policy design – in other words it is the first and foremost aim of central banks – to try and manage an economy to be within their target band of inflation – between 2% to 3% p.a. – from 2015 to 2020 the inflation rate was below what the RBA targeted – and over these 5 years the money supply when measured by M3 increased 30%

  1. Inflation in a rational economic world should be detested – it erodes the real value of your savings and investments – and reduces your purchasing power – it would be better to get a 1% pay increase each year with -1% inflation compared to a 5% pay increase if inflation is 6%
  2. But for those economies that are debt laden – and based around modern economies – almost every nation with a central bank is massively debt driven – where every dollar issued is debt obligated to a central bank – essentially money is debt – therefore inflation is ideal – as the real value of these debts decline with inflation –
    1. Why do central banks have an inflation target? They are basically saying they want to devalue your assets and savings in real terms by 2% to 3% each year – but also your liabilities –
    2. Back in 1579 – Great Brittan’s Francis Drake who was a privateer used to pillage Spanish ships and took some of the gold they used to transport back in treasure fleets – It is estimated up to 10% of Spanish gold was lost to piracy – probably closer to 5% –
    3. Privateers like Francis Drake gave a good portion of their stolen gold to the Crown – who used this windfall to pay off the UK national debt – so piracy was one way to deal with a national debt
  3. This is in part, why I find central banks antithetical to a market that allows people to prosper financially – beyond the main reason that they centrally plan an economy through controlling the very cost of the medium of exchange – something the USSR central planners never dreamed of
    1. The cost of money – being the interest rate – should be something that the market demands –
    2. This can help to avoid inflation – by adjusting interest rates based around demand – not what is being guessed upon by committee
  4. Central banks will always get it wrong – Why? A few individuals who try to guess what to set monetary price at will always fail to do so correctly –
    1. As an example – The RBA has 9 board members – so these individuals have the final say if rates rise, fall or stay the same – They may be the smartest 9 people on earth– but their collective knowledge will always be less than 26 million people who make up Australia’s population – or the potentially billions who are demanding goods from Australia in AUD – both directly and indirectly
    2. The issues with centralised knowledge is that there is now feedback loops and a lack of consequences –
      1. If someone were to buy someone in the open market place – and the price increases by $1 – and the company selling this good see that there is a massive drop in their demand, resulting in a loss of profit – by the following month this would have been fixed the price back to a profitable position – as there is an instant feedback loop – and there are as consequences – as the companies directors feel the brunt of the results – they can lose their jobs if they make bad decisions as shareholders can vote them out
      2. Hence – there are as close to perfect instant feedback loops as one can get in a market place – plus consequences to their actions –
    3. For the 9 people on the board of the RBA – not only are there no real time feedback loops – where they can adjust prices in an instant rather than waiting to the 1st Tuesday of each month – even though they wouldn’t have received the data back from their decisions and may have to wait 2 years to see if what they have done has had any affect – which is all a guessing game at the end of the day – there are no consequences to their action – they keep their jobs as they have periods of service – normally 5 years at minimum – which can be extended
  5. This is probably the biggest issue – they can constantly be wrong – and nothing happens


In Summary –

  1. The golden age of piracy really never went away – it really just morphed into taking from originally pillaging other nations traders to in the modern era – CBs aim of eroding the wealth of their own populous through inflating it away to reduce real levels of debt
  2. Now – the inflation spike we are seeing at the moment is not really in control of central banks – it is due to supply chain issues – where demand for consumption has remained relatively the same in most things – but the prices are rising due to supply shortages
    1. But central banks are trying to solve a problem they have no place in solving – increasing rates to combated this is simply eroding investors wealth at the same time that inflation is doing this as well
  3. In my view – deflation should be the ideal policy – that would be a market policy – but a central bank targets inflation – and this type of policy really hurts those in lower income brackets the most – when inflation is present, it affects those who are reliant on every day goods that take up a larger allocation of their income
  4. Say you earn $1k p.w. – after taxes this works out to be $838 – if you are spending $300 on rent and $200 on food – then a 10% increase in these costs leads to a major reduction in your spending capacity when compared to someone on double your income
  5. But what Central banks are doing at the moment is too much too late – the supply chain needed to catch up first and prices come back in line with spending capacities

The prudent policy would have simply been to keep bank lending in line with a servicing rate of 7% to avoid a massive increase in credit growth – but this would be fiscal policy – but this is another topic for another day

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