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Central Bank Magic PotionUruguay is an economic basket case. However, it is far less of a basket case than say… Argentina. But this fact does not preclude its government and economists to make the very same stupid mistakes and use the very same irrational and erroneous economic theories.

The Uruguayan newspaper El Pais - Uruguay has been kind enough to inform us that Uruguayan politicians have obtained the Magic Potion that will "contain" the raise of inflation. And what is the name of this sacred elixir you ask?

Ahhh… grasshopper, we shall tell you.

It is called an "Agreement of Prices and Government Actions".

There you have it. How simple and how stupid of all these other governments that have not yet come to the realization of this golden fact. We should publish this wonderful solution to all the economic evils that haunt us.

According to the article "Agreement of prices and government measures contains raise of inflation", the yearly inflation to Feb 2014 was about 9.82% while a similar measure to March 2014 was of only 9.73%. This is due to the wonderful agreement to freeze prices up to May 2014 and the removal of the VAT (Value Added Tax) from fixed telephony and electricity and the price discount on tickets for the popular lottery "5 de Oro" (5 of Gold).

Side Note: No, we are not making this stuff up. This lottery ticket is actually included in the calculation of Uruguayan inflation.

There you have it! Proof positive. All we need to do to stop the evil, evil inflation in its tracks is to get agreement between retailers not to raise prices and remove taxes.

Presto!

Done!

Solved!

Next!

Well… not so fast.

There is an ugly, greasy, fat fly in the soup According to Mr Ignacio Munyo (an economist from the IEEM - the Business School from the University of Montevideo), although the inflation did indeed drop from 9.9% to 9.7%, the underlying inflation actually grew from 9.9% to 10.2% !!

And you thought that inflation was unique and immutable. Silly you.

On the same token, we can tell you with 99.564% confidence that about 87.57785% of the population is of the opinion that 34.568885% of the cost of living is absolutely correlated to 97.46923% of the increase in consumption due to the 65.59872% of the people who are of the opinion that they need to be consuming less than the other 76.563% of the population who obviously is not aware of these figures. Got that?

And why is that Uruguayans have inflation?

Ahhh… grasshopper, for that answer we need to go to the newspaper Mercopress, and in its article "Uruguay lowers growth estimate for 2014 to 3% for GDP; inflation still a challenge". In there we find the well thought–out elaborations of Mr. Bergara (the Uruguayan minister of economy) who expressed that given the fact that Uruguay has had 3 years of full employment, the inflation is, of course, a supply side issue. It would seem that inflation is happening because there isn't enough supply in Uruguay to satisfy demand. He adds, that the Uruguayan inflation target is in the range of 3% to 7% but that the prices were in control and that the depreciation of the Uruguayan peso of 15% in the past year is in line with other emerging markets.

No, again, we are not making this stuff up.

Let's see. In 2013 the Uruguayan peso was devaluated by 15%. The current real inflation is trending towards 15% but, this is just a coincidence!!! Nothing to see here, keep moving, keep moving…

And now, for something completely different, as the Monty Pythons would say.

Let's take a look at reality. Please dear reader, observe the the graph below.

Uruguay Inflation and Consequences

This graph needs some explaining.

The Red line is the average Uruguayan inflation per decade.

The Blue line is the average cumulative loss of purchasing power in Uruguay

The dotted Black line is the average Uruguayan GDP change per decade

The Green Zone marks the decades when Uruguay had a Gold Standard

The Pinkish Zone marks the decades when Uruguay had Fiat money

The values of the 2010-2020 decade are extrapolations from current data.

Let's see if we can make sense of this graph.

Between 1870 and 1915 there was almost no inflation and the purchase power was pretty much unchanged at 100%. This coincided with the Gold Standard.

Between 1915 and 1925, Uruguay suspended the Gold Standard and started printing Fiat money. During this period inflation spikes and the purchase power starts to drop (after a lag due to the influence of the previous Gold Standard).

During 1925 and 1935, Uruguay returns to the Gold Standard and we can see that inflation is stopped dead on its track and at the same time the loss of purchasing power begins to slow down.

After 1935, when Uruguay finally drops the Gold Standard in favor of Fiat money, purchasing power drops like a stone, achieving a momentous milestone of reaching zero value when compared to gold (this happened sometime in 1969). Meanwhile, we can also see that since 1935 inflation becomes, in essence, out of control and the Uruguayan government produces not one but two currency changes in a ratio of 1:1000. This is, each new–and–improved unit of currency is worth 1000 times one of the old ones. This is called "chopping zeros" in economic slang.

The moral of this story is clear.

Inflation is produced by fiat money, this is, Central Bank printing.

But how about the assertion that inflation is the result of a fully active economy?

Ahhh… grasshopper, we have an answer to that too.

If you care to take a look at the graph, you will notice the Black dotted line. This line is the average GDP variation per decade (in percentage - the scale was linearly modified to make it more visible, but this does not change its meaning in any way). If it is true that an increase in economic activity also increases inflation, then, the opposite should also be true.

In the two decades between 1960 to 1980 the GDP was dropping like a stone, yet, inflation increased!!!

Hummm…

In the next two decades, between 1980 to 2000, when the GDP actually grew, inflation remained flat or began to drop!!!

Hummmm…

And then, past the 2000, when the GDP remained flat, inflation continued to drop!!!

So, for some strange reason the economy and the inflation had the exact opposite relationship from what Uruguayan economists keep saying. Worse. This happen for over 40 years!!! This cannot be dismissed as a blip in the statistical radar. Something is severely screwed-up in this picture… and we know what it is.

It is simple. Inflation is purely a Central Bank issue. The more the Central Bank prints, the more inflation one gets. This is as basic as one can possibly get… yet, we keep hearing the very same nonsense from economists time and time again. GDP growth (i.e. an increase in economic activity) does not spur inflation. However, printing will affect the GDP but the effects change over time; they are not permanent and this process invariably end up in tears.

It's the Magic Potion and the Magic Elixir all over again.

Pixie dust and magic beans.

Economic witchcraft and computerized crystal ball glancing.

It is precisely for this reason and because of this kind of world-wide Bull Shit (or Horse Manure - we are a non-discriminating organization) that we publish our thoughts. The whole system is corrupted and broken no matter which country you look at. It's all the same across the globe.

And if this is true, and we meant really true, then, there is only one solution: get rid of all governments!

It is for this reason that we are Absolute Austro-Libertarians, because we believe in people, not the state. We believe in you.

You can now continue to believe in economic hocus-pocus or look at reality in the face. It's your choice; we can only show you the big picture. It's up to you to look in its direction. Or not.

Note: please see the Glossary if you are unfamiliar with certain words.

 

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