Inflation Is Noise in the Price Signal

Americans are well-acquainted with the primary effect of inflation– higher prices across the economy. Those not versed in Austrian Business Cycle Theory may not realize that inflation also disrupts and confuses economic calculation, the critical process by which capital is directed toward its best use.

The following article was originally published by the Mises Institute. The opinions expressed do not necessarily reflect those of Peter Schiff or SchiffGold.

In 1948, Claude Shannon published “A Mathematical Theory of Communication” in the Bell System Technical Journal, a paper that established information theory as a formal discipline. Shannon’s central contribution was to show that information can be measured, that communication channels have finite capacity, and that—when noise is introduced into a channel—the receiver’s ability to reconstruct the original message degrades in precise, calculable ways. The paper was concerned with telephone wires and radio signals, but its logic applies to any system in which one agent transmits information to another—including the system through which millions of economic actors coordinate their plans through prices.

A market price is an information packet. It encodes the scarcity of a resource, the cost of producing it, the state of demand from consumers, and the expectations of everyone who has traded it recently; all compressed into a single number that any buyer or seller can act on without knowing any of the underlying details. Friedrich Hayek’s 1945 essay “The Use of Knowledge in Society” described how this compression works: no central planner can gather and process the dispersed local knowledge that prices summarize, which is why decentralized markets outperform central planning at allocating resources. What Hayek described was, in the language Shannon would formalize three years later, a distributed information network operating near its theoretical efficiency limit.…