Mrs. Greaves is a member of the senior staff of The Foundation for Economic Education, author of the two volume Free Market Economics published by the Foundation in 1975, and translator of Ludwig von Mises’ On the Manipulation of Money and Credit, Percy L Greaves, Jr., editor (Dobbs Ferry, N.Y.: Free Market Books, 1978).
Whenever we act, we want our actions to be successful. It always helps to take stock of the past and to try to foresee the future. As all of us are buyers of some things and sellers of others, the more we can know about what is likely to happen to prices the better.
Nowadays, more and more people complain of the higher and higher prices asked for practically all the things they want to buy and they expect prices to keep on rising further. Many say these higher prices are "inflation." Then, because most producers and sellers of goods and services raise their prices frequently, people blame them for "inflation." They blame businessmen who are asking higher prices, labor unions who obtain higher wages for their members, the international oil cartel (OPEC) when it raises the price of petroleum, farmers who ask more for beef, manufacturers who raise steel prices which add to the costs of producing many other items. Then, when the higher prices of U.S. manufactured goods discourage foreigners from buying, they blame the declining "balance of payments" due to fewer sales abroad. The list of culprits blamed for "inflation" is almost as long as the number of persons offering goods on the market.
Usually ignored in these discussions is the one thing all prices have in common—the fact that they are expressed in dollars. Because prices are dollar prices, it would seem obvious that the number of dollars must have something to do with higher prices and "inflation."
Certainly people with more money will be able to spend more than those with less. They will generally be willing—and able—to offer higher prices for any particular item they want. Thus, when higher prices are not only being asked, but are actually being paid, for many or most goods and services on the market, it must mean that many people have more dollars to spend. Therefore, an increase in the number of dollars may be the real culprit to blame for higher prices. Perhaps the increase in the quantity of money itself is the real "inflation." Let us look at the situation.
Do People Have More Dollars?
In this country, only the national government, the Federal Reserve, and the banking system are now legally permitted to create U.S. dollars. If you and I were to manufacture dollar bills, this would be "counterfeiting." But the U.S. government and the banks may add to the money stock without fear of penalty. And they do just that. This expansion is carried out primarily by monetizing Federal debt, by Federal Reserve "open market operations" and by credit expansion through commercial bank loans to private borrowers. In other words, the Federal Reserve System, with the aid and support of the U.S. government, is responsible for the number of dollars in existence.
The official estimate of U.S. dollars is reported regularly by the Federal Reserve. Their figures show that the stock of money has been increased tremendously in recent decades, especially since World War II. It was almost doubled during the War—from about $64.5 billion at the end of 1941 to $132.5 billion by the end of 1945. Since then the number of U.S. dollars has mushroomed—during Republican and Democratic administrations alike. From a figure of $620 billion in January 1975, the money stock (currency plus private checking deposits plus commercial time and savings deposits) rose to $806 billion at the end of 1977. With so many new dollars being created is it any wonder that many people are spending more than ever before? As a matter of fact, the increase in the number of dollars is inflation. It is this increase that accounts for the higher prices we all must pay for most of the things we buy.
Who Spends the Newly Created Dollars?
Who spends the newly created dollars? And for what? That depends on the choices and actions of those who receive them—(a) the U.S. government, (b) the banks expanding credit to make loans and (c) those who receive the funds created. When the U.S. government is the beneficiary, the newly created dollars go into the general "pot" and are drawn on for various expenses. When the new dollars are issued by the banks in the form of increased loans, the banks determine to whom they are lent and each borrower decides how to use his borrowed money.
From October 1, 1976, through September 30, 1977, the federal government spent $406.4 billion, only $358.3 billion of which were covered by its receipts from various sources—taxes, bonds sold to private persons, revenues paid for services rendered, and the like. Newly created money and/or credit made up the difference of $48.1 billion. When the government spends these newly created dollars, they go for its various programs. No one knows who is getting old dollars earned in production and paid to the government in taxes and who is getting new ones. The tax funds and the newly created money all look alike and all go into the same U.S. government "pot" from which it pays its expenses.
However, we can be sure that these additional dollars enable the federal government to spend more freely and to support more no producers than it otherwise could. And such federal programs, transferring wealth from producers and taxpayers to others who earn little or nothing themselves, have been growing fast. In 1975, Roy L. Ash, formerly director of the federal government’s Office of Management and Budget, estimated that the U.S. government’s "transfer payments" such as Social Security, payments to retired railroad and government employees, for Medicare and Medicaid, for welfare and social services, for food stamps, for veterans benefits and for the unemployed then comprised one-half of federal expenditures—up from only 20 per cent in 1950 (Wall Street Journal, July 28, 1975).
Not surprisingly, those who benefit under these government "transfer" programs are more willing and better able to pay higher dollar prices for the things they want than if they had to rely on their own resources. Their greater willingness to spend enables those who sell to them to ask for, and to receive, higher prices for these particular items. And these sellers must ask for more, if they want to stretch out their available supplies to meet the new demand from "transfer payment" recipients. Thus, the pressure toward higher prices increases. Then step by step, as the newly created money travels from one seller to another, it begins to affect other prices also.
When the new dollars come on the market in the form of bank loans to private consumers and business firms, the new borrowers are in a position to offer higher prices than before for whatever they want. Whether they spend their borrowed funds for consumers’ goods, to hire workers, to purchase raw materials, to build factories, to expand or to start new production, those offering these particular goods or services on the market soon learn that these new borrowers will pay more than most previous customers had been ready to pay. Then they too begin to raise their asking prices in response to this newly stimulated demand.
This helps to stretch out the available supplies to meet the increased demand. It also serves to spur producers to expand production or to embark on new projects to satisfy their new customers. Then again, step by step over time, as the newly created money is traded from person to person the higher prices paid by beneficiaries of this credit expansion influence other prices also.
What are the effects of creating new dollars? One effect of creating additional dollars, i.e., of inflation, as we have seen, is generally higher prices. However, they are only one effect. And they are not the most serious effect of inflation at that.
Increasing the number of dollars leads to shifts in wealth and income. As prices rise, more dollars are needed to buy things. The dollar’s purchasing power goes down. As a result also the value of the dollar declines in the minds of people. Anyone who has been holding dollars and/or somebody’s promise to pay dollars, suffers the loss of a part of their value. After a time when he spends his dollar savings, he encounters higher prices then prevailed when he was working and saving. Without going near his wallet, "piggy bank" or savings deposit, the inflaters have deprived him of a part of his wealth. The beneficiaries of the inflation and those who receive unexpectedly higher prices for their goods and services gain "windfall profits" at the expense of the previous owners of dollars and assets fixed in dollars.
Increasing the number of dollars discourages saving. Certainly if new dollars are being created in large quantities, holding dollars offers no real assurance of having anything like the same purchasing power later. Why work hard and save if the purchasing power of any dollar saved is expected to fall? Better spend one’s entire pay check, enjoy life today and hope for the best tomorrow.
Increasing dollars spent on "transfer payments" helps to keep no producers dependent on government handouts. With respect to one form of "transfer payment," the great free market economist Ludwig von Mises (18811973) described unemployment relief in 1931 as "one link in the chain of causes which actually makes unemployment a long-term mass phenomenon." By paying people not to work, "transfer payments" help keep no producers idle. Thus they tend to weaken self-respect and individual responsibility. At the same time, the cost of paying more and more no producers becomes an increasingly heavy burden on those who continue working and producing. If the programs are not discontinued taxes must be increased again and again. Or government officials, who believe sincerely in the "need" for continuing "transfer payments," are likely to resort to further inflation.
Higher taxes and more inflation are serious drags on production. They distort prices, alter the pattern of production, shift wealth from savers to spenders, discourage savings and investment and hamper individual effort, initiative and ingenuity.
Destroys Hope for Security and Independence
Perhaps the most demoralizing effect of inflation, however, is that it discourages the desire and the hope of people for financial security and economic independence. It first destroys the value of the dollar so as to weaken the incentive to save. Then by holding out the hope of government guaranteed security from retirement to the grave, government undermines one of the most powerful reasons to strive for financial independence. Self-respect, individual responsibility and family ties are bound to suffer. Thus, the end result of inflation is to dampen ambition, industry, the desire to save and invest, and pride in personal accomplishment and independence—all traits on which the future freedom and welfare of this country must rest.