Mr. Fertig is a noted economist and journalist. This article is extracted by permission from a paper delivered November 14, 1974 at a conference of the Committee for Monetary Research and Education.
Just a few months ago when President Ford took office it was proclaimed from the White House, and nightly on television and in the press, that inflation is our Enemy Number One. But then — in the words of the famous play — a Funny Thing Happened on the Way to the much-publicized Summit meetings. It was discovered by many authorities that inflation is not necessarily Enemy Number One, but might be considered Enemy One-Half, One-Fourth —or perhaps Enemy Zero.
It was said we faced what was called "Stagflation," and it was asserted that we had better fight the "Stag" part and not pay too much attention to the "flation." Professor Walter Heller, who had viewed with unconcern the substantial monetary inflation of the past many years, asserted some months ago that our present trouble is "the costly stagnation arising out of a short-fall in aggregate demand." Other distinguished professors lent their authority to this diagnosis. Professor James Tobin of Yale declared in an ingenious formulation that "Monetary inflation is not the cause of current rising prices," and he agreed with Dr. Heller that a good prescription was a little more of the hair of the dog that bit you.
Since monetary inflation, which is always and everywhere the basis of price inflation is being thus minimized, I conclude that some attention might well be paid to assessing the political costs of this dangerous process.
Some people ask, "Why this heavy accent on curbing inflation when it is now plain that we are in the midst of a serious recession?" The answer to that question is two-fold. In the first place this recession and all its symptoms — rising unemployment, falling commodity prices, lower production, and the like — are the direct result of the previous roaring inflation and constitute the penalty that must be paid if the dangerous inflation of past years is to be brought under control. This nation has been on a monetary binge, and our financial managers have created a vast ocean of paper money and credit which has had its baneful effect on markets.
The Danger of Hyper-Inflation
The second part of the answer to the above question is most important. We have the power to curb the inflationary process over the period of a year or two at the cost of recession and some national sacrifice. If we do so we will lay the foundation for a much sounder economy — an economy that can produce efficiently and amply. But if we do not take restrictive measures now, then inevitably we will be headed for a roaring hyper-inflation. This could well result in price increases five or ten times as great as those we have already suffered. So the choice is either recession and curbing the monetary inflation now versus a continuation of our past monetary policy which could result in hyper-inflation and national disaster.
It’s plain, I believe, that the political, economic and social costs of inflation are all bound up together. It is impossible to disentangle one from the other. They act and re-act upon each other as both cause and effect. For instance, when a government inflates its currency to cover a substantial deficit, and after a time-lag prices zoom upward, the natural result is social unrest. In turn, the frustrations of citizens may cause them to succumb to the blandishments of politicians who offer economic nostrums which result in socialization, a decline in essential capital investment, and a fall in the standard of living.
This is precisely what happened in Britain after Mr. Heath chose to inflate in 1971 in order to achieve "growth" and to meet the money demands of the labor unions. The results of the October 1974 election will surely be a giant step toward a poorer, Socialist Britain. While Wilson has a majority of only three seats, he can count on many of the 14 Scottish and Welsh nationalists to vote with him on such crushing legislation as a tax on wealth, increased subsidies, price controls, and perhaps even on the nationalization of some large industries. No, we cannot unscramble the economic, social and political where parliamentary government prevails and every citizen is entitled to cast a ballot in free elections.
However horrible may be the consequences of continued monetary inflation, the penalties to be borne for a continuation of this policy are generally believed to be sometime in the future. Of course the distant future never presents the terrors of the immediate present. So it is generally felt that we can rest on our oars a little. It is rather pleasant, as even Professor Galbraith pointed out, to fight a possible recession by monetary expansion rather than to contain a present inflation by monetary restraint.
Economic Nationalism Ahead
One of the most frightening political costs of continued inflation, which isn’t obvious to the general public, is the intolerable strain on our international alliances and the frenzied flight toward economic nationalism. Nations try to offset the detrimental consequences of inflation by import quotas, higher tariffs, subsidies for export, and the like. But it is plain that in a world in which practically every naton is inflating — not every nation can have an export surplus. This kind of competition causes acrimonious debates among former friends.
Many people used to glibly assert that devaluation of a nation’s currency is a prescription to cure its economic difficulties. Since its exports would be cheaper in world markets after devaluation, such a move, it was said, would redress its balance of payments. In the short run this would perhaps be so, but not in the long run. Imports for such a nation become more expensive. Other nations can play that game too, by devaluating their currency. In time, real values of international products tend to re-establish their old relationship, all other things being equal.
Regardless of long-term effects, a nation in trouble because of inflation always seeks to gain a temporary advantage by any possible means. Under such conditions the weakening and eventual breakup of political alliances becomes very probable. At that point, the non-Communist nations of the West are in as grave danger as the weakened traveler in the arctic who is no longer able to resist the attack of wolves. If, under these conditions major nations of the West succumb, there would be no return to parliamentary government. If Communist regimes were established in any of the major nations of the West, it would be almost impossible to overthrow them and return to a free society.
It’s interesting to note that in another age — from the mid-19th Century to World War I — when nations voluntarily subjected themselves to monetary discipline, when internal adjustments of inflationary and deflationary forces were automatic, the break-up of the Western world was not threatened. Those were the days when nations were guided by the rules of neo-classical economics, when major wars were few and far between, and when nations adjusted themselves voluntarily to economic realities.
One more point needs to be emphasized in discussing the international repercussions of inflation. The essential defense of the United States becomes endangered since it is politically impossible to cut total Federal expenditures without seriously eroding the defense budget.
While the defense budget becomes an easy target of attack, the very largest, the most overblown department in U.S. government, which spends more than any other, is almost sacrosanct. The Department of Health, Education, and Welfare, with a current budget of $110 billion after severe trimming, still represents a 16 per cent increase over last year. I must note that the subsidy checks which go out from this Department to tens of millions of voters are a powerful political force in causing fear on the part of anyone in political life who wishes to drastically revise this budget.
On the domestic effects of in-inflation, the incontestable fact is that inflation undermines and corrodes the economic, political and social structure of a nation. Its long-run effects are catastrophic. In the long run it is death to parliamentary government itself.
Consider for a moment the effect of continued inflation upon the political structure of this country. The government of the United States is no more stable than the emotions and ideas of the electorate who ultimately control the legislature and, as Mr. Dooley said, even the Supreme Court. Representative government in time responds to the insistent demands of an outraged public.
What are the reactions of millions of people who find themselves frustrated and helpless in the face of rising prices which they cannot control? It is quite natural to opt for any short-term solution which, it is claimed by candidates for high office, will ease their pain. That so-called solution may have nothing whatever to do with the cause of inflation. But it may be plausibly presented and emotionally approved by the electorate.
The basic problem is simply this. Under great stress people tend to approve solutions which seem to provide short-term benefits, but which will in the long run have tragic consequences. They are unwilling, for any length of time, to subject themselves to short-run costs and restraints. When people feel that way, their representatives in government subscribe to current demands and provide short-run panaceas — regardless of long-run effects.
The terrible price we pay for political intervention to achieve short-run effects in an era of inflation is well illustrated by our current policy to meet the energy shortage. The government now sets the price of domestic "old oil" at less than half the true market price. It is estimated this currently saves the consumer about a nickel on a gallon of gasoline. But it also means that, because ofthe present lower consumer price and the increased consumer demand, we are importing 500,000 barrels a day of higher-priced oil — thus becoming hostage to the Arab world.
Now, in the long run the way to defeat the Arab cartel is to increase the American price of oil. This would stimulate more exploration and production, and most important, it would stimulate energy substitutes — gasification of coal, and so forth, which will become profitable to produce only when oil sells at a higher price. So what do we choose — a nickel or a dime now — or American independence of Arabs? There, in a nutshell, is a horrible example of the baneful effect of government intervention during an inflationary period.
2-Party System Undermined
Now this accent on immediate benefits encourages demagoguery. It politically rewards the demagogue who promises most. In effect it tends to undermine the two-party system without which the United States would fall victim even more easily to the demands of minorities and to the chaos which frequently characterizes multi-party government. The reason it undermines the two-party system is because it becomes unprofitable and even politically dangerous for a major party to oppose insistent public demand. Such opposition is usually penalized at the polls, no matter how statesmanlike, how right, how wise the opposition may be.
Today we know that even if it is at all possible to curb inflation by a gradual approach over many years, some sacrifice, some restraint, some fortitude on the part of the public is required. Will it be forthcoming over many months and perhaps over several years? That is the question which must be answered before we know whether we can curb inflation. The crucial point is that the problem is a political one and not altogether economic.
During a long period of inflation, when the public is distressed and frustrated, it inevitably looks around for a scapegoat. That uncontrollable desire to "hang somebody for the fix we’re in" is aided and abetted not only by demagogic politicians but even by more moderate legislators who shudder at standing in the way of the steam-roller of public opinion.
Now who would you guess would be the most natural scapegoat — the unperson, so to speak, who has few defenders and a host of critics? Why of course it’s the Corporation — big business which we know is largely responsible for the fantastic increase in America’s standard of living, and which is the income producer for most families.
Muckraking is an old and honored tradition in this country, especially by leading commentators on TV and radio, by columnists, by intellectuals in the academic fraternity, and many others who are important in the formation of public opinion.
No matter how logical the answer made by corporations to these attacks, no matter how tightly reasoned the defense, the opposition poisons public opinion and urges the politicians to penalize profits and capital investment. But it is an elementary fact that increased capital investment and profit opportunities for business are the only possible way for a nation to improve its standard of living. No matter — Naderism will have its day, and the attempt will be made to inflame the public against "excessive profits." The fact that profits were inordinately low for a decade or more (as in the steel industry), or that high profits are necessary to attract capital to a most needed resource such as oil — all this seems to have little bearing upon public opinion during an inflationary period. When economists point to "phantom profits" due to inadequate depreciation and to false inventory profits, the answer of politicians and of the public when inflation is rampant is a mere shrug of the shoulders. The stated dollar increase of corporate profits becomes ipso facto an indictment of corporations.
Envy Is Encouraged
Not only are corporations adversely affected by the public reaction to inflation, but individuals and groups who are important in their performance of basic economic functions are also subject to attack. During a high level inflation there is naturally a tremendous amount of speculation. Speculators, short-sellers, commodity traders, all perform a function in the market. But they become targets for political attacks to a great extent because they are successful in offsetting the effects of inflation. In fact, any group in society which becomes affluent under an inflation is open to attack.
In any analysis of this phenomenon, I would call attention to a basic psychological fact which is treated in masterly fashion by Professor Helmut Schoeck. His scholarly book, Envy, uncovers and reveals the social and political implications of a deeply repressed motive — envy. Professor Schoeck says "Envy is a drive which lies at the core of man’s life and social being." Sociologists of modern liberal persuasion refuse to admit this, but it seems to me a very meaningful assumption. During any violent inflation this basic human trait is exacerbated, and expresses itself in oppressive social and political action.
Death of Parliamentary Government
I have catalogued briefly some of the political consequences of continued inflation. But I do not believe that the public generally realizes what a corrosive social and political force it can be. As I pointed out earlier in this discussion, politicians who appeal to the public seem ready to give them every kind of assurance and are often unscrupulous in recommending measures which will not only be unrelated to curbing the inflation but will actually, in the long run, increase it. As it continues over the years, inflation becomes so unmanageable that finally there is one inevitable consequence. It is a distressing fact that under continued high-level inflation parliamentary government and the democratic process will die. The repressive measures essential to curbing hyper-inflation can never be undertaken by freely-elected representatives in parliamentary fashion. It requires a dictator and the power of an army behind him to put into effect those measures which will curb a violent inflation over the years. The inevitable consequence is for the public to rely upon the promises of some man on horseback.
This is precisely what happened in Brazil and in Argentina. And this pattern will beyond doubt be repeated in other countries of the world when their inflation gets severe enough and becomes unmanageable. In Brazil inflation reached the proportion of 90 per cent annually, when parliamentary government was eliminated and the Army was called in. A similar set of circumstances prevailed in Argentina. In recent months we have been reading of the threat of military action proposed even in the home of the Mother of Parliaments — Great Britain. The inevitable arrival of dictatorship when inflation is prolonged and severe enough is a distressing fact which we must face, but it is one to which the public has never been adequately educated.
Now, since the penalties of continued inflation can be so tragic and since monetary restraint is at the heart of the solution to this great problem, what hope is there in the United States? There is a glimmer — only a glimmer of hope — in the fact that after January 1st gold can be owned by American citizens. The price of gold will hold up a mirror to the weakness or strength of the dollar. It will, to some extent, act as an automatic restraint on dollar creation. But this is not enough. It is essential that we be permitted to make contracts with each other payable in gold, or in the dollar value of gold. Whether this is permissible now under our present laws is a grave question. But there is no doubt that in a free society contracts made in gold should be just as permissible as contracts made in any other commodity. This — plus the ownership of gold — would act as a brake on the insatiable appetite of government for more and more printed paper money. It would be a most important aid in the fight against inflation.
It is quite easy, of course, to state some of the terrible costs —political, social and economic — of continued inflation. If the public really grasped the tragic nature of inflationary consequences it would respond more readily to the discipline which would curb inflation. But it will never respond until there appears on the scene a political leader who is willing to lay his career on the line and, as the saying goes, "tell it as it is." That leader may never again be elected to high public office, but he will have performed a noble public duty which would in history earn the gratitude of this nation.