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Friday, December 12, 2014

#35—“Government Is an Inflation Fighter”


 

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#35—“Government Is an Inflation Fighter”

“Government,” observed the renowned Austrian economist Ludwig von Mises, “is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.”

Mises was describing the curse of inflation, the process whereby government expands a nation’s money supply and thereby erodes the value of each monetary unit—dollar, peso, pound, franc, or whatever. It shows up in the form of rising prices, which most people confuse with the inflation itself. The distinction is important because, as economist Percy Greaves once explained so eloquently, “Changing the definition changes the responsibility.”

Define inflation as rising prices and, like Jimmy Carter, you’ll think that oil sheiks, credit cards, and private businesses are the culprits, and price controls are the answer. Define inflation in the classic fashion as an increase in the supply of money, with rising prices as a consequence, and you then have to ask the revealing question, “Who increases the money supply?” Only one entity can do that legally; all others are called “counterfeiters” and go to jail.

It’s certainly true that many things, some beyond the control of any human being, can cause some prices to rise. A freeze in Florida, by reducing the supply of oranges at least temporarily, will prompt a spurt in orange juice prices. Bombing factories in wartime will boost the prices of whatever those factories were making. After people pay higher prices for reduced supplies, they may have less money in their pockets for buying other things, causing downward pressure on those other prices. But a prolonged, broad-based rise in most or all prices is the result of one thing: a decline in the value of money, and that occurs because whoever is producing the money is overdoing it.

Consider this analogy: Let’s say you like Campbell’s tomato soup so much you eat it every week. Then one week you notice that it’s a little less red and doesn’t taste quite as “tomatoey.” A week later, it’s downright pink instead of red and tastes more like water than tomatoes. Week after week this disagreeable trend continues. Would you blame consumers or would you point your finger at Campbell’s, the producer? When your money buys less and less, year after year, what sense would it make to blame the people who use the stuff instead of the people who manufacture the stuff?

Most economists worth their salt have long argued that inflation is always and everywhere a monetary matter. As one of them put it, rising prices no more cause inflation than wet streets cause rain. The monetary authorities inflate and then prices rise, in that order, and if the people’s confidence in that money dissipates, the price hikes will be astronomical. A little history lesson is in order.

Before paper money, governments inflated by diminishing the precious-metal content of their coinage. The ancient prophet Isaiah reprimanded the Israelites with these words: “Thy silver has become dross, thy wine mixed with water.” Roman emperors repeatedly melted down the silver denarius and added junk metals until the denarius was less than 1 percent silver. The Saracens of Spain clipped the edges of their coins so they could mint more until the coins became too small to circulate. Prices rose as a mirror image of the currency’s worth.

Rising prices are not the only consequence of monetary expansion. Inflation also erodes savings and encourages debt. It undermines confidence and deters investment. It destabilizes the economy by fostering booms and busts. If it’s bad enough, it can even wipe out the very government responsible for it in the first place. It can lead to even worse afflictions. Hitler and Napoleon both rose to power in part because of the chaos of runaway inflations.

All this raises many issues economists have long debated and about which I have my own views. Who or what should determine a nation’s supply of money? Why do governments so regularly mismanage it? What is the connection between fiscal and monetary policy? Suffice it to say here that governments inflate because their appetite for revenue exceeds their willingness to tax or their ability to borrow. British economist John Maynard Keynes was an influential charlatan in many ways, but he nailed it when he wrote, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

At varying rates, the unbacked (or “fiat”) paper money issued by government central banks has been falling in value all over the world for decades. Even the U.S. dollar is worth about a nickel of its value in 1915, the first full year of operation of its monopoly issuer, the Federal Reserve. In recent years, perhaps no place was more ravaged by inflation than Zimbabwe in southern Africa. Prices there rocketed upwards at an annual rate exceeding 11 million percent in 2007. After printing trillions of Zimbabwean dollars to finance its socialist schemes, the Mugabe dictatorship ruined the currency utterly.

South America is home to many serial inflationists—corrupt, crackpot regimes that destroy one paper money after another. Prices in Argentina and Venezuela, for example, are currently climbing between 50 and 100 percent annually, and all indications are that the rates will accelerate in coming months.

In April 1985 I visited Bolivia to observe the world’s then-highest rate of price hikes, an astonishing 50,000 percent. After stiffing its foreign creditors in the early 1980s, the government in La Paz could only finance its bad habits through taxing its own people and printing paper money. It did lots of both. By 1985, however, only 10 percent of its spending was covered by taxes; the rest was taken care of by the printing press. Paper money became the country’s third largest import. Its own presses couldn’t keep up with the government’s demands, so planeloads of the stuff were flown in every week from Europe.

On the day I arrived, the Bolivian peso traded at 150,000 to the dollar. Just days later, it had sunk to 200,000. I brought nine million pesos home with me—a million pesos (in 1,000-peso notes) in each of nine wads bound together with string by a local bank. I kept one million, which I have to this day, and sold the other eight to gold bugs and currency collectors for $500 each. Not bad, considering that, at 200,000 to the buck, I paid just $5 for each million-peso wad ($45 for the whole nine million). That little bit of international arbitrage financed my trip, incidentally.

Bolivian hyperinflation ended just four months later, in August 1985, after the socialist government that engineered it was ousted. It had printed pesos until they were worth less than the ink and paper.

So, you say, inflation may be nasty business but it’s just the really rotten few that do it. Not so. The late Frederick Leith-Ross, a famous authority on international finance, observed: “Inflation is like sin; every government denounces it and every government practices it.” Even Americans have witnessed hyperinflations that destroyed two currencies—the ill-fated continental dollar of the Revolutionary War and the doomed Confederate money of the Civil War.

Today’s slow-motion dollar depreciation, with prices rising at persistent but mere single-digit rates, is just a limited version of the same process. Government spends, runs deficits, and pays some of its bills through the inflation tax. How long it can go on is a matter of speculation, but trillions in national debt and public officials who get elected by making promises they don’t want to pay for are not factors that should encourage us. Government is not an inflation fighter. In a world of deficit budgets, out-of-control public sector spending and debt, and pie-in-the-sky promises that government will give you just about everything, government is an inflation factory.

So it is that inflation is very much with us and is arguably one of the inevitable consequences of government run amok. But it’s not a permanent, sustainable policy. It must end someday. A currency’s value is not bottomless. Its erosion must cease either because government stops its reckless printing or prints until it wrecks the money. Surely, which way it concludes will depend in large measure on whether its victims come to understand what it is and where it comes from.

Summary

  • When you change the definition of “inflation,” you change the responsibility for it.
  • Inflation is not rising prices. In fact, you have inflation first and then as one of the consequences, you get rising prices. Inflation, properly defined, involves an increase in the supply of money.
  • Historically, the more control government exerts over money, the more likely the money will lose its value. The more that government spends and doesn’t pay for with tax revenue, the more likely it will resort to the printing press.
  • It’s far more accurate to think of government as an inflation factory, not an inflation fighter.
  • For further information, see:

“Something Besides Money Growth Causes Inflation?” by Howard Baetjer: http://tinyurl.com/prt2cpe

“Toward Radical Monetary Reform” by Lawrence W. Reed: http://tinyurl.com/p7af4jm

“Lessons of the German Inflation” by Henry Hazlitt: http://tinyurl.com/pefhnfp

“The Causes of Inflation” by Hans Sennholz: http://tinyurl.com/mstjqmk

“What Price Control Really Means” by Lawrence W. Reed: http://tinyurl.com/qjuzmjx


  • Lawrence W. Reed is FEE's President Emeritus, having previously served for nearly 11 years as FEE’s president (2008-2019). He is also FEE's Humphreys Family Senior Fellow and Ron Manners Global Ambassador for Liberty. His Facebook page is here and his personal website is lawrencewreed.com.