A Promise to Inflate

Copyright 1967, Los Angeles Times. Reprinted by permission.

Lyndon B. Johnson “pledged” the American people in his State of the Union message to “do every­thing in the President’s power to lower interest rates and to ease money.” Whether he knows it or not, this was a pledge to resume and increase inflation.

He blandly took it for granted that it is a legitimate function of government to decide how high in­terest rates ought to be.

To begin with, this is govern­ment price-fixing, for the interest rate is a price. It is, in fact, the most important single price in the whole economy. It is the discount on future goods as against present goods. It affects the price of every­thing else.

But under the influence of his Keynesian advisers, Mr. Johnson tells us that his administration “will press forward toward easier credit and toward lower interest rates.” What he and they fail to see are the consequences of trying to do this.

If the free market rate of inter­est on short-term loans to business were under given conditions 6 per cent, and government arbitrarily ruled that it must be only 5 per cent or 4 per cent, the demand for loans to business would be much greater than the supply of exist­ing funds. Credit would then have to be rationed among different borrowers, with the government dictating who should get how much.

This is precisely what the Fed­eral Reserve Board tried to do last September when it demanded a curb on bank loans to business so that more credit would be available in other directions. It has since wisely revoked this directive.

The only other way in which gov­ernment monetary authorities can hold the rate of interest below the market rate is either to allow the quantity of money to increase or deliberately to increase it. Other things being equal, lower interest rates encourage business borrow­ing from the banks. When banks increase their loans, they increase their deposit credits. These in­creased deposits are an increase in the effective supply of money.

The monetary authorities may increase the money supply on their own initiative by buying govern­ment securities in the open market. They pay for these either by grant­ing increased deposit credits to the member banks from which they bought the securities or by issuing and paying out new Federal Re­serve notes. This is known as “monetizing” government securi­ties.

Governments (and many busi­nessmen and bankers) think this is fine because the increased bor­rowing and money creation, at the beginning, stimulates production and employment.

But it also soon has another ef­fect. The increased supply of dol­lars cheapens the value of the dol­lar and raises prices. The higher prices then tend to halt the increase in demand. Because of the higher prices, businessmen have to in­crease the amount of their borrow­ing still further to continue to do the same volume of business. If the monetary authorities then fail to continue the inflation by issuing still more money, interest rates soar.

That is what happened last Sep­tember when interest rates went to their highest levels in more than 30 years.

Trying to force interest rates below their natural level finally re­sults in causing them to rise much above their natural level.

Easy money policies, in short, finally lead to the opposite results from those that their sponsors hope for. What is temporarily saved in interest is more than lost in higher prices.

Easy money policies are infla­tionary policies. It makes no sense at all to ask at the same time for higher taxes and for cheaper money.