Mr. Hazlitt is the well-known economist and financial analyst, columnist, lecturer, and author of numerous books.
What is the present outlook for inflation in the United States?
In trying to answer that question it is well to begin by reminding ourselves of how long we have been having inflation and how far it has already gone.
We started to depreciate our money officially, so to speak, in 1933, when we not only suspended gold payments but prohibited our citizens from owning gold. Then in 1934 we devalued the dollar in terms of gold by 41 per cent.
So far as the movement of prices is concerned, however, the most convenient benchmark to take is 1939. The average prices that consumers pay in the United States today are 167 per cent higher than in 1939. Putting this in another way, today’s dollar has only as much purchasing power as 37 cents had then.
Some people are trying to take comfort from the fact that the annual rate of price rise, on the official index, is still slightly less than 6 per cent a year. Is that worth worrying about?
I think it is. Let me quote an excerpt from a calculation made in its bulletin of August 26, 1969, by S. J. Rundt & Associates, a leading consulting firm on international monetary affairs:
An American who starts to work at 18 and who must live with 5.5 per cent per annum inflation will see prices double before he is 31. And he will see prices doubled for the third time in his adult life ahead of his 57th birthday. And if a healthy constitution and modern medicine keep him going, he will see prices doubled for the fourth time prior to age 70. In other words, when he reaches 70 he will have to pay 16 times as much for whatever he buys as he did when he started out in gainful life. His greenback will have shriveled to 61/4 cents, or by 93.75 per cent.
If we carry this calculation on to the young man’s 83rd birthday, prices will have doubled once more; he will have to pay 32 times as much for equivalent goods and services as he did when he took the first job; his dollar will have shrunk to a mere 3¹/s cents.
The only trouble with the foregoing calculation is that it is already outdated. Prices have recently been rising at an annual rate close to 6 per cent. At such a rate prices would double every 12 years instead of every 13.
How It Began
How did our present inflation get started? And how did we get to the point where we are? Our inflation came about, to put it briefly, because for 30 out of the past 38 years the Federal government has been spending more money than it has taken in taxes, and has paid for the difference by printing irredeemable paper money. At the end of 1939, the nation’s stock of money, as measured by currency in circulation and demand bank deposits, was $36 billion. Today it is $200 billion, almost a sixfold increase.
Inflation is caused, always and everywhere, by an increase in the stock of money and credit in excess of any increase in the supply of goods and services. The five- or sixfold increase in the supply of money in the last thirty years might have resulted in something like a five- or sixfold increase in prices if it had not been for a substantial increase also in the production of goods and services in that period. The official index of industrial production has increased more than fourfold in that period. This is the main reason why the increase in prices was not as great in that period as the increase in the stock of money.
In trying to forecast the probable future of inflation, it is important to keep in mind that this inflation is not something confined to the United States. In the same period, most countries have inflated even more. Though the American dollar at the end of 1968 bought only 83 per cent as much as it had ten years before, the German mark bought only 80 per cent as much, the Swiss franc only 76 per cent as much, the British pound only 74 per cent as much, the French franc only 69 per cent as much, the Japanese yen only 62 per cent as much, the Chilean escudo only 11 per cent as much, the Argentine peso only 7 per cent as much, and the Brazilian cruzeiro only 2 per cent as much. The reader can imagine what this has meant in economic distortions and disruptions and in personal tragedies.
Let us come back to the point that inflation, always and everywhere, is caused by the policies of governments, not of private individuals. It is brought about directly by governmental monetary policies, and indirectly by government fiscal policies. Why do governments launch such policies?
Usually they do so by default, most often by getting into a war. The great chronic inflations of this century were triggered by World War I and then World War II. A government at war has to increase its spending suddenly and enormously; it usually lacks the courage to increase taxation correspondingly; in fact, it usually regards such a course as impossible. It usually also decides that it cannot even issue bonds to be paid for out of savings to finance the difference between its expenditures and its revenues. So in effect it finances its deficits by printing paper money. The inflation is then on. Prices soar.
But when the war is over, the country does not go back to its previous lower level of spending. One reason is that prices have soared; all government services cost more. Another reason is that vested interests have already been established in favor of continuing and even increasing the wartime level of spending. Still another reason is that there is great fear, however unjustified, that if the budget is now overbalanced by cutting back expenditures, and a surplus develops which is used to pay off accumulated national debt, it will precipitate a deflation, with terrible consequences in bankruptcies, unemployment, and depression.
In brief, vested interests are created in a continuance of inflation. Theories grow up rationalizing and glorifying inflation. From the middle thirties to the middle sixties these theories were typically represented by Keynesianism.
The theories differ in detail, but broadly they run something like this: When there is depression or unemployment it is because people do not have enough "purchasing power," or do not spend enough even of the money they have because they think prices are going to go still lower. If the government runs a deficit and prints more money, this will increase demand for products and therefore increase employment. This will not bring on "true inflation" if the additional money is not issued in too great amount; but even if it does increase prices, this will increase profit margins and so stimulate more production and more employment.
Now these theories combine multiple fallacies with some element of truth. When there is stagnation and unemployment, it is nearly always because there is some lack of coordination between prices, wages, and other costs. The appropriate remedy is to restore this coordination, usually by a lowering of certain key costs, such as wage rates, in relation to final prices. Under today’s conditions, the resistance of powerful labor unions tends to make it "impossible" to lower wage rates. So the only apparent remedy is to increase prices.
Stimulative Effects in the Early Stages of Inflation
In its early stages inflation does precisely this, and so tends to restore demand, prices, and profit margins, and hence employment and production. This is the element of truth in the theories that inflation is necessary or desirable. It is this stimulative effect that makes inflation initially popular. But this is only the early effect of the first "dose" of inflation. When business activity is restored and full employment is restored, costs begin to catch up again, or even once more race ahead of final prices. The price of raw materials rises. Unions demand higher wages—including both "cost of living" increases and "productivity" increases. Soon profit margins are reduced again or even wiped out in certain lines, and there is a demand for a second dose of inflation.
It is particularly instructive to study what happens to interest rates. Whenever business is slack, governments are under great pressure to keep interest rates down, to "encourage borrowing." There is apparently a simple way to do this. Interest is the money paid to borrow loanable funds. It seems to the government that the simple way to reduce interest rates (and hence, it is argued, to reduce costs of production) is to increase the supply of loanable funds by increasing the supply of credit and paper money. And for a while this may indeed reduce interest rates. But soon another consequence follows. As a result of the increased supply of money and credit, prices rise. Let us say that as a result of an increase in the stock of money by 5 per cent, prices rise about 5 per cent. Then businessmen will have to borrow 5 per cent more than they did before in order to do the same volume of business. Hence, the demand for money will increase 5 per cent, so catching up with the 5 per cent increase in the supply of money; and as a result interest rates will tend to go higher again.
Pressure for More Money
Then there will be political pressure for a second dose of inflation, say another 5 per cent increase in the supply of loanable funds, to bring interest rates down again. This will have the result also of increasing prices of commodities and of increasing the demand for borrowed money, once more raising interest rates, and leading to pressure for a third dose of inflation to get them down again; and so on.
(To simplify the exposition, I have been assuming here that prices will increase roughly in proportion to increases in the money stock. Of course, in the earlier stages of an inflation this is unlikely to happen. Because of increasing annual production of goods and services, and for other reasons, the average of prices is likely to go up less than the stock of money is expanded. But for the moment we can ignore such qualifications.)
But there will now also be an additional effect. Suppose, as a result of an annual dose of inflation of about 5 per cent a year for the past few years, prices have been rising at a rate of 5 per cent a year. Then a lender, asked to lend his money at an annual rate of 5 per cent, will say to himself: "Why should I? Even if the loan is safe, and I get my principal back a year from now, it will probably be worth some 5 per cent less in purchasing power than it is worth now. Therefore, I am in effect being asked to lend my money at a zero rate of interest."
So on top of his regular interest the lender will want what is called a price premium to compensate him for rising prices. This is the reason why interest rates have now soared in this country to the highest levels since the Civil War. If prices have risen nearly 6 per cent in the last twelve months and are expected to rise as much in the next twelve months, and so on indefinitely, then even a lender who is getting 9 per cent on his money figures he is getting a real interest of only about 3 or 4 per cent net.
40 Per Cent Loss in Seven Years
Let me cite just one concrete illustration, from the December, 1969, letter of the First National City Bank of New York, of the combined effect of rising interest rates and depreciating money so far: "The market value of the U. S. Treasury 41/4s of 1992/87, issued only seven years ago at the highest rate permissible under the legal ceiling, has dropped since then by about 30 per cent. After allowing for the loss of the purchasing power of the dollar, the real loss suffered by anyone who bought the bonds when they were issued is somewhat over 40 per cent."
What happens to interest rates is merely an illustration of what tends to happen throughout the economy. If commodity prices have been rising at an annual rate of nearly 6 per cent, and people expect them to continue to rise at that rate, then everybody tries to compensate; everybody tries to adjust his interest, rents, prices, and wages accordingly. Individual workers, and especially unions, if they expect a 6 per cent annual rise in consumer prices, will ask for a 6 per cent annual "cost of living" rise in wages to compensate. They will want this on top of any "productivity" or other increase to which they otherwise think themselves entitled. Thus, costs of production will rise as fast as prices, if not faster. Real profit margins will not increase. There will be no expectation of any real increase in profit margins. In brief, a constant rate of inflation will cease to have any stimulative effect on business—on buying, production, or employment.
This applies not only to an inflation of a "mere" 6 per cent a year. It applies just as much to any constant rate of inflation whatever—10 per cent, 50 per cent, 100 per cent a year.
Higher than Expected
We arrive, then, at the general principle that any rate of inflation that is generally expected has no stimulative effect on the economy, even if the expectation continues to be fulfilled. For an inflation to have a stimulative effect, it must be unexpectedly high; the rate must come as a surprise to the business community, so that it is not already discounted in current prices and costs. This is almost equivalent to saying that the rate of inflation, if it is to continue to have a stimulative effect, must be accelerative. But we finally arrive at the paradox that even an increasing rate of inflation will have no stimulative effect if the acceleration itself is generally expected; it must always be greater than what is generally expected, no matter how high expectations may be.
And if the rate of inflation is suddenly less than has been generally expected, the result is likely to be a crisis followed by a recession. This is true at any level of inflation. It will be true if the expected rate of inflation is "only" 5 per cent but proves to be zero. It is important to understand just why this is so. The business community (and in this term I include not only producers but consumers) is always operating on expectations. These expectations at any moment are built into existing prices. An obvious and outstanding example is the stock market. The existing price of any stock does not merely reflect its present yield or the company’s present earnings per share; it reflects what the company is expected to earn and what the stock is expected to be worth in the future. The prices of all basic commodities on the speculative markets—wheat, cotton, copper, silver—reflect foreseeable or expected future conditions of supply and demand. The present price of land and houses reflects not only the existing inflation, but the expected future rate of inflation—what buyers and sellers expect the state of inflation to be a year, two years, twenty years from now. So if something happens to bring even a 5 per cent annual rate of inflation to a halt—or if it is expected very soon to come to a halt—buying will suddenly fall off, prices will drop, unemployment will rise, and we will find ourselves in a mild or severe crisis.
I must mention still an additional factor to be considered. All businessmen must constantly plan ahead. A typical retail haberdasher may need to plan only six months ahead—for example, to order from the wholesaler in the spring the clothes he wants to stock in the fall. But a manufacturer may need to plan his output, both in kind and in quantity, a year or two years ahead. A builder or a manufacturer deciding whether to expand his plant may need to plan three to five years ahead. And so on.
All these investment plans call for a present outlay of money to be recouped, hopefully with a profit, at the completion of a certain period. Nearly all plans made during an already prolonged inflation are consciously or unconsciously based on the assumption of the continuance of this inflation. If this assumption is disappointed, there will be widespread losses, bankruptcies, and unfinished projects; and, of course, unemployment.
Attempts to Compensate
One further point must be made about the role of expectations. In the early stage of any long-term inflation (and this stage may persist for several years) the rise in prices does not keep pace with the increase in the money stock, because most people do not regard the rise in prices as permanent. In the middle stages of inflation, people begin to assume first that the past price increases are permanent and then that the past rate of price increase is likely to continue into the future. They therefore try to make compensating readjustments. But these widespread efforts to make protective readjustments (demanding higher wages, higher interest, higher rents, borrowing more, buying in advance, and so forth) tend in themselves to increase the rate of price increase still further.
This explains why it is an illusion to assume, as so many inflationists have done in the last decade or two, that some uniform "moderate" rate of price rise—3, 4, or 5 per cent—can be kept going year by year indefinitely by some uniform corresponding increase in the money supply or other means. It is not merely that the expectation of such a price rise will lead speculators, investors, entrepreneurs, workers, lenders, borrowers, consumers, and so on to try to anticipate it, thus destroying any stimulative effect, but that these countervailing and cost-raising actions by private individuals and groups will put political pressure on the government and the monetary managers to increase the rate of inflation to prevent unemployment and depression.
As soon as it is recognized that the past rate of inflation has been accelerative, expectations arise that they will continue to be accelerative. Still further compensating reactions by individuals take place. This is still another reason why it is so hard to stop a long-term inflation. Even if the monetary authorities halt the increase in the money supply, price advances will tend to go on for a while.
The Impact Is Uneven
I must confess at this point that, in order not to introduce too many complications at once, I have been indulging in a dangerous oversimplification. This is to talk in terms of aggregates and averages—an aggregate increase in the money supply, an average increase in prices of such-and-such per cent. Discussion in such terms can be grossly misleading if it involves the tacit assumption (as it sometimes does) that everybody is affected in the same proportion, or that all prices rise simultaneously and by a uniform percentage. One of the chief consequences of any inflation, on the contrary, is the wanton way in which it redistributes wealth and income.
The new credit or new money is always paid out first to certain specific groups, increasing their income; it is spent by them in turn to other specific groups, and these in turn deal with still other groups, until the new money has percolated through the whole community. The groups to whom the money goes first are benefited most; those to whom it comes last are hurt most.
But the point at which the new money enters the economy also affects the balance and structure of production. In an analysis published in 1931, Prices and Production, F. A. Hayek pointed out that an increase in the money supply made available to entrepreneurs through increased bank credit would at first cause an increase in the demand of capital goods in relation to consumer goods, and hence would raise the prices of capital goods in relation to those of consumer goods. This would lead to an expansion of the capital goods industries in relation to the consumer goods industries. But the same annual rate of increase in the money supply would have to continue in order to maintain this new relationship. In fact, in order to bring about any further relative expansion of the capital goods industries the new money or credit would have to increase at a constantly increasing rate. And if the original monetary inflation were not annually continued at at least the initial rate, there would be a reversal in the price relationship of capital goods and consumer goods, bringing on a relative forced shrinkage in the capital goods industries, leading to depression.
The Addict’s Dilemma
So this is the dilemma that inflation finally brings us to. We have a tiger by the tail. If we try by inflation to keep the economy at a constant peak of full employment and expanding incomes we must constantly increase the pace of inflation, with a day of crackup and collapse inevitable in any case; and meanwhile even a galloping inflation may be accompanied by bankruptcies and unemployment. If we stop or even substantially slow down the inflation, we are certain to disappoint expectations; we may face price declines, insolvencies, unemployment, and at least a mild crisis.
But this does not mean that we should continue inflating. We should stop the inflation as soon as we can, and face the possibility of an immediate but relatively mild crisis to prevent far greater evils later on. Inflation has been sometimes compared to a drug. The comparison is even more apt than is imagined by most of the people who make it. When a youth takes a drug that he doesn’t need in the first place, he has to take larger and larger quantities of it to experience the same lift or "high"—with increasingly demoralizing consequences. But if he tries to halt, he may experience agonizing withdrawal symptoms.
What is the actual outlook today? This is in any case difficult to say, and any forecast might be outdated by the time this appears in print. Powerful forces are operating in both directions. The Federal Reserve Board, compared with the recent past, has been following a policy of severe monetary restraint. As a result, the stock of money in the country, consisting of demand deposits plus currency held by the public, increased from December to June at a 4 per cent annual rate, and from June to the end of October was practically unchanged. In comparison, money grew at an annual7 per cent rate in the previous two years.
In addition to this record of monetary restraint, the unified Federal budget for the fiscal year 1970 has been planned to yield a surplus (though it may not be achieved) of as much as $6 billion.
On the other hand, as soon as one result or accompaniment of monetary restraint was a slight increase in unemployment, the Nixon Administration came under sharp criticism. It remains to be seen whether the administration will be able or willing to hold to its course in restraining inflation.
Congress has been recently voting increases in expenditures and reductions in taxes. The political pressures for continuing inflation are still enormously greater than the pressures for stopping it.
Inflation may be troubling us Earthlings, but now it has taken on a deep space aspect. According to the National Research Bureau, back in 1891 a French widow allegedly left 100,000 francs (then worth $20,000) to the first man to set foot on a heavenly body.
Astronaut Neil Armstrong is theoretically in a position to collect, but thanks to the inflation in France over the decades, that once-munificent sum now has a purchasing power equivalent to $180.
Had an American widow made the same $20,000 bequest it would have suffered quite a severe shrinkage, too. Today it would have a purchasing power equivalent to $4,180.
RICHARD H. MILLER
From the October ¹969 issue of Brevits issued by Vance, Sanders & Company, Inc.