Inflation, Money, and Freedom

Jay Habegger is a sophomore at the University of Colorado at Boulder. He was an intern at FEE this past summer, preparing research materials for the 1986-87 high school debate topic.

      This essay was a runner-up in The Foundation for Economic Education’s 1985-1986 Freedom Essay Contest.

It is widely believed that the coining of money is a proper function of government. In reality, however, state control of the money supply leads to a destructive inflationary spiral. All those who hold cash, especially those on fixed incomes, ultimately bear the economic burden of state-sponsored inflation. Inflation reduces real wages, diminishes living standards, and destroys investment opportunities.

The state can offer no solution to these problems. Only by allowing the market to operate unfettered with regard to money can there be an assurance of a stable, noninflationary currency. Only freely acting individuals can provide the consumer with an alternative to the inflation and uncertainty of the present government monopoly over money.

Inflation is caused by a government-sponsored expansion of the money supply. Only flat currencies—backed by nothing more than a government decree, and not by a fixed resource such as gold—can be rapidly expanded, and thus produce high rates of inflation. Due to the limited availability of gold, currencies fully backed by gold are susceptible to only a negligible rate of inflation, As long as the state possesses control over the money supply, however, the potential for rampant inflation remains.

Even a “gold standard” is no guarantee against government-sponsored inflation. Adam Smith recognized this as early as 1776, and wrote in the Wealth of Nations, “. . . the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have, by degrees, diminished the real quantity of metal, which had been originally contained in their coins.”[1] Economic distress, coupled with political opportunism, will lure the state and its agents to abandon the gold standard and institute fiat paper in its place.

Governments have shown time and again that they are unable to maintain the political discipline needed to avoid fiat money inflation. Even the institution of legal barriers to monetary growth have had little effect. During the French Revolution of the 1790s,.legal limits on the amount of currency in circulation were repeatedly made by the French Assembly with little success.[2] The limits on inflation were consistently broken, which led to new legislated limits, which in time were also ignored. Short term political benefits such as re- election or national prestige usually take priority over monetary sanity.

Indeed, even the economic knowledge and experience available in our time have not prevented modern politicians from following the siren call of fiat paper. While some measure of monetary stability was attained prior to World War II, when most nations maintained a token adherence to the gold standard, the gold standard was abandoned by almost all countries after the war. The resulting age of floating exchange rates, rampant inflation, and general economic uncertainty offers evidence that politicians are unable, or unwilling, to follow a path of long-term monetary discipline in the face of short-term political gains.

Inflation can be a seductive tool for politicians facing a political or economic crisis. For the politician facing a large public debt, for example, state control of flat paper makes inflation seem like a practical alternative to reducing spending. Inflating the money supply increases the nominal value of an individual’s wages and assets, while reducing their purchasing power. If progressive tax rates are left unadjusted for inflation, the increased face value of the wage earner’s income and assets will place him in a higher tax bracket, where the state receives a greater portion of his income and assets. Thus, while the individual is actually earning less, the state demands a higher share, and uses the additional revenue to pay its debts. Inflation, in this case, amounts to a subtle form of taxation.

Inflation has other political uses. The politician facing re-election, or otherwise seeking popular support, often uses inflation to bring temporary economic prosperity. Rapidly inflating the money supply may induce increased economic activity, which results in greater employment and more consumer goods. It should be emphasized, however, that these politically desirable effects of inflation are temporary, often lasting just long enough to overcome the current political crisis.

Effect on Savings

Inflation is a subtle form of thievery. Even while assets sit seemingly safe in a bank vault, their purchasing power is steadily eroded, no less so than if one’s pocket had been picked. The difference in the two crimes, however, is that the state is committing the crime in the former case, and a single criminal commits the crime in the latter.

Inflation makes long-term saving nearly impossible. An individual may watch his life’s savings be inflated away through no fault of his own. The solution soon becomes apparent: spend one’s money on real estate, gold, and other hard assets because they possess lasting value in comparison with a depreciating currency. In fact, inflation in our time can be traced in the price of gold. Since the complete abandonment of the gold standard in 1971, the price of gold has risen from $35 an ounce to over $320 an ounce—an 800 per cent increase.[3] The purchase of gold and other assets is often made by going into debt, which is desirable in an inflationary period because payment will be made with currency worth less then it was when the debt was assumed. Inflation favors debtors at the expense of creditors.

A society preoccupied with obtaining as much debt as possible, and purchasing goods and services for immediate gratification, leaves little capital for business investment. Eventually, business becomes unable to find the necessary capital for further expansion or increased production. The production of consumer goods falls, and an afterburner is ignited on already soaring prices. As prices rise, people save even less and spend even more, which only accelerates the spiral. For example, during the post-World War I German inflation, workers eventually demanded that their wages be paid in cash so they could immediately purchase any available goods.[4]

The State may try to stop the inflationary spiral by introducing more currency into the economy or passing legislation designed to control prices. This also fails. The infusion of more currency only accelerates the inflation while price controls drive goods off the market.

The inflationary spiral during the French Revolution provides a striking example. On September 29, 1793, the French Assembly introduced the Law of the Maximum, which was designed to limit rising prices.[5] It failed miserably, and businesses closed their doors in droves. The French Assembly chose to ignore the laws of economics, and legislated more restrictions on the market. When these also failed, the Assembly imposed the death penalty for committing economic crimes, such as raising prices or asking what currency one was to receive. The economic chaos in France shows the final fate of the individual in a state-sponsored inflationary spiral.

Prevention of inflation and the economic trauma it brings can be accomplished only by removing the money supply from state control—abolishing the state monopoly on the coining of money. As Ludwig von Mises made clear, money is a commodity, the value of which lies in its utility as a medium of exchange[6] There is no reason to believe that the market would handle the production of money in a fundamentally different way than it handles the production of any other commodity—the coinage of money simply would be another business. As with any other business, the private coiners’ goal will be to best satisfy the consumers’ desires in order to achieve the maximum profit.

Private Coinage

The private coiner will provide the type of money in greatest demand. Since most individuals desire a stable currency with lasting value, this is what the coiner will provide; there will be no demand for inflationary fiat money. While a stable currency can be backed by almost any resource, history has shown gold to be the metal of choice. Coiners will provide coins stamped with a guarantee of their weight and fineness.

While the possibility of fraud in the coin industry will always exist, it will be held in check by the forces of competition.[7] We find examples of this when we study the history of private mints. Before private coinage was completely prohibited by the United States government in 1864, there were competing private mints in Georgia, North Carolina, and the gold-producing Western territories. These private mints provided honest and reliable service. The chronicler of one such mint operating in the early 1860s, Clark, Graber and Company in Denver, Colorado, wrote that “Their business transactions were honest and above any reproach; they always dealt fairly with their customers, giving them full value for all their gold.”[8]

It is, however, very inconvenient to carry gold coins when one wants to make a purchase. Undoubtedly, the market would also provide a solution to this problem. A warehouse system might develop where one could store his gold and then be issued a receipt[9] Instead of carrying gold coins, one could simply carry the warehouse receipts and make purchases with them. These receipts would be the equivalent of paper money; they would represent a certain amount of gold held in reserve.

Indeed, some consumers might even find this method of purchasing items too cumbersome. The use of debit cards would allow one to transfer gold from one account to another without ever seeing the gold or warehouse receipts. Computer and communications technology offers almost unlimited possibilities for money services. A merchant could check the quality of a currency before accepting it by using a computer network much like those used today to clear checks and credit cards. Warehouse receipts could be electronically transferred across the globe by computer.

A multitude of consumer choices is the beauty of the free market. Where people are free to choose, they select a noninflationary currency. Private enterprise must be free to coin money if inflation and its accompanying ills are to be stopped. []

1.   Adam Smith. An Inquiry into the Nature and Causes of the Wealth of Nations (The University of Chicago Press, 1976).

2.   Andrew Dickson White, Fiat Money Inflation in France (Foundation for Economic Education, 1959).

3.   Susan Lee, “Gold: the Ultimate Burglar Alarm,” Forbes, September 23, 1985.

4.   Ringer, Fritz K., “The German Inflation of 1923" (Oxford University Press, 1969).

5.   White, op. cit.

6.   Mises, Ludwig von. The Theory of Money and Credit (Foundation for Economic Education, 1971).

7.   Murray N. Rothberd, What Has Government Done to Our Money? (Libertarian Publishers).

8.   Nolie Mumey, Clark, Gruber and Company (1860-1865): A Pioneer Denver Mint (Artcraft Press, 1950).

9.   Rothbard, op. cit.