Mr. Peters left the presidency of the First National Bank of Loveland, Colorado, to become for many years the editor of Rand McNally & Company’s Bankers Monthly magazine.
The greatest mistake that can be made in economic investigation is to fix attention on mere appearances, and so to fail to perceive the fundamental difference between things whose externals alone are similar, or to discriminate between fundamentally similar things whose externals alone are different.
LUDWIG VON MISES, The Theory of Money and Credit
Attempts to penetrate the nation’s economic future are engaging the attention of its business and industrial leaders as never before. They are avidly reading and consulting experts in the fields of economics and politics in an endeavor to interpret as accurately as possible all that is happening today in terms of its implications for the future.
But to attempt to read our economic future in projections based on current developments and those of the recent past is a difficult and unproductive undertaking. It is far more to the point to obtain from the reading and contemplation of what has happened over an extended period of economic history an improved knowledge and understanding of what we may do to give that future the shape and direction we want it to take. Samuel Taylor Coleridge said it well sometime during the early years of the nineteenth century: “If man could learn from history, what lessons it might teach us! But passion and party blind our eyes, and the light which experience gives us is a lantern on the stern which shines only on the waves behind us.”
We have an unexcelled opportunity to avail ourselves of the lessons of economic history in the many writings of Ludwig von Mises, who predicted the inflation which followed World War I in a work entitled The Theory of Money and Credit, the first German-language edition of which was published in 1912.1 His writings thus cover a period of nearly sixty years of experimentation with the monetary and fiscal measures invoked by governments in their sundry endeavors to deal with all manner of economic problems. All that follows is based on those of his observations which have a special bearing on the causes of inflation,2 its consequences, and its sole remedy : stopping the arbitrary expansion of the money supply.
A Pernicious Fallacy Invades Economic Thought
Perhaps the most pernicious idea that has ever invaded the economic thinking of this or any other time is the one that sees inflation as a more or less harmless device by means of which the welfare of all or some segment of the public may be effectively and permanently advanced. And perhaps the most pernicious aspect of that idea lies in the readiness with which it lends itself to the purposes of demagogues who are quite content to promote the adoption of inflationary measures as a means of achieving some momentary political advantage, regardless of what the more remote consequences of their expansionary efforts may prove to be.
Time was when monetary inflation was achieved by employing a single device for a single purpose: the coin of the realm was clipped, and the motive was profit. The government needed financial help and that was the only then known method of tampering with the currency as a means of satisfying that need. Questions of currency policy played no part in the deliberations that prompted it. There was no thought of influencing economic trends or the general price level by manipulating supply and demand factors.
More recently, however, our currency has been debased by a number of devices for a number of reasons, most of them poorly considered and far more harmful than helpful, but nevertheless purportedly rooted in well-intentioned currency policy. The free coinage of silver, for example, was advocated by one group of proponents as a means of increasing the price of silver as a commodity, while the prime concern of another group was to raise the general level of prices by increasing the money supply.
It was through the efforts of the latter that paper inflationism came to be advocated in many states, partly as a forerunner of bimetalism and partly in combination with it. But the closely related issues of monetary policy and inflation were then inadequately comprehended and poorly understood by the public at large, a condition that is all too prevalent to this day.
Although today’s currency is nominally based on gold, it actually consists in large part of credit and fiat money, the available quantity of which can be increased or decreased almost at will by our monetary authorities for whatever purposes happen to serve the needs or expediencies of the moment. Every such change is presumed to play a thoroughly considered role in effecting some desired change in the objective exchange-value of the money in circulation.
Indirect Taxation
However valid or otherwise the course pursued to the end in question may be, there remains the problem of the degree to which the prescribed remedy should be applied. To this there can be no precise answer because economists and statisticians have the greatest difficulty in isolating and identifying the determinants of the value of our money, and our Federal agencies and lawmakers find it even more difficult, if not impossible, to control them. Inflation, however, lends itself most readily to any effort to engage in painless spending; and because the effects achieved, particularly in the earlier stages of the process, are quite unobjectionable to both the payers and gatherers of taxes, it has at such times gained considerable unwarranted popularity.
Stated differently, the basic cause of inflation lies in government’s unwillingness to raise the funds it requires by increasing taxation, or its inability to do so by borrowing from the public. Inflation as a means of financing World War I, for example, had the great advantage of evoking an appearance of both economic prosperity and added wealth. Calculations of every kind were thus falsified, giving rise to distortions in the figures upon which business and industry relied for guidance in the conduct of their affairs. These distortions led, among other things, to the taxing away of portions of the public’s capital without its knowledge.
It is thus that political considerations all too often interfere with the proper functioning of one phase or another of the economic process. Left to its own devices, the economy has a way of effecting its own cures of maladjustments as they arise. If its pricing mechanism is permitted to reflect without outside interference the extent and urgency of the needs and wants of the public, supply and demand will inevitably arrive at a condition of balance.
It is generally supposed that inflation favors the debtor at the expense of the creditor, but this is true only if and to the extent that the reduction in the value of money is unforeseen. Inflationary policy can alter the relations between creditor and debtor in favor of the latter only if it takes effect suddenly and unexpectedly.
If, on the other hand, inflation is foreseen, those who lend money will feel obliged to include in the rate of interest they ask both a rate that will compensate them for the loss to be expected on account of the depreciation actually anticipated, and as much more as might result from a less probable further depreciation. And any who hesitate to pay this additional compensation will find that the diminished supply of funds available in the loan market will compel them to do so. Savings deposits, incidentally, decreased during the inflation that followed World War I because savings banks were not inclined to adjust interest rates to the altered conditions created by variations in the purchasing power of money.
Supposed Benefits of Inflation Are Illusions
There are inflationists who, though they are admittedly quite aware of the evils of inflation, nevertheless hold that there are higher and more important aims of economic policy than a sound monetary system. A failure on the part of the public to comprehend all of the implications of the position thus taken makes inflation a readily available political expedient. When governments are relieved of the necessity for making ends meet, socialistic trends and other unpopular consequences of a given policy are all too readily of accuracy, and any decisions based on an assumed ability to do so is sure to be highly conjectural, to say the very least.3
It is clear, therefore, that inflation functions quite inadequately as a purely political instrument. Its effects cannot be predicted with any degree of precision, and if continued indefinitely it must lead to a collapse. Its popularity is due in the main to the public’s inability to fully understand its consequences.
Barriers to Reversal
Standing in sharp contrast to the great ease with which a policy of inflation may be used by those in authority for their own purposes is the great difficulty of reversing that process—of invoking and implementing a policy of restrictionism or restraint which has the effect of increasing the value of money. This may be done (1) by reducing the supply of money in a period of constant demand, or (2) by holding it at a uniform level or one that is insufficiently high to meet anticipations based on recent price trends. The latter less severe method consists in simply waiting for an increase in the demand for a limited supply of money to manifest as a condition of restraint.
Adding to the difficulty of pursuing a policy of restraint are these considerations:
1. Far from bringing to the national Treasury the added dollar resources to which inflation too readily gives rise, restraint diminishes them.
2. It tends to induce a scarcity of some economic goods by facilitating exports and restricting imports.
3. Taxation becomes more burdensome.
4. Unpopular creditors, as a class, are thought to gain at the expense of the far more numerous debtors. (Today in the United States, the large corporations tend to be the debtors, while the creditors by and large are numerous small savers with insurance, savings accounts, and the like.)
Redeemability
But every inflationary policy must sooner or later be abandoned, and there will then remain the problem of replacing it with another. It was the clear intent of the law in the first place to preserve the metal parity of our currency, and that can be the only legally and morally acceptable objective of the new policy. Suspension of convertibility left that premise altogether unchanged.
The inflation made possible by the suspension of convertibility, however, has already worked grave inequities in contractual relations of every kind, and to abandon metal parity in the formulation of a new policy could only serve to make bad matters worse. Although the consequences of inflation cannot be eliminated by a mere reversal of policy, and existing inequities would in large part remain, metal parity would at least hold more promise of future stability than any available alternative.
Even so, the value of our currency will be too largely subject to political pressure, and it is to be hoped that the electorate will see to it that a preponderance of such pressure is exerted in behalf of a stable currency. For it is, after all, no part of the proper function of government to influence the value of the medium of exchange.
That is the function of the market, in the use and operation of which government is only one of many participants. It is to the market itself that all must look for the means of establishing the relative exchange values of economic goods, and government has, or should have, little actual voice in the matter.
The result of any attempted intervention by government will be determined in large part by the subjective values placed on goods by the masses of participating individuals through the pricing process. While our monetary authorities have some knowledge of the factors that determine the value of money, they have no way of determining the extent to which subjective estimates of value (prices) are affected by variations in the quantity of money. Governmental intervention is therefore confronted with the impossible problem of calculating the intensity with which variations in the ratio of the supply of money to the demand for it affect the market.
The Evils of Price Control
The adoption of price and wage ceilings is frequently suggested as a means of controlling inflation, but history’s case against that course is devastatingly complete. Such ceilings would automatically stimulate demand for and curtail production of the very goods that happened to be in scarce supply. The mechanism of the market would no longer be effective in allocating available supplies, so it would be necessary to bring other forces to bear on the problem. These have historically led through various intermediate stages, beginning with the rationing of the most important necessities, to the eventual abolition of private property. There is no workable substitute for the age-old laws of supply and demand.
And so it is with the balance of international payments. If natural forces are permitted to function without interference, the tighter money conditions which will normally prevail in the debtor country will induce a reduction in its prices, thus discouraging imports and encouraging exports, and thereby tending to bring about a restoration of equilibrium. The government in question can best serve its own needs by refraining from intervention of any kind.
The role of the speculator is a further case in point. In times long past the activity of speculators was held to be responsible for the depreciation of money; but, here again, history makes it clear that prices are determined in the market, and that any attempt to alter them over a given period by speculation is sure to fail; that the immediate effect of speculation is to reduce price fluctuations rather than to increase them. In the case of a steadily weakening currency, however, the effect of speculation will be to cause the expected depreciation to depart from its otherwise uniform pattern, and to proceed by fits and starts, with intermittent pauses. But the framework will be set by the extent to which market factors are responsible for the decline; and if inflation happens to be the cause of the difficulty, it is to the cure of that malady that all corrective efforts must be directed.
We are faced with a choice between the forces that make for monetary stability and those that will inevitably take us in the opposite direction. We can’t have it both ways.
—FOOTNOTES—
1 The first English edition of a version written in 1924 appeared in the 1930′s, and the book, to which was added a then current essay on “Monetary Reconstruction,” was last published in 1953.
2 Von Mises indicates a strong preference for the use of “inflationism” as the only term that conveys the precise meaning intended. He defines “inflationism” as “that monetary policy that seeks to increase the quantity of money,” whereas “inflation” is said to mean “an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term) so that a fall in the objective exchange-value of money must occur.” He makes the further point that inflationism must occur on a very substantial scale before it will manifest as inflation in the ordinarily accepted sense of the term. “Inflationism,” in other words, may be said to be the policy that tends to induce “inflation.” In the present situation, the policy and its effect appear to be generally regarded as one and the same.
3 An article entitled “Psychology and the Consumer,” which appeared in the August, 1969, issue of Business in Brief, published by The Chase Manhattan Bank of New York, strongly supports this view. The author variously described the consumer as a “hero,” a “villain,” and a “victim,” the respective roles played by him in the (1) 1965-66 period of caution, (2) the period of excessive optimism which got under way at the beginning of 1967, and (3) in the current year of disregard of the restraints on consumer spending which it was sought to impose by the boost in Social Security taxes and the tax surcharge. Notwithstanding the latter, “for 1968 as a whole, consumer outlays were 9.0% above 1967—significantly contributing to inflationary pressure.”
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What You Should Know About Inflation
One of the most stubborn fallacies about inflation is the assumption that it is caused, not by an increase in the quantity of money, but by a “shortage of goods.”
HENRY HAZLITT
