All Commentary
Sunday, June 1, 1980

Runaway Investors

Mr. Anderson was Executive Secretary of The Foundation for Economic Education when this article was published.

After a generation of exported U.S. inflation, resulting in a worldwide flood of dollars, the tide is starting to reverse. Foreigners are finally convinced that it’s time to send some of those dollars back. Observing the bargain basement prices in the United States when compared to what these same dollars will buy in their own countries, foreign dollar holders are beginning to “Buy American” with a vengeance.

For years dollars have been accumulated overseas, billions of them being held as foreign currency reserves. In the beginning such dollars were acquired by foreign govern ments because they were redeemable in gold. But that option was withdrawn in August 1971. Since that time the acquiring and holding of dollar reserves has resulted either from inertia or in some vain hope that the dollar’s value would remain intact.

Throughout the 1970s the U.S. Government’s monetary policies have literally inundated the world market with dollars, destroying any hope that the dollar’s value would be preserved. Aggravated by the monopoly pricing policies of OPEC oil, the world is glutted with dollars of diminished purchasing power. For years, foreign dollar holders have absorbed billions of newly-created dollars, thus preventing those dollars from bidding up U.S. prices. But foreign holders are less and less willing to play the “sucker role” in the game of “exported” inflation.

The first signs of realization came to these dollar holders when they began to observe the massive disparity between the dollar’s purchasing power in the United States and in the world market. Not only was America getting OPEC oil while the Arabs accumulated our paper, but foreign dollar claimants throughout the world were helping to pay for the oil in an ever-declining dollar purchasing power.

A Flood of Dollars

The most surprising aspect of this monetary development is that it has taken foreign dollar holders so long to wake up. And their awakening is not going unnoticed in the United States. The American buying public is reading the lesson from abroad, and reacting in a buying spree that is rapidly driving domestic prices into line with higher world market levels. The result is that the dollar strengthens in world money markets while it plummets at home.

These changing events are most frustrating to the masters of econometrics. The tools of their trade, the computers, have been churning out all kinds of mathematical data, assuring us of a coming recession. Meanwhile, consumers continue to confound them with their buying surge, utterly indifferent to the computers’ messages. The macro economist’s meek response is that the recession is still out there, but like the Amtrak train, just a little behind schedule.

The errors of the macro economists can be found in their computer programming. Looking back instead of forward, they totally ignore that there have been fundamental changes in the “rules of the game.” Devoting all their attention to statistical aggregates of the past, all of which fit so neatly into their computers, they have ignored the changing actions of the individuals lumped into their totals.

If macro economic statistics are reflecting no recession now and that times today are good, then it’s time to take a closer look. For the fact is that this country is in deep economic trouble. The recession which may appear hidden by the computer’s statistics, is nevertheless very much upon us.

As everyone is now painfully aware, we have entered the era of double-digit inflation. While this certainly represents a new experience for today’s United States citizen, it is an old development that all too often has devastated other societies. Whether our path will end in such destruction cannot be known, but it is clear that we are heading in that direction.

Even the casual observer must sense the growing conflict and deterioration in our society. The high costs of energy, housing, and medical care are denying such resources to the needy. Pensioners and others on fixed incomes are pauperized by the destruction of their purchasing power. Urban transportation in many cities barely functions. The quality of educational services in our schools is at an historic low. Violence and crime threaten our public safety. A revolt of the special interests generates conflict and thrusts unbelievable hardship on innocent victims.

The Burden of Interventions

The impact of government intervention on our lives has reached a breaking point. Not a day passes without some new insanity of regulatory harassment. Investment incentives in productive activity are being crushed under a punitive tax burden. Existing controls and the constant threat of more controls have placed a moratorium on a multitude of ventures.

In sum, we are witnessing a decline in our material way of life. People are travelling less, driving smaller cars, living in condominiums instead of single family homes, turning down the heat or turning off the air conditioning, cutting back on dining out, and reducing the menu quality at home. No matter how one rationalizes it all, such changes clearly reflect a decline in the quality of life.

The concentration of macro economic statistics on aggregates such as gross national product has told us little about this concealed decline in our material standard of living. The impact of double-digit inflation on the accumulated wealth of the individual has received far too little attention. While the toll of higher prices on personal income has been scrutinized closely, the loss of real wealth in money holdings is largely ignored. The facts are that the economic burden from a doubling of gasoline prices pales before the awesome loss of real wealth inflicted on individual savings accounts, pensions, and fixed income securities in our country today.

This insidious nature of inflation destroys the purchasing power of all money instruments. And while it is readily recognized that current incomes buy less, we seem to need reminding that accumulated money buys even less tomorrow. It is from this “hidden” loss on accumulated savings that our society is today floundering in a growing recession, a decline in the material well-being of millions of citizens.

After two generations of inflation that has consumed over eighty per cent of the dollar’s purchasing power, the American people are finally awakening along with the rest of the world. Folks in New York are starting to think and act like folks in Buenos Aires.

Victims of accelerating inflation can not stay passive forever. The panic for survival changes both their outlook and their economic behavior. In the face of double-digit inflation individuals act in a radically different way than under conditions of sound money. Everything changes, from our values and actions to their impact upon the institutional foundations of society. A society of sound money and orderly growth rapidly gives way under inflation to a society of chaotic decline.

Panic Buying

Throughout history the appearance of double-digit inflation has more often than not been a prelude to the ultimate destruction of money. As more and more holders of money come to realize this, the growing response is to abandon money in the hope that one can somehow escape the ravages of inflation. The tragedy of such action, however, is that panic buying only worsens and accelerates the pace of the runaway inflation.

The first principle of preserving real wealth in an era of double-digit inflation is to acquire “things.” Anyone holding his wealth in money is eventually doomed by double- digit inflation. The transformation of “money” savings into “things” savings becomes a first priority in an age of inflation. The passing of time proves over and over to inflation’s victims that money today can no longer buy what it bought yesterday.

The ominous results of these changing attitudes and behavior are becoming ever clearer in the United States. A reduction in saving and an increase in consumption is observed. Speculation replaces production. Bond prices collapse while stocks fluctuate wildly. Higher prices accompany falling productivity. Controls and regulations supplant economic freedom. Pockets of poverty and prosperity appear everywhere. Confusion and dismay grip everyone.

The individual’s response to double-digit inflation is never pleasant, but it is inevitable. The first rule has been learned: get out of money. With a vengeance, inflation’s victims incur debt and withdraw savings to do so. Rising interest rates hopelessly try to reflect the onslaught of buying and the vanishing money market. But as interest rates lag behind the double-digit rates of inflation, they only make “things” investment all the more attractive. The high bank rates become a “signal” that the money market is rapidly collapsing.

The withdrawal of savings and the sale of bonds to buy “things” accelerates the process of rising goods prices. The collapse of the money market accompanies the panic. The rush out of monetary investments and into real goods in order to preserve one’s wealth takes on a psychology of a bank run. The panic feeds upon itself as it races out of control.

Threats of price and wage controls in such an economic climate only speed the process. Anticipating the inevitable shortages that must come from such controls, the panic buying of “things” increases. Producers, fearing the “cost trap” from coming controls, raise their prices even faster. Speculators likewise respond by hedging in any and all areas where they believe controls cannot reach, anticipating the future profits waiting them in the coming black markets.

At this point appears one of the great ironies in the final stage of runaway inflation. It is a shortage of money. As individuals seek more debt in order to acquire “things,” as the money market vanishes due to a failure of lenders, the increasing volume of buying activity creates an illusion of scarce money. In the end, the massive inflation which in creased the supply of money and precipitated the panic, creates the illusion of money shortages.

Inflation Invokes New Rules of Prudence

What the computers have not been telling their econometric programmers is that the “old rules” are no longer obeyed in an age of double-digit inflation. Folks no longer buy to consume, but instead they buy to “save.” Rising interest rates do not attract savers, but instead serve as a signal to savers that inflation is outpacing them. The destruction of money forces all money holdings into the haven of “things,” in a last ditch effort to preserve what wealth remains.

The flight from money to precious metals is merely the tip of the iceberg. It reflects the beginning of a panic process by those individuals in society who understand what is happening. But while it is a beginning, it is not an end. The end comes with the ultimate destruction of money in a final burst of runaway inflation—an inflation so extreme that it renders the money worthless as a medium of exchange and therefore unacceptable to anyone in the market.

The sharp increase in precious metal prices should serve as a reminder and warning to everyone of how quickly a panic can begin. Just a moderate loss of dollar confidence led to an explosion of precious metal prices. Imagine the impact on all prices should such a panic extend to all dollar holders. Gold and silver have provided a frightening and cheap lesson to all dollar holders—if we will have learned it.

The greatest danger of double-digit inflation is that it can establish the base for tomorrow’s panic. Already foreign dollar holders seem to be leading the way. The traditional statistics on personal debt or disposable income, rates of saving or profits, no longer have their old meaning. They can only conceal the runaway inflation in the form of a “delayed recession.”

In such an atmosphere the individual has no choice but to become a runaway investor. His money wealth is being rendered worthless. To forgo consumption becomes ever more costly. Present buying for future consumption proves his best investment. When he needs one of a thing, he learns instead to buy two, three, or more.

The runaway investor discovers that his used goods sell for more than when new. Only when he replaces goods does he learn that his dollar gains are not wealth gains. The market quickly teaches him that “things” are a bettor investment than dollars.

Neither the limitation of heavy consumer debt nor productive income will stop the runaway investor—not until all his money savings are transformed into “things.” By then it is all over, for runaway inflation has run its course and the dollar has been destroyed as a medium of exchange.

The fear of a runaway inflation has finally drawn the attention of the engineers who have fed it. The rhetoric and actions of the Federal Reserve Board reflect concern. But Federal Reserve policies of moderate growth in bank credit and higher discount rates are too little and too late. The awesome magnitude of the outstanding money supply that can be liquidated for “things” by panicked consumers demands stronger action. Nothing less than monetary contraction may now be required to restore confidence in the minds of dollar holders. Otherwise, an uncontrollable dollar panic, feeding upon itself, can lead to a final burst of runaway inflation.

If such a scenario should be our curse, the yields or earnings in the stock market will be meaningless. Holding shares in a tire company may at least give the dollar holder an owner’s claim to a tire—a real good that will be far more valuable than depreciating money. Dollars in a six per cent passbook savings account won’t compare to the pair of shoes that has doubled in price. The race for “things” becomes the only concern of the runaway investor.

A Game Without Winners

The tragedy of runaway inflation is that it is a negative-sum game. While one may think he is winning in the beginning, the final result is that all must lose. The destruction of money through runaway inflation cripples our social division of labor, annihilates all money markets, consumes productive capital, and thus lowers the general standard of living for everyone. In its aftermath, the political, social, and economic foundations of society are seriously threatened. All too frequently the chaos, conflict, and impoverishment that it generates has led to the authoritarian society.

It is imperative, therefore, that inflation be stopped now. Many already believe that it may be too late. But to fail because we did not try would be unconscionable. Not since 1860 has this nation faced a greater threat to its survival than it does today.

The prospect of this kind of runaway inflation is terrifying. Fortunately, another path does exist. It is the path of restoring sound money. And sound money means the restoration of gold as money.

Such a solution, however, is a paradox. It is both exceedingly simple and profoundly difficult to implement. The economic solution is to simply stop expanding the supply of money and reinstate gold convertibility for paper dollars. The first action could be implemented by the Federal Reserve today, the latter by Congress later. But, only if they wished to do so.

And here lies the profound difficulty. Have the political forces in America reached a point where such action cannot or will not be done? The answer to this question will determine whether our destiny is sound money or runaway inflation.

The present magnitude of government deficits, the massive growth in the size of the “public trough,” voters’ expectations of more political largess, a continuing penchant for further political direction of our society—all must be reduced if the choice is sound money. Any hope at this point for more of the same is sheer fantasy.

Now is the time to face the conflict between the political problem and the economic solution. The inexorable economic repercussions from years of past inflation are closing in on the political managers. The horror of runaway inflation is imminent. It can and must be prevented.

Otherwise, the people who hold our nation and economy together—the middle class—will be wiped out financially. At such a point, a closed society and the loss of individual freedom of choice becomes a very real possibility.

Let’s hope it’s not too late.

  • Robert G. Anderson taught economics and business management at Grove City College, Pennsylvania, and served as Executive Secretary of the Foundation for Economic Education in the 1970s.