What You Should Know About Inflation


July, 1964. Preface. Over the years in which I have been writing the weekly .... an individual dollar depends simply on the present supply of dollars outstanding.

What You Should Know About Inflation by HENRY HAZLITT

SECOND EDITION

D. VAN NOSTRAND COMPANY, INC. PRINCETON, NEW JERSEY TORONTO LONDON NEW YORK

D. VAN NOSTRAND COMPANY, INC. 120 Alexander St., Princeton, New Jersey (Principal office) 24 West 40 Street, New York 18, New York D. VAN NOSTRAND COMPANY, LTD.

358, Kensington High Street, London, W.14, England D. VAN NOSTRAND COMPANY (Canada), LTD.

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COPYRIGHT © i960, 1965 BY

D. VAN NOSTRAND COMPANY, INC. Published simultaneously in Canada by D. VAN NOSTRAND COMPANY (Canada), LTD.

No reproduction in any form of this boo\, in whole or in part (except for brief quotation in critical articles or reviews), may be made without written authorization from the publishers.

PRINTED IN THE UNITED STATES OF AMERICA

Preface to the Second Edition This book was first published in i960. For the present edition, the main statistical comparisons and tables have been brought up to date. Where older figures and comparisons, illustrate the particular principle or contention involved fully as well as more recent figures would, however, they have been allowed to stand. HENRY HAZLITT

July, 1964.

Preface Over the years in which I have been writing the weekly "Business Tides" column for Newswee\, I have received frequent inquiries from readers asking where they could obtain a brief and simple exposition of the causes and cure of inflation. Others have asked for advice concerning what course they could follow personally to prevent further erosion in the purchasing power of their savings. This book is designed to answer these needs. iii

PREFACE

Most of the material in it has appeared in my ~Newswee\ articles during recent years; but all of the statistics and references have been brought up to date, and new material has been added to complete and round out the exposition. The book has been deliberately kept short. But readers who are not interested in some of the collateral problems, but wish only a brief over-all view, may find what they are looking for either in the first six chapters or in the final chapter, "The ABC of Inflation," which attempts to summarize what is most important in the preceding discussion. There are some repetitions in the book, but I offer no apology for them. When, as in this subject, basic causes are persistently ignored and basic principles persistently forgotten, it is necessary that they be patiently reiterated until they are at last understood and acted upon. HENRY HAZLITT

July, i960.

IV

Contents

Preface i. What Inflation Is 2. Some Qualifications 3. Some Popular Fallacies 4. A Twenty-Year Record 5. False Remedy: Price Fixing 6. The Cure for Inflation 7. Inflation Has Two Faces 8. What "Monetary Management" Means 9. Gold Goes With Freedom 10. In Dispraise of Paper 11. Inflation and High "Costs" 12. Is Inflation a Blessing? 13. Why Return to Gold? 14. Gold Means Good Faith 15. What Price for Gold? 16. The Dollar-Gold Ratio 17. Lesson of the Greenbacks 18. The Black Market Test 19. How to Return to Gold

iii 1

4

7 10 12

15 19 22

25 28 3i

34 37 40

43 47

5° 54

58

CONTENTS

20. Some Errors of Inflationists 21. "Selective" Credit Control 22. Must We Ration Credit? 23. Money and Goods 24. The Great Swindle 25. Easy Money = Inflation 26. Cost-Push Inflation? 27. Contradictory Goals 28. "Administered" Inflation 29. Easy Money Has an End 30. Can Inflation Merely Creep? 31. How to Wipe Out Debt 32. The Cost-Price Squeeze 33. The Employment Act of 1946 34. Inflate? Or Adjust? 35. Deficits vs. Jobs 36. Why Cheap Money Fails 37. How to Control Credit 38. Who Makes Inflation? 39. Inflation as a Policy 40. The Open Conspiracy 41. How the Spiral Spins 42. Inflation vs. Morality 43. How Can You Beat Inflation? 44. The ABC of Inflation Index

VI

62

67 70

73 76 79 82

85

88 91

93 96 99 102

104 108 in

"5 118 121

124 127 130

133 138 152

1 What Inflation Is

No subject is so much discussed today—or so little understood—as inflation. The politicians in Washington talk of it as if it were some horrible visitation from without, over which they had no control—like a flood, a foreign invasion, or a plague. It is something they are always promising to "fight"—if Congress or the people will only give them the "weapons" or "a strong law" to do the job. Yet the plain truth is that our political leaders have brought on inflation by their own money and fiscal policies. They are promising to fight with their right hand the conditions brought on with their left. Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit. If you turn to the American College Dictionary, for example, you will find the first definition of inflation given as follows: "Undue expansion or increase of the currency of a country, esp. by the issuing of paper money not redeemable in specie." In recent years, however, the term has come to be used in a radically different sense. This is recognized in the second definition given by the American College Dictionary:

WHAT YOU SHOULD KNOW ABOUT INFLATION

"A substantial rise of prices caused by an undue expansion in paper money or bank credit." Now obviously a rise of prices caused by an expansion of the money supply is not the same thing as the expansion of the money supply itself. A cause or condition is clearly not identical with one of its consequences. The use of the word "inflation" with these two quite different meanings leads to endless confusion. The word "inflation" originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended. It is not mere pedantry to insist that the word should be used only in its original meaning. To use it to mean "a rise in prices" is to deflect attention away from the real cause of inflation and the real cure for it. Let us see what happens under inflation, and why it happens. When the supply of money is increased, people have more money to offer for goods. If the supply of goods does not increase—or does not increase as much as the supply of money—then the prices of goods will go up. Each individual dollar becomes less valuable because there are more dollars. Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before. A "price" is an exchange ratio between a dollar and a unit of goods. When people have more dollars, they value each dollar less. Goods then rise in price, not because goods are scarcer than before, but because dollars are more abundant. In the old days, governments inflated by clipping and debasing the coinage. Then they found they could inflate cheaper and faster simply by grinding out paper money on

WHAT INFLATION IS

a printing press. This is what happened with the French assignats in 1789, and with our own currency during the Revolutionary War. Today the method is a little more indirect. Our government sells its bonds or other IOU's to the banks. In payment, the banks create "deposits" on their books against which the government can draw. A bank in turn may sell its government IOU's to the Federal Reserve Bank, which pays for them either by creating a deposit credit or having more Federal Reserve notes printed and paying them out. This is how money is manufactured. The greater part of the "money supply" of this country is represented not by hand-to-hand currency but by bank deposits which are drawn against by checks. Hence when most economists measure our money supply they add demand deposits (and now frequently, also, time deposits) to currency outside of banks to get the total. The total of money and credit so measured was $63.3 billion at the end of December 1939, and $308.8 billion at the end of December 1963. This increase of 388 per cent in the supply of money is overwhelmingly the reason why wholesale prices rose 138 per cent in the same period.

Some Qualifications It is often argued that to attribute inflation solely to an increase in the volume of money is "oversimplification." This is true. Many qualifications have to be kept in mind. For example, the "money supply" must be thought of as including not only the supply of hand-to-hand currency, but the supply of bank credit—especially in the United States, where most payments are made by check. It is also an oversimplification to say that the value of an individual dollar depends simply on the present supply of dollars outstanding. It depends also on the expected future supply of dollars. If most people fear, for example, that the supply of dollars is going to be even greater a year from now than at present, then the present value of the dollar (as measured by its purchasing power) will be lower than the present quantity of dollars would otherwise warrant. Again, the value of any monetary unit, such as the dollar, depends not merely on the quantity of dollars but on their quality. When a country goes off the gold standard, for example, it means in effect that gold, or the right to get gold, has suddenly turned into mere paper. The value of the

SOME QUALIFICATIONS

monetary unit therefore usually falls immediately, even if there has not yet been any increase in the quantity of money. This is because the people have more faith in gold than they have in the promises or judgment of the government's monetary managers. There is hardly a case on record, in fact, in which departure from the gold standard has not soon been followed by a further increase in bank credit and in printing-press money. In short, the value of money varies for basically the same reasons as the value of any commodity. Just as the value of a bushel of wheat depends not only on the total present supply of wheat but on the expected future supply and on the quality of the wheat, so the value of a dollar depends on a similar variety of considerations. The value of money, like the value of goods, is not determined by merely mechanical or physical relationships, but primarily by psychological factors which may often be complicated. In dealing with the causes and cure of inflation, it is one thing to keep in mind real complications; it is quite another to be confused or misled by needless or nonexistent complications. For example, it is frequently said that the value of the dollar depends not merely on the quantity of dollars but on their "velocity of circulation." Increased "velocity of circulation," however, is not a cause of a further fall in the value of the dollar; it is itself one of the consequences of the fear that the value of the dollar is going to fall (or, to put it the other way round, of the belief that the price of goods is going to rise). It is this belief that makes people more eager to exchange dollars for goods. The emphasis by some writers

5

WHAT YOU SHOULD KNOW ABOUT INFLATION

on "velocity of circulation" is just another example of the -error of substituting dubious mechanical for real psychological reasons. Another blind alley: in answer to those who point out that inflation is primarily caused by an increase in money and credit, it is contended that the increase in commodity prices often occurs before the increase in the money supply. This is true. This is what happened immediately after the outbreak of war in Korea. Strategic raw materials began to go up in price on the fear that they were going to be scarce. Speculators and manufacturers began to buy them to hold for profit or protective inventories. But to do this they had to borrow more money from the banks. The rise in prices was accompanied by an equally marked rise in bank loans and deposits. From May 31,1950, to May 30,1951, the loans of the country's banks increased by $12 billion. If these increased loans had not been made, and new money (some $6 billion by the end of January 1951) had not been issued against the loans, the rise in prices could not have been sustained. The price rise was made possible, in short, only by an increased supply of money.

Some Popular Fallacies

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." It is true that a rise in prices (which, as we have seen,, should not be identified with inflation) can be caused either by an increase in the quantity of money or by a shortage of goods—or partly by both. Wheat, for example, may rise in price either because there is an increase in the supply of money or a failure of the wheat crop. But we seldom find, even in conditions of total war, a general rise of prices caused by a general shortage of goods. Yet so stubborn is the fallacy that inflation is caused by a "shortage of goods," that even in the Germany of 1923, after prices had soared hundreds of billions of times, high officials and millions of Germans were blaming the whole thing on a general "shortage of goods"—at the very moment when foreigners were coming in and buying German goods with gold or their own currencies at prices lower than those of equivalent goods at home. The rise of prices in the United States since 1939 is

WHAT YOU SHOULD KNOW ABOUT INFLATION

constantly being attributed to a "shortage of goods." Yet official statistics show that our rate of industrial production in 1959 was 177 per cent higher than in 1939, or nearly three times as great. Nor is it any better explanation to say that the rise in prices in wartime is caused by a shortage in civilian goods. Even to the extent that civilian goods were really short in time of war, the shortage would not cause any substantial rise in prices if taxes took away as large a percentage of civilian income as rearmament took away of civilian goods. This brings us to another source of confusion. People frequently talk as if a budget deficit were in itself both a necessary and a sufficient cause of inflation. A budget deficit, however, if fully financed by the sale of government bonds paid for out of real savings, need not cause inflation. And even a budget surplus, on the other hand, is not an assurance against inflation. This was shown in the fiscal year ended June 30, 1951, when there was substantial inflation in spite of a budget surplus of $3.5 billion. The same thing happened in spite of budget surpluses in the fiscal years 1956 and 1957. A budget deficit, in short, is inflationary only to the extent that it causes an increase in the money supply. And inflation can occur even with a budget surplus if there is an increase in the money supply notwithstanding. The same chain of causation applies to all the so-called "inflationary pressures"—particularly the so-called "wageprice spiral." If it were not preceded, accompanied, or quickly followed by an increase in the supply of money, an increase in wages above the "equilibrium level" would not cause inflation; it would merely cause unemployment. And 8

SOME POPULAR FALLACIES

an increase in prices without an increase of cash in people's pockets would merely cause a falling off in sales. Wage and price rises, in brief, are usually a consequence of inflation. They can cause it only to the extent that they force an increase in the money supply.

A Twenty-Tear Record

I present in this chapter a chart comparing the increase in the cost of living, in wholesale commodity prices, and in the amount of bank deposits and currency, for the twentyyear period from the end of 1939 to the end of 1959. Taking the end of 1939 as the base, and giving it a value of 100, the chart shows that in 1959 the cost of living (consumer prices) had increased 113 per cent over 1939, wholesale prices had increased 136 per cent, and the total supply of bank deposits and currency had increased 270 per cent. The basic cause of the increase in wholesale and consumer prices was the increase in the supply of money and credit. There was no "shortage of goods." As we noticed in the preceding chapter, our rate of industrial production in the twenty-year period increased 177 per cent. But though the rate of industrial production almost tripled, the supply of money and credit almost quadrupled. If it had not been for the increase in production, the rise in prices would have been much greater than it actually was. Nor, as we also saw in the last chapter, can the increase in prices be attributed to increased wage demands—to a "cost 10

A TWENTY-YEAR RECORD

push." Such a theory reverses cause and effect. "Costs" are prices—prices of raw materials and services—and go up for the same reason as other prices do. If we were to extend this chart to a total of 24 years—that is, to the end of 1963—it would show that, taking 1939 as a base, the cost of living increased 124 per cent, wholesale prices increased 136 per cent, and the total supply of bank deposits and currency increased 360 per cent in the period.

100

'40 '41 '42 '43 '44 '45 '46 '47 '48 '49 '50 '51 '52 '53 '54 '55 '56 '57 '58 '59 *

1939-40 equals 100

II

False Remedy: Price Fixing

As long as we are plagued by false theories of what causes inflation, we will be plagued by false remedies. Those who ascribe inflation primarily to a "shortage of goods," for example, are fond of saying that "the answer to inflation is production." But this is at best a half-truth. It is impossible to bring prices down by increasing production if the money supply is being increased even faster. The worst of all false remedies for inflation is price fixing and wage fixing. If more money is put into circulation, while prices are held down, most people will be left with unused cash balances seeking goods. The final result, barring a like increase in production, must be higher prices. There are broadly two kinds of price fixing—"selective" and "over-all." With selective price fixing the government tries to hold down prices merely of a few strategic war materials or a few necessaries of life. But then the profit margin in producing these things becomes lower than the profit margin in producing other things, including luxuries. So "selective" price fixing quickly brings about a shortage of the very things whose production the government is most eager to encourage. Then bureaucrats turn to the specious 12

FALSE REMEDY! PRICE FIXING

idea of an over-all freeze. They talk (in the event of a war) of holding or returning to the prices and wages that existed on the day before war broke out. But the price level and the infinitely complex price and wage interrelationships of that day were the result of the state of supply and demand on that day. And supply and demand seldom remain the same, even for the same commodity, for two days running, even without major changes in the money supply. It has been moderately estimated that there are some 9,000,000 different prices in the United States. On this basis we begin with more than 40 trillion interrelationships of these prices; and a change in one price always has repercussions on a whole network of other prices. The prices and price relationships on the day before the unexpected outbreak of a war, say, are presumably those roughly calculated to encourage a maximum balanced production of peacetime goods. They are obviously the wrong prices and price relationships to encourage the maximum production of war goods. Moreover, the price pattern of a given day always embodies many misjudgments and "inequities." No single mind, and no bureaucracy, has wisdom and knowledge enough to correct these. Every time a bureaucrat tries to correct one price or wage maladjustment or "inequity" he creates a score of new ones. And there is no precise standard that any two people seem able to agree on for measuring the economic "inequities" of a particular case. Coercive price fixing would be an insoluble problem, in short, even if those in charge of it were the best-informed economists, statisticians, and businessmen in the country, and even if they acted with the most conscientious impartiality. 13

WHAT YOU SHOULD KNOW ABOUT INFLATION

But they are subjected in fact to tremendous pressure by the organized pressure groups. Those in power soon find that price and wage control is a tremendous weapon with which to curry political favor or to punish opposition. That is why "parity" formulas are applied to farm prices and escalator clauses to wage rates, while industrial prices and dwelling rents are penalized. Another evil of price control is that, although it is always put into effect in the name of an alleged "emergency," it creates powerful vested interests and habits of mind which prolong it or tend to make it permanent. Outstanding examples of this are rent control and exchange control. Price control is the major step toward a fully regimented or "planned" economy. It causes people to regard it as a matter of course that the government should intervene in every economic transaction. But finally, and worst of all from the standpoint of inflation, price control diverts attention away from the only real cause of inflation—the increase in the quantity of money and credit. Hence it prolongs and intensifies the very inflation it was ostensibly designed to cure.

6 The Cure for Inflation

The cure for inflation, like most cures, consists chiefly in removal of the cause. The cause of inflation is the increase of money and credit. The cure is to stop increasing money and credit. The cure for inflation, in brief, is to stop inflating. It is as simple as that. Although simple in principle, this cure often involves complex and disagreeable decisions on detail. Let us begin with the Federal budget. It is next to impossible to avoid inflation with a continuing heavy deficit. That deficit is almost certain to be financed by inflationary means—i.e., by directly or indirectly printing more money. Huge government expenditures are not in themselves inflationary—provided they are made wholly out of tax receipts, or out of borrowing paid for wholly out of real savings. But the difficulties in either of these methods of payment, once expenditures have passed a certain point, are so great that there is almost inevitably a resort to the printing press. Moreover, although huge expenditures wholly met out of huge taxes are not necessarily inflationary, they inevitably reduce and disrupt production, and undermine any free enterprise system. The remedy for huge governmental ex15

WHAT YOU SHOULD KNOW ABOUT INFLATION

penditures is therefore not equally huge taxes, but a halt to reckless spending. On the monetary side, the Treasury and the Federal Reserve System must stop creating artificially cheap money; i.e., they must stop arbitrarily holding down interest rates. The Federal Reserve must not return to the former policy of buying at par the government's own bonds. When interest rates are held artificially low, they encourage an increase in borrowing. This leads to an increase in the money and credit supply. The process works both ways—for it is necessary to increase the money and credit supply in order to keep interest rates artificially low. That is why a "cheap money" policy and a government-bond-support policy are simply two ways of describing the same thing. When the Federal Reserve Banks bought the government's 2l/2 per cent bonds, say, at par, they held down the basic long-term interest rate to 2% per cent. And they paid for these bonds, in effect, by printing more money. This is what is known as "monetizing" the public debt. Inflation goes on as long as this goes on. The Federal Reserve System, if it is determined to halt inflation and to live up to its responsibilities, will abstain from efforts to hold down interest rates and to monetize the public debt. It should return, in fact, to the tradition that the discount rate of the central bank should normally (and above all in an inflationary period) be a "penalty" rate—i.e., a rate higher than the member banks themselves get on their loans. Congress should restore the required legal reserve ratio of the Federal Reserve Banks to the previous level of 35 16

THE CURE FOR INFLATION

and 40 per cent, instead of the present "emergency" level of 25 per cent put into effect as a war-inflation measure in June 1945. Later I shall discuss other means of preventing an undue increase in the supply of money and credit. But I should like to state here my conviction that the world will never work itself out of the present inflationary era until it returns to the gold standard. The gold standard provided a practically automatic check on internal credit expansion. That is why the bureaucrats abandoned it. In addition to its being a safeguard against inflation, it is the only system that has ever provided the world with the equivalent of an international currency. The first question to be asked today is not how can we stop inflation, but do we really want to? For one of the effects of inflation is to bring about a redistribution of wealth and income. In its early stages (until it reaches the point where it grossly distorts and undermines production itself) it benefits some groups at the expense of others. The first groups acquire a vested interest in maintaining inflation. Too many of us continue under the delusion that we can beat the game—that we can increase our own incomes faster than our living costs. So there is a great deal of hypocrisy in the outcry against inflation. Many of us are shouting in effect: "Hold down everybody's price and income except my own." Governments are the worst offenders in this hypocrisy. At the same time as they profess to be "fighting inflation" they follow a so-called "full employment" policy. As one advocate of inflation once put it in the London Economist: "Inflation is nine-tenths of any full employment policy." What he forgot to add is that inflation must always end 17

WHAT YOU SHOULD KNOW ABOUT INFLATION

in a crisis and a slump, and that worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of "capitalism." Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals. But it is never "inevitable." We can always stop it overnight, if we have the sincere will to do so.

18

Inflation Has Two Faces It must be said, in sorrow, that the American public, generally speaking, not only does not understand the real cause and cure for inflation, but presents no united front against it. Feelings about inflation are confused and ambivalent. This is because inflation, like Janus, has two opposite faces. Whether we welcome or fear it depends upon the face we happen to look at. Or, putting the matter another way, we are each of us sometimes Dr. Jekyll and sometimes Mr. Hyde in our attitude toward inflation, depending upon how it seems to affect our personal interest at the moment. All this was once vividly illustrated in a message to a special session of Congress, in 1947, by President Truman. "We already have an alarming degree of inflation," he declared; "and, even more alarming, it is getting worse." Yet he pointed with pride to the results of inflation at one moment and denounced them the next moment. He claimed credit for its popular consequences and blamed his political opponents for its unpopular consequences. Like the rest of us, the President wanted to have his shoes small on the outside and large on the inside. 19

WHAT YOU SHOULD KNOW ABOUT INFLATION

It should be obvious that high prices, which everybody affects to deplore, and high money incomes, which everyone wants to achieve, are two sides of the same thing. Given the same amount of production, if you double the price level you double the national income. When President Truman boasted in July of 1947 that we had "surpassed previous high records" with a gross national product of $225 billion, he was boasting in large part of the higher dollar totals you get when you multiply volume of output by higher dollar prices. At one point in his "anti-inflation" message Mr. Truman declared: "In terms of actual purchasing power, the average income of individuals after taxes has risen (since 1929) 39 per cent." But a little later he was asking, inconsistently, how "the cost of living can be brought and held in reasonable relationship to the incomes of the people." Yet if the incomes of the people had in fact already risen so much faster than living costs that the individual could buy nearly 40 per cent more goods than he could before, in what did the alleged inflation "emergency" of 1947 consist ? "Rents are rising," complained Mr. Truman at another point, "at the rate of about 1 per cent a month," and such a rise imposed an "intolerable strain" upon the family budget. But as the average weekly earnings of factory workers had then gone up 112 per cent since 1939, while rents had gone up only 9 per cent, the average worker paid, in fact, a far smaller percentage of his income for rent than he did before the war. "The harsh effects of price inflation," said Mr. Truman at still another point, "are felt by wage earners, farmers, and 20

INFLATION HAS TWO FACES

businessmen." Clearly this did not refer to the inflation of their own prices, but of somebody else's. It is not the prices they got for their own goods and services, but the prices they had to pay for the goods and services of others, that they regarded as "harsh." The real evil of inflation is that it redistributes wealth and income in a wanton fashion often unrelated to the contribution of different groups and individuals to production. All those who gain through inflation on net balance necessarily do so at the expense of others who lose through it on net balance. And it is often the biggest gainers by inflation who cry the loudest that they are its chief victims. Inflation is a twisted magnifying lens through which everything is confused, distorted, and out of focus, so that few men are any longer able to see realities in their true proportions.

21

8 What "Monetary Management" Means

Ever since the end of World War II, the public in nearly every country has been told that the gold standard is out-ofdate, and what is needed in its place is "monetary management" by the experts. It is interesting to notice what some of the consequences of this have been. When Sir Stafford Cripps, then Chancellor of the Exchequer, announced the devaluation of the British pound on September 18, 1949, Winston Churchill pointed out that Cripps had previously denied any such possibility no fewer than nine times. A United Press dispatch of September 18 listed nine such occasions. A haphazard search on my own part uncovered three more—on September 22 and 28, 1948, and April 30,1949. Incorporating these in the UP list, we get the following record of denials: Jan. 26, 1948—"No alteration in the value of sterling is contemplated by the British Government following the devaluation of the franc." March 4, 1948—A reported plan to devalue the pound is "complete nonsense." May 6, 1948—"The government has no intention of embarking on a program to devalue the pound." 22

WHAT "MONETARY MANAGEMENT" MEANS

Sept. 22,1948—"There will be ho devaluation of the pound sterling." Sept. 28, 1948—The government has "no idea whatever" of devaluing the pound sterling. Devaluation would "increase the price of our imports and decrease the price of exports, which is exactly the opposite of what we are trying to accomplish." Oct. 5, 1948—"Devaluation is neither advisable nor even possible in present conditions." Dec. 31, 1948—"No one need fear devaluation of our currency in any circumstances." April 30, 1949—"Sterling revaluation is neither necessary nor will it take place." June 28, 1949—"There has been no pressure on me by America to devalue the pound." July 6, 1949—"The government has not the slightest intention of devaluing the pound." July 14,1949—"No suggestion was made at the conference [with Snyder and Abbott] . . . that sterling be devalued. And that, I hope, is that." Sept. 6, 1949—"I will stick to the . . . statement I made [July 14] in the House of Commons." In brief, Sir Stafford emphatically denied at least a dozen times that he would do what he did. The excuse has been made for him that naturally he could not afford to admit any such intention in advance because no one would then have accepted sterling at {4.03. This "defense" amounts to saying that unless the government had lied it could not have successfully deceived the buyers of British goods and the holders of sterling. 23

WHAT YOU SHOULD KNOW ABOUT INFLATION

For this is what "devaluation" means. It is a confession of bankruptcy. To announce that IOU's hitherto guaranteed to be worth $4.03 are in fact worth only $2.80 is to tell your creditors that their old claims on you are now worth no more than 70 cents on the dollar. When a private individual announces bankruptcy, he is thought to be disgraced. When a government does so, it acts as if it had brought off a brilliant coup. This is what our own government did in 1933 when it jauntily repudiated its promises to redeem its currency in gold. Here is how the London Bankers' Magazine described the 1949 devaluation of the pound by the British Government: "The political technique for dealing with these issues has worn thin. It consists of strenuous, even vicious repudiation beforehand of any notion of revaluation. It insists that the move would be ineffective and utters portentous warning about the dangers. When the unthinkable happens the public is slapped on the back and congratulated on the best piece of luck it has encountered for years." This is what governments have now been doing for a generation. This is what "monetary management" really means. In practice it is merely a high-sounding euphemism for continuous currency debasement. It consists of constant lying in order to support constant swindling. Instead of automatic currencies based on gold, people are forced to take managed currencies based on guile. Instead of precious metals they hold paper promises whose value falls with every bureaucratic whim. And they are suavely assured that only hopelessly antiquated minds dream of returning to truth and honesty and solvency and gold. 24

9 Gold Goes With Freedom

The question whether or not it is desirable to return to a real gold standard, and when, and under what conditions, and at what rate, and by precisely what steps, has become extremely complicated. But an excellent contribution to the subject was made in a speech of W. Randolph Burgess, then chairman of the executive committee of the National City Bank of New York, before the American Bankers Association in November of 1949. I quote in part: "Historically one of the best protections of the value of money against the inroads of political spending was the gold standard—the redemption of money in gold on demand. This put a check-rein on the politician. For inflationary spending led to the loss of gold either by exports or by withdrawals by individuals who distrusted government policies. This was a kind of automatic limit on credit expansion. . . . "Of course the modern economic planners don't like the gold standard just because it does put a limit on their powers. . . . I have great confidence that the world will return to the gold standard in some form because the people 25

WHAT YOU SHOULD KNOW ABOUT INFLATION

in so many countries have learned that they need protection from the excesses of their political leaders... . "There is a group of people today asking for the restoration of the full gold standard immediately in the United States. Today we have a dollar that is convertible into gold for foreign governments and central banks; these people are asking for the same rights to hold gold for our own citizens. In principle I believe these people are right, though I think they are wrong in their timing, and overemphasize the immediate benefits. . . . "If you try to force the pace by resuming gold payments before the foundations are laid through government policies on the budget, on credit, and on prices, the gold released may simply move out into hoards and become the tool of the speculator. "Gold payments are only part of the building of sound money, and they are in a sense the capstone of the arch...." The great virtue of this statement is not only that it recognizes the central importance of returning to a real gold standard but that it takes account also of the formidable difficulties that our past and present errors and sins have placed in the way. The gold standard is not important as an isolated gadget but only as an integral part of a whole economic system. Just as "managed" paper money goes with a statist and collectivist philosophy, with government "planning," with a coercive economy in which the citizen is always at the mercy of bureaucratic caprice, so the gold standard is an integral part of a free-enterprise economy under which governments respect private property, economize in spend26

GOLD GOES WITH FREEDOM

ing, balance their budgets, keep their promises, and refuse to connive in overexpansion of money or credit. Until our government is prepared to return to this system in its entirety and has given evidence of this intention by its deeds, it is pointless to try to force it to go on a real gold basis. For it would only be off again in a few months. And, as in the past, the gold standard itself, rather than the abuses that destroyed it, would get the popular blame. In the preceding chapter I recited the shabby record of Sir Stafford Cripps, not as a personal criticism but as an illustration of what typically, if not inevitably, happens under a "managed" paper-money system. For Sir Stafford was not the lowest type of politician likely to be entrusted to manage the people's money; he was the highest type. To millions he had been the very symbol of political integrity and courage. "If gold ruste," as Chaucer asked, "what shal iren do?" Which reminds us that real gold doesn't rust. As a currency basis it may lack one or two of the perfections that theorists dream of, but it weighs more and can be kept longer than a politician's pledge.

10 In Dispraise of Paper

A speech by Allan Sproul, then president of the Federal Reserve Bank of New York, before the American Bankers Association in 1949, was a startling revelation of official doctrine. "I perceive," said Sproul, "no moral problem involved in this question of gold convertibility." Let's see whether we cannot perhaps perceive one. Prior to the year 1933 our government pledged itself to pay interest and principal on its bonds in gold of a specified weight and fineness. It also pledged the holder of every currency note that it would redeem that note on demand in gold of a specified weight and fineness. It violated its most solemn pledge. It deprived the rightful owners of their gold. And it made the possession of gold by anybody but the thief illegal. Now our monetary managers tell us how lucky we are at last to have a system at home of irredeemable paper. Sproul sings paeans in praise of paper. "We use a paper money," he says, "which has the supreme attribute of general acceptability." He neglects to add—at a constantly falling value. The purchasing power of a paper dollar in 1949, according to the Department of Commerce, 28

IN DISPRAISE OF PAPER

was only 52 cents, as measured by wholesale prices, in terms of the 1935-39 dollar. It is now only 43 cents by the same measure. Sproul resorts to flag waving. "The integrity of our money does not depend on domestic gold convertibility. It depends upon the great productive power of the American economy. . . ." Those who recall the disastrous paper money inflations of history must shiver at this argument. Listen to Andrew D. White's report of speeches made in the French Assembly in 1791 to defend the paper assignats: "Tear nothing; your currency reposes upon a sound mortgage.' Then followed a glorification of the patriotism of the French people, which, he asserted, would carry the nation through all its difficulties." The nub of SprouPs defense of our internal irredeemably is that the bureaucrats must be trusted implicitly but that the people cannot be trusted at all. It appears that when you allow the people to redeem their money in gold they always want to do it at the wrong time—i.e., just when it is most embarrassing for the government to meet the demand; in other words, just when the government has connived in an inflationary expansion and issued more paper claims than it is able to honor. "The principal argument for restoring the circulation of gold coin," Sproul declares, "seems to be distrust of the money managers and of the fiscal policies of government." He couldn't have said it better. What he fails to see is that this mistrust has been richly earned. In addition to the shabby record of Sir Stafford Cripps? we need to remind ourselves that some 30 governments instantly followed the 29

WHAT YOU SHOULD KNOW ABOUT INFLATION

British example. They wiped out overnight, by simple ukase, part of the value of every paper currency unit in the hands of their own people. Yet in the face of this almost universal record of currency debasement (not to bring up our own sorry record of currency inflation since 1933), Sproul can seriously speak of leaving everything to what he calls "competent and responsible men." Said Sir Stafford Cripps, in explaining his devaluation record: "Even if we had then had some future intention of altering the rate of exchange, which in fact we had not, no responsible minister could possibly have done otherwise than deny such intention." Here, then, is an authoritative definition. A "competent and responsible" monetary manager is one who not only lies to his people regarding the future of their currency but even considers it his duty to deceive them. Sproul's currency theory may be summed up thus: Put your faith in the monetary managers, who have always fooled you in the past.

30

11 Inflation and High "Costs"

In an earlier chapter I declared that inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. There is nothing peculiar or particularly original about this statement. It corresponds closely, in fact, with "orthodox" doctrine. It is supported overwhelmingly by theory, experience, and statistics. But this simple explanation meets with considerable resistance. Politicians deny or ignore it, because it places responsibility for inflation squarely on their own policies. Few of the academic economists are helpful. Most of them attribute present inflation to a complicated and disparate assortment of factors and "pressures." Labor leaders vaguely attribute inflation to the "greed" or "exorbitant profits" of manufacturers. And most businessmen have been similarly eager to pass the buck. The retailer throws the blame for higher prices on the exactions of the wholesaler, the wholesaler on the manufacturer, and the manufacturer on the rawmaterial supplier and on labor costs. This last view is still widespread. Few manufacturers are students of money and banking; the total supply of

WHAT YOU SHOULD KNOW ABOUT INFLATION

currency and bank deposits is something that seems highly abstract to most of them and remote from their immediate experience. As one of them once wrote to me: "The thing that increases prices is costs." What he did not seem to realize is that a "cost" is simply another name for a price. One of the consequences of the division of labor is that everybody's price is somebody else's cost, and vice versa. The price of pig iron is the steelmaker's cost. The steelmaker's price is the automobile manufacturer's cost. The automobile manufacturer's price is the doctor's or the taxicab-operating company's cost. And so on. Nearly all costs, it is true, ultimately resolve themselves into salaries or wages. But weekly salaries or hourly wages are the "price" that most of us get for our services. Now inflation, which is an increase in the supply of money, lowers the value of the monetary unit. This is another way of saying that it raises both prices and "costs." And "costs" do not necessarily go up sooner than prices do. Ham may go up before hogs, and hogs before corn. It is a mistake to conclude, with the old Ricardian economists, that prices are determined by costs of production. It would be just as true to say that costs of production are determined by prices. What hog raisers can afford to bid for corn, for example, depends on the price they are getting for hogs. In the short run, both prices and costs are determined by the relationships of supply and demand—including, of course, the supply of money as well as goods. It is true that in the long run there is a constant tendency for prices to equal marginal costs of production. This is because, though what a thing has cost cannot determine its price, what it 32

INFLATION AND HIGH "COSTS"

now costs or is expected to cost will determine how much of it, if any, will be made. If these relationships were better understood, fewer editorial writers would attribute inflation to the so-called "wage-price spiral." In itself, a wage boost (above the "equilibrium" level) does not lead to inflation but to unemployment. The wage boost can, of course (and under present political pressures usually does), lead to more inflation indirectly by leading to an increase in the money supply to make the wage boost payable. But it is the increase in the money supply that causes the inflation. Not until we clearly recognize this will we know how to bring inflation to a halt.

33

12 Is Inflation a Blessing?

The late Sumner H. Slichter, professor of economics at Harvard, was a clear, vigorous, able, and highly influential writer. He made many instructive contributions, but in the field of money and inflation, to which he mainly devoted himself in the last years of his life, I cannot believe that his influence was for the good. I take as one example an article by him in Harper's Magazine of August, 1952, under the title "How Bad Is Inflation?" This article, in fact, seemed to epitomize all the shopworn fallacies that have been put forward as apologies for inflation in the last two centuries. Professor Slichter began by dismissing the conclusions on inflation by the American Assembly, a group of distinguished economists, as "uncritical and almost hysterical." The assembly concluded that "inflation is a continuous and serious threat to the stability of the American economy and to the security of the entire Western world." This judgment was not hysterical, but restrained. It was Slichter who was appallingly uncritical. He not only thought that it is easy for a government to plan and control "a slow rise in prices"; he actually believed that an "extreme" inflation "is not easily started." It would be inter34

IS INFLATION A BLESSING?

esting to learn what his definition was of an "extreme" inflation, and what his concept was of difficulty. Germany inflated until its mark fell to one-trillionth of its previous value. Nationalist China inflated until the yuan reached 425 million to the dollar. In Great Britain prices at the time this Harpers article appeared were three times as high as they were before World War II; in the Argentine (with no "war" excuse) prices were already five to eight times as high; in France, more than 25 times as high; in Italy, more than 50 times as high. None of these countries found it at all difficult to get its inflation going, but most of them were finding it politically almost impossible to stop. Slichter's argument throughout was based on assumptions that are neither proved nor warranted. One of these is that a rising price level is necessary for prosperity. This is refuted by a wealth of historical experience. The great American boom from 1925 to 1929, for example, occurred in spite of a falling price level. And Slichter did not seem to remember that depressions are caused chiefly by the collapse of previous inflations. Nor did Slichter seem to understand how inflation temporarily works its magic. It does so only as long as prices run ahead of costs (mainly wages). Then the prospective restoration or increase of profit margins may lead to an increase in production and employment. But the jig is up once labor gets on to the game, and wages and other costs begin to rise faster than prices. The apostles of permanent inflation ("continuous slow" inflation) are those who believe that labor can be permanently fooled. Slichter did not explain in his article by exactly what 35

WHAT YOU SHOULD KNOW ABOUT INFLATION

process a "slow" permanent rise in prices—say 2 or 3 per cent a year—could be produced. He did not understand why no nation has yet succeeded in keeping an inflation, once started, under control. He forgot that you can't afford to tell people in advance that you are planning to cheat them. A government can't plan a "gradual" increase in prices, because if people \now that prices will be 3 per cent higher, say, next year, they will bid prices up nearly that much right away. If creditors \now that the purchasing power of the money they are asked to lend today is going to depreciate 3 per cent within a year, they will add 3 per cent to whatever interest rate they would otherwise demand; so that instead of lending at 5 per cent, say, they will ask 8. Most astonishing of all, Slichter advocated a continuous inflation to combat Communism. One might have referred him to the late Lord Keynes, who wrote a generation ago: "Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. Lenin was certainly right. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose." Slichter, alas, was not that one man.

13 Why Return to Gold?

Fifty years ago practically every economist of repute supported the gold standard. Most of the merits of that standard were clearly recognized. It was, for one thing, international. When the currency unit of nearly every major country was defined as a specified weight of gold (previous to 1934 the American dollar, for example, was defined as 23.22 grains of fine gold), every such currency unit bore a fixed relation to every other currency unit of the same kind. It was convertible at that fixed ratio, on demand, to any amount, and by anybody who held it, into any other gold currency unit. The result was in effect an international currency system. Gold was the international medium of exchange. This international gold standard was the chief safeguard against tampering with the currency on the part of politicians and bureaucrats. It was the chief safeguard against domestic inflation. When credit inflation did occur, it produced a quick sequence of results. Domestic prices rose. This encouraged imports and discouraged exports. The balance of trade (or payments) shifted "against" the inflating country. Gold started to flow out. This caused a con37

WHAT YOU SHOULD KNOW ABOUT INFLATION

traction of the bank credit based on the gold, and brought the inflation to a halt. Usually, in fact, the chain of consequences was shorter, quicker, and more direct. As soon as foreign bankers and exchange dealers even suspected the existence of inflation in a given country, the exchange rate for that country's currency fell "below the gold point." Gold started to flow out. Then the central-bank managers of the country that was losing gold raised the discount rate. The effect was not merely to halt credit expansion at home, but to draw funds from abroad from lenders who wanted to take advantage of the higher short-term interest rates. The gold flow was stopped or reversed. Thus so long as the gold standard was resolutely maintained, a whole set of related benefits ensued. Domestic currency tampering and anything more than a relatively moderate inflation were impossible. As gold convertibility had to be maintained at all times, confidence had to be maintained not only through every year but every day. Unsound monetary and economic policies, or even serious proposals of unsound policies, were immediately reflected in exchange rates and in gold movements. The unsound policies or proposals, therefore, had to be quickly moderated or abandoned. Because there was a fixed and dependable exchange ratio as well as free convertibility between one currency unit and another, international trade, lending, and investment were undertaken freely and with confidence. And, finally, the international gold standard established (apart from differences caused by shipping costs and tariffs) uniform world 38

WHY RETURN TO GOLD?

prices for transportable commodities—wheat, coffee, sugar, cotton, wool, lead, copper, silver, etc. It has become fashionable to say that in a major crisis, such as war, the gold standard "breaks down." But except to the extent that the citizens of a country fear invasion, conquest, and physical seizure of their gold by the enemy, this is an untrue description of what happens. It is not that the gold standard "breaks down," but that it is deliberately abandoned or destroyed. What the citizens of a country really fear in such crises is inflation by their own monetary managers, or seizure of their gold by their own bureaucrats. This inflation or seizure is not "inevitable" in wartime; it is the result of policy. In short, it is precisely the merits of the international gold standard which the world's money managers and bureaucrats decry. They do not want to be prevented from inflating whenever they see fit to inflate. They do not want their domestic economy and prices to be tied into the world economy and world prices. They want to be free to manipulate their own domestic price level. They want to pursue purely nationalistic policies (at the expense or imagined expense of other countries), and their pretenses to "internationalism" are a pious fraud.

39

14 Gold Means Good Faith

Nothing has more clearly demonstrated the need for the gold standard than its abandonment. Since that occurred, in Britain in 1931 and in the United States in 1933, the world has been plunged, both in wartime and in peacetime, into a sea of paper money and unending inflation. Although the inflation everywhere has been blamed on "the war," it has occurred in nations that were never involved in the war (throughout Latin America, for example), and it has continued to rage since the war ended. As an indirect index of this, wholesale prices have increased in this country 73 per cent since 1945; in Britain 115 per cent; in France 810 per cent.* And everywhere this result has been due primarily to the increase in the paper money supply. The monetary managers are fond of telling us that they have substituted "responsible monetary management" for the gold standard. But there is no historic record of responsible paper-money management. Here and there it is possible to point to brief periods of "stabilization" of paper money. But such periods have always been precarious and * Before the introduction of the "heavy franc," at the beginning of 1960, at a valuation of 100 old francs.

40

GOLD MEANS GOOD FAITH

short-lived. The record taken as a whole is one of hyperinflation, devaluation, and monetary chaos. And as for any integrity in paper-money management, we need merely recall the record of Sir Stafford Cripps, who, in the two-year period preceding his devaluation of the pound sterling on September 18, 1949, publicly denied any such possibility no fewer than a dozen times. This is what happens under monetary management without the discipline of the gold standard. The gold standard not only helps to ensure good policy and good faith; its own continuance or resumption requires good policy and good faith. If I may repeat what I pointed out in Chapter 9: The gold standard is not important as an isolated gadget but only as an integral part of the whole economic system. Just as "managed" paper money goes with a statist and collectivist philosophy, with government "planning," with a coercive economy in which the citizen is always at the mercy of bureaucratic caprice, so the gold standard is an integral part of a free-enterprise economy under which governments respect private property, economize in spending, balance their budgets, keep their promises, and above all refuse to connive in inflation—in the overexpansion of money or credit. So if, as it should, the American government decides to return to a full gold standard, its first step must be to bring inflation to a halt. Without this preliminary or accompanying step any attempted return to gold would be certain to collapse. And once again the gold standard itself, rather than the inflation, would probably be discredited in the popular mind.

WHAT YOU SHOULD KNOW ABOUT INFLATION

How, then, does one halt inflation? The economist Ludwig von Mises has maintained that no increase whatever should be allowed in the quantity of money and bank credit that is not ioo per cent covered by deposits paid in by the public. Although this is basically the result that should be aimed at, it would be politically more acceptable, I think, if this result were brought about by means in accordance with our own best practices and past traditions. I therefore suggest that the halting of inflation should be achieved by these four means: i—Start balancing the budget. 2—Stop using the banking system either to buy and peg government bonds at fixed rates, or as a dumping ground for huge new issues of short-term government securities. (The peacetime rule, in fact, might be to permit no further net increase in the total volume of government securities held by the country's banking system.) 3—Insist that the Federal Reserve Banks impose discount rates that would penalize borrowing by member banks rather than make it profitable. This means that the rediscount rate should be kept above the rate to prime borrowing customers at the great city banks. 4—Restore the legal reserve requirements of the Federal Reserve Banks (over a reasonable time period) to 40 per cent from their "war emergency" reserve level of only 25 per cent adopted in 1945 (or from whatever still lower gold reserve requirement exists at the time of the reform). There is no more effective way in which Congress could register its own opposition to further inflation. 42

15 What Price for Gold? Granted that it is desirable, and even imperative, to return to a full gold standard, by what methods should we return? And at precisely what dollar-gold ratio—i.e., at what "price for gold"? These difficult problems have split into dissident groups even the minority of economists who are actively urging a return to a gold standard. One group, for example, contends that we can and should return to a full gold standard immediately, and at the present price of $35 an ounce. It bases this contention on the arguments that we are already on a limited gold standard at that rate (foreign central banks, at least, are permitted to buy gold from us and sell it to us at $35 an ounce); that we should not suspend this limited gold standard even as a transitional step for a few months; that in the interests of good faith and stability there should be "no further tampering" with this rate; and that at this rate we would in fact have a large enough gold reserve to maintain full convertibility against present outstanding paper currency and deposit liabilities. These arguments, however, rest on debatable assumptions. Some superficial comparisons, it is true, seem to support 43

WHAT YOU SHOULD KNOW ABOUT INFLATION

them. At the beginning of 1933, the United States money supply (time and demand bank deposits plus currency outside of banks) was $44.9 billion, and the country's gold holdings (measured at the old rate of $20.67 an ounce) were $4.2 billion, or only 9.4 per cent of the country's money supply. At the end of 1963 our outstanding money supply was $265 billion, and our gold holdings against it (measured at the current rate of $35 an ounce) were $15.6 billion, or less than 6 per cent. Thus our gold reserve ratio is less than in 1933. And we were thrown off gold in 1933. In writing this, I recognize that the run on gold, at the particular moment at which it took place, was at least in part precipitated by the growth of uncontradicted rumors and press reports that the Roosevelt Administration was planning to suspend gold payments. Nevertheless, the relation of credit volume and commodity prices to gold at that time was still such that we had only the choice of going off gold, which we did; or devaluing the dollar and staying on gold (i.e., raising the official gold price); or suffering still further stagnation and deflation. In any case, the run on gold in 1933, before payments were suspended, means that the gold reserves at that time were not in fact sufficient, in relation to other conditions, to maintain confidence. Present gold reserve comparisons with past periods must take account, moreover, of changes in the relative percentage of the world's gold supply held in the United States. In 44

WHAT PRICE FOR GOLD?

December 1926, the United States held 45 per cent of the world's monetary gold supply (excluding Russia); in December 1933 it held only 33.6 per cent. In 1953 it held 60.8 per cent. At the end of 1959 it held 48.3 per cent. If the United States alone returned to gold it could conceivably continue to hold an abnormal percentage for a certain time. But if other countries followed suit within a few years (which would be both desirable and probable), they would presumably attract their previous proportion of the world's gold. More immediately important: In mid-1964, against our gold holdings of $15.5 billion, short-term liabilities to foreigners reported by American banks came to $26.3 billion. And the United States was still showing a heavy deficit in its international balance of payments. But the real error of those who think we could safely return to a full gold standard at a rate of only $35 an ounce lies in the assumption that there is some fixed "normal" percentage of gold reserves to outstanding money liabilities that is entirely safe under all conditions. This, in fact, is not true of any gold reserve of less than 100 per cent. In periods when public confidence exists in the determination of the monetary managers to maintain the gold standard, as well as in the prudence and wisdom of their policy, gold convertibility may be maintained with a surprisingly low reserve. But when confidence in the wisdom, prudence, and good faith of the monetary managers has been shaken, a

45

WHAT YOU SHOULD KNOW ABOUT INFLATION

gold reserve far above "normal" will be required to maintain convertibility. And today confidence in the wisdom, prudence, and good faith of the world's monetary managers has been all but destroyed. It may take years of wisdom, prudence, and good faith to restore it. Until that is done, any effort to resume a full gold standard at $35 an ounce might lead to a panicky run on gold, while a determined effort to maintain that rate might precipitate a violent deflation.

16 The Dollar-Gold Ratio

The gold-standard supporters are divided into three main groups: ( i ) those who think we could safely return to a full gold standard at $35 an ounce; (2) those who urge return to a full gold standard at some specific higher price for gold (e.g., $70 an ounce) which they claim they already know to be the "correct" one; and (3) those who recommend that we permit a temporary free market in gold for guidance in fixing a final dollar-gold conversion rate. I have already discussed the main arguments of those who urge a return to gold at $35 an ounce, and what I consider to be some of the shortcomings of those arguments. Those who are urging that we set the price of gold at a higher figure, and who claim to know already what that figure should be, commonly base their conclusion on some comparison of price levels. For example, since 1932, the last full year in which we were on a real gold basis (at $20.67 a n ounce), wholesale prices have increased 182 per cent. On the argument that only a corresponding increase in the price of gold could prevent a fall in prices if we went back to a full gold standard, the new price of gold would have to be about $58. Again, the price of gold was set at $35 an ounce on 47

WHAT YOU SHOULD KNOW ABOUT INFLATION

January 31, 1934. For the next seven years wholesale prices averaged only 43 per cent of their present level. If we assume that $35 was the "right" price of gold in those seven years—1934-40—then the price of gold necessary to maintain the present wholesale price level might have to be about $82. The dubious nature of the assumptions behind such calculations is clear. But the rate at which we return to a full gold standard is not a matter of indifference. Charles Rist, one of the world's leading monetary economists, argued in a powerful article in Foreign Affairs in April 1934 that one of the major causes of the world crisis of 1929-33 was the attempt of leading countries, including the United States, to maintain or return to gold convertibility at their prewar rate for gold after having enormously multiplied their paper currency circulation. The case of Great Britain is clear. It had gone off gold in World War I. The pound had dropped from a gold parity of $4.86 to a low of $3.18 in February 1920, and had returned in late 1924 to approximately 10 per cent below the gold parity. But wholesale prices in Britain in 1924 were still 70 per cent above their prewar level. The British Government decided to resume the gold standard at the old par in 1925. The result was a steady fall in wholesale prices over the next seven years from an index number of 171.1 (1913 equals 100) in January 1925 to 99.2 in September 1931, the month in which England abandoned the gold standard. As the British all during this period were unwilling to make corresponding cuts in retail prices and wage rates, the result was falling exports, stagnation, and unemployment. And it

T H E DOLLAR-GOLD RATIO

was the gold standard itself, not the false rate (or the internal inflexibility of wages), that got the blame. The British repeated this pattern in essence in the summer of 1947, when they tried to make the pound convertible into the dollar at the wholly unrealistic rate of $4.03. When that experiment broke down within a few weeks, the British once more blamed convertibility itself, and not the false rate, for the breakdown. It is of the highest importance not only to our own economic future, but to the future of the world, that we do not repeat the British errors by trying to return to gold convertibility at an overvaluation of the paper dollar (which would mean an undervaluation of gold). A temporary free market in gold would give us more guidance regarding what the new conversion rate should be than either an adamant insistence on $35 an ounce or some dubious calculation based largely on hypothetical assumptions.

49

17 Lesson of the Greenbacks

One of the worst consequences of inflation is that most of its mischiefs and injustices are irreparable. They cannot be cured by deflation. This merely brings about its own hardships and injustices, which are just as likely to fall upon the previous victims of inflation as upon its beneficiaries. We cannot, for example, cure the inflationary erosion or wiping out of the purchasing power of savings-bank deposits, government bonds and insurance policies by a deflation which may bring about the unemployment or bankruptcy of the very people who suffered from the inflation. So when an inflation has gone beyond a certain amount, the best we can do is to try to stabilize at the new level. When an inflation has gone to the lengths of that in Germany in 1923, for example, or that in France today, a return to the pre-inflation level is inconceivable. Just what should be attempted, therefore, after an inflation has passed a certain point, becomes an awkward practical problem to which there simply cannot be any completely "just" or satisfactory solution. We have seen in the preceding chapter what happened in Britain when it tried to go back to the gold standard at the 50

LESSON OF THE GREENBACKS

old parity in 1925. But there are many who believe that our own resumption of gold payments on January 1,1879, at the prewar parity, after the paper money inflation of the Civil War, was an unalloyed success. The fears of a gold drain, they argue, proved quite unfounded. And they attribute the subsequent American recovery of 1879 largely or wholly to gold resumption. A closer examination of the whole inflationary and deflationary period from 1862 to 1879, however, tells a different story. As soon as the government started issuing irredeemable "greenbacks" in 1862, gold went to a premium on the open market and commodity prices started to soar. In 1864, the greenbacks fell as low as 35 cents on the dollar in terms of gold. From i860 to 1865, inclusive, though the average of European prices rose only 4 to 6 per cent, average prices in the United States advanced no less than 116 per cent. But immediately after the end of the war, American prices started downward. At first this was politically popular, because wages had not yet advanced as much as the cost of living. But after 1866 wages had more than caught up with prices. The continued fall in prices soon began to cause bankruptcies and unemployment. Finally came the panic of 1873 which, in the measured judgment of some economists, "left the country's financial and commercial structure almost a ruin." The causes of the panic were complex. But one of them was certainly the continued fall of commodity prices that accompanied the rise of the greenbacks toward parity. By 1873 the greenbacks were only about 15 per cent below parity, and wholesale prices were down to about 30 per cent above prewar levels.

WHAT YOU SHOULD KNOW ABOUT INFLATION

The result of the panic of 1873 was greatly to increase inflationist sentiment. It is true that the Resumption Act was passed on January 7, 1875, but by a repudiated lameduck Republican Congress that had nothing more to lose. Even more ironic, it was passed, the economist J. Laurence Laughlin tells us, "only under the delusion that it was an inflation measure," because "on its face it looked like a bill to expand the national bank circulation." Many commentators today think it was foolish and needless for the Resumption Act to put off the actual day of resumption to January 1, 1879—four years after passage of the act. They forget, however, that time, skill, and determination were required to accumulate a gold reserve which would inspire so much confidence that gold would not be demanded when the day of redemption came. And they forget, too, that returning to gold at the original parity involved a still further decline (of about 30 per cent) in American commodity prices to bring them into line with world gold prices. This decline actually took place between 1875 and 1879, and the whole period was one of "economy and liquidation." In 1878, for example, the record of insolvencies far exceeded even that of the panic year 1873. Many commentators today attribute the recovery that came in the second half of 1879 to the return to gold redemption. The facts do not support them. "With hardly an exception," writes the economic historian, Alexander D. Noyes, "the country's staple industries sank, during the early months of 1879, into complete stagnation." What suddenly turned the tide was an unparalleled coincidence: Europe suffered the worst crop disaster in many years, whereas the

LESSON OF THE GREENBACKS

American wheat crop reached a new high record. This meant high prices and crop exports unparalleled up to that time. All this is not to argue that after the greenback inflation

of the Civil War this country should have returned to gold at a lower parity for the dollar. It is simply to point out that we had to pay a heavy price for the course we actually took, even though our economy was far more flexible then than now, particularly as regards wage-rates. We must take care that when we return to gold this time we do so at a rate that involves neither inflation nor serious deflation.

53

18 The Black Market Test

It may perhaps be argued that the collapse of the attempted return by Britain in 1925 to the old gold parity, or the hardships involved in the American resumption of specie payments after the Civil War, are irrelevant to the present problem of the United States because (1) we are already on a de facto gold standard at $35 an ounce so far as foreign central banks are concerned, and (2) even in the black market the price of gold bullion has sometimes been no higher than $35 an ounce. These arguments have some weight, but they are far from conclusive. As regards the first argument, it may be pointed out that our restricted gold standard at $35 an ounce has been maintained only in a highly abnormal world situation that cannot be counted on to continue. It would, in fact, prove ultimately disastrous if it continued. For even this token American gold standard has been tenable only because the United States has for twenty-six years been the least unsafe place for gold, and because most other leading countries have inflated even more. A slight shift in this situation could easily lead to a heavy drain on American gold. There has been a sub54

THE BLACK MARKET TEST

stantial drain on our gold, in fact, since the high point of $24.5 billion was reached in 1949. The better the monetary behavior of foreign countries becomes, in other words, the more precarious will become the maintenance even of our closely restricted gold standard at $35 an ounce. And this $35 an ounce standard might give way entirely if private citizens, private businessmen and private bankers, American and foreign, were as free to demand gold for their notes as are foreign central banks. In fact, it is this very fear that is used to justify the present prohibitions against gold convertibility for the private citizen. As regards the second argument, I do not believe that the black market price of gold bullion, under present circumstances (gold coins are still at a premium), is a reliable guide to anything in particular. There are innumerable possible leaks between the American buying-and-selling rate of $35 an ounce, and the black market, which make the former dominate and control the latter. (The American Federal Reserve Banks feed out gold to the Bank of England to help it hold down the "free" London market price.) There are more than a hundred member nations in the International Monetary Fund. How can the American Federal Reserve System, or the I.M.F., supervise and police them all?—not to speak of individual officials in them? Many of these member nations are very poor; it would help their position, or the position of their central banks, if they could buy gold at $35 an ounce from the American Federal Reserve and resell it to private individuals in their own country at a premium. If something like this were going on, even in a few instances, it would mean the existence of 55

WHAT YOU SHOULD KNOW ABOUT INFLATION

"arbitrage" transactions which would prevent more than a moderate spread between the black market and the official market. I am not framing this as an accusation, but simply as an illustration of one way in which the disappearance of the former black market premium on gold bars could be accounted for. Nicolaas C. Havenga, the South African Minister of Finance, and the eminent French economist, the late Charles Rist, have both implied, in fact, that a sufficient explanation of the disappearance of the black market premium price is that the demand for gold is still subjected almost everywhere to legal restrictions and prohibitions, while the available supply has been becoming more and more abundant. In any case, it would be a very dubious inference to take the absence of a black market premium as any guarantee of the "rightness" or tenability of the present official $35 price. And certainly any such coincidence of price is not a valid argument for continuing to prohibit a truly free American and world market in gold. The reason free markets in gold do not exist under a full gold standard is not because they are forbidden, but because the universal ability of everyone to buy or sell gold at the official rate leaves no need for a free market. Under a full gold standard, a free market would have nothing to do, no purpose to serve, no function to perform. It is needed only under a paper-money standard, or under a discriminatory and half-fictitious "gold standard" of the sort the United States has had since 1934. It is precisely when a free gold market is needed that most 56

THE BLACK MARKET TEST

modern governments seek to suppress it. For it reflects and measures the extent of the lack of confidence in the domestic currency; and it exposes the fictitious quality of the "official" rate. And these are among the very reasons why it is needed.

57

19 How to Return to Gold

If we grant that there is a great potential danger in trying to return immediately to a full gold standard at $35 an ounce, by what steps are we to return? And how are we to determine the dollar-gold ratio—which would decide the new "price of gold"—at which the return should be made ? It is a sound general principle that unless there are the strongest reasons for change, the dollar-gold ratio, once fixed, ought not to be tampered with. This rule certainly applied to the pre-1933 r a t e °f $20-67 an ounce, because that was a real rate, at which anybody was entitled to demand gold, and got it. But the $35 rate, fixed by RooseveltMorgenthau whim in 1934, is not a rate at which real convertibility has existed. It is only foreign central banks, not American citizens, that have been permitted to buy gold from our Federal Reserve Banks at $35 an ounce, and even they have been allowed to do this only under certain conditions. The present $35-an-ounce gold standard is a window-dressing standard, a mere gold-plated standard. There is no reason for treating the $35 figure as sacrosanct. The new dollar-gold ratio that we should aim at is one at which gold convertibility can be permanently maintained, 58

HOW TO RETURN TO GOLD

and that will not be in itself either inflationary or deflationary—that will neither, in other words, in itself bring about a rise or a fall in prices. There are some economists who contend on unconvincing evidence that $35 an ounce is that rate. Others profess to have some mathematical formula for arriving at such a rate, and on this basis confidently advocate $70 an ounce or some other figure. Their diverse results in themselves invite suspicion. Values and prices are not set by mathematical calculations, but by supply and demand operating through free markets. Because of the enormous inflation in the thirty years since we departed from a real gold standard, and the enormous shock to confidence that inflations, devaluations, and repudiations have produced, we must test the state of confidence in a temporary free market for gold—a market that will also give us a guide to a new dollar-gold ratio that we can hold. The following time schedule of gold resumption is put forward chiefly for purposes of illustration: 1—The Administration will immediately announce its intention to return to a full gold standard by a series of steps dated in advance. The Federal Reserve Banks and the Treasury will temporarily suspend all sales or purchases of gold, merely holding on to what they have. Simultaneously with this step, a free market in gold will be permitted. 2—After watching this market, and meanwhile preventing any further inflation, the government, within a period of not more than a year, will announce the dollar-gold ratio at which convertibility will take place. 59

WHAT YOU SHOULD KNOW ABOUT INFLATION

3—On and after Convertibility Day, and for the following six months, any holder of dollars will be entitled to convert them into gold bars, but at a moderate discount on the paper dollars he turns in. To put the matter the other way, he would be asked to pay a premium on gold bars above the new valuation—equivalent, let us say, to l/2 of 1 per cent a month. The purpose of this would be to spread out the first demands for conversion and discourage excessive pressure on reserves at the beginning. The same purpose could be achieved also by a wide but gradually narrowing spread between the official buying and selling prices of gold bars. Of course, the free market in gold would continue during this period, and if gold could be obtained in this free market for less than the official premium rates, it would not be demanded from the government's reserves. 4—Six months after Convertibility Day, the country will return to a full gold-bullion standard. Conversion of dollars into gold bars, or vice versa, will be open to all holders without such discounts or premiums and without discrimination. 5—One year later still, on January 1, 19—, the country will return to a full gold-coin standard, by minting gold coins and permitting free conversion. A full gold-coin standard is desirable because a goldbullion standard is merely a rich man's standard. A relatively poor man should be just as able to protect himself against inflation, to the extent of his dollar holdings, as a rich man. The reason for returning to a full gold-coin standard in several stages is to prevent too sudden a drain on gold reserves before confidence has been re-established. 60

HOW TO RETURN TO GOLD

We achieved this end after the Civil War by delaying actual resumption for four years after passage of the Resumption Act. A program like the foregoing would provide a faster schedule.

61

20 Some Errors of Inflationists In every year of the past quarter-century of inflation articulate individuals or groups have insisted that we were in fact in a depression or a deflation, or on the verge of one, or at the very least that our "economic growth" was not as fast as the adoption of their particular inflationist schemes could make it. A typical example is a "report" of the National Planning Association (a group of statist planners who frequently manage to get their pronouncements on the front pages of leading newspapers) in mid-1954. This report declared that the country must step up its production of goods and services by "at least $25 billion" over the next twelve months to keep the economy healthy. Why, as long as they were simply talking about what was desirable, they stopped at a mere $25 billion, I do not know. The pronouncement, however, was so typical of current inflationist fallacies that it is worth a little analysis. The NPA firmly believed that what primarily caused the "recession" from mid-1953 to mid-1954 was a drop in defense spending, and therefore what could pull us out was a boost in defense spending. Such a judgment, however, finds no 62

SOME ERRORS OF INFLATIONISTS

support in either economic theory or experience. In the fiscal year 1944 the Federal government spent $95 billion; in the fiscal year 1947 it spent $39 billion. Here was a drop in the annual Federal spending rate in this three-year period of $56 billion. Yet, far from there being a recession in this three-year period, there was a substantial increase in employment, wages, and prices. I may add that there was a very sharp increase in industrial production and employment between mid-1954 and mid1955—though in that fiscal year total Federal spending, instead of being increased (as recommended by NPA), was further reduced by more than $3 billion. This fact did not escape the notice of observers at the time. In a column in The New Yor\ Times of September 8, 1955, Arthur Krock drew attention to official statistics which showed that private spending in the United States had been steadily replacing, and in fact exceeding, the billions cut from the budget by the Eisenhower Administration over a two-year period. The following table shows the comparison: *953

*954

^955

Gross national product $369.3 $357-6 $384.8 Federal purchases of goods and services 61.0 48.6 45.2 All other expenditures 3°8-3 3°9-° 339-6 What is really compared in the foregoing table is the second quarters of 1953, 1954, and 1955. The figures are expressed, however, in billions of dollars at seasonally adjusted annual rates. They show that while government spending was running at an annual rate of $3.4 billion less in the 1955 quarter than in 1954, and $15.8 billion less than 63

WHAT YOU SHOULD KNOW ABOUT INFLATION

in the corresponding 1953 quarter, nongovernmental activity was running in the second quarter of 1955 at a rate $30.6 billion higher than in the same period of 1954 and $31.3 billion higher than in 1953. There is really nothing astonishing in such figures except to those who tenaciously hold to a quite erroneous preconceived view. Yet again and again in recent years we find it stated or assumed by business "forecasters" that the future of business activity depends primarily on the government's defense-spending program. If that rises, we are told, business activity and prices will rise; but if it declines, there is no telling how much business will deteriorate. This assumption would lead to the absurd conclusion that the more resources we are forced to devote to making planes, carriers, submarines, nuclear bombs, and guided missiles, the richer we become. Indeed, many amateur economists have not shrunk from this conclusion, and tell us with a knowing air how lucky we are to have a constant threat of Communist aggression—for if this threat were suddenly and miraculously to disappear, what would become of prosperity, "economic growth," and full employment? Every new Communist act of aggression, on this theory, does us an economic favor. The fallacy consists in looking only at the government's defense payments and forgetting that the money for these comes ultimately from taxes. If defense payments suddenly dropped from $46 billion to $16 billion, taxes vcould also be cut by $30 billion. Then the taxpayers would have $30 billion more to spend than they had before, to make up for the $30 billion drop in government spending. There is no 64

SOME ERRORS OF INFLATIONISTS

reason to suppose that the over-all volumes of output or activity would decline. The whole theory that defense spending is necessary for prosperity, as I pointed out previously, got a crushing refutation at the end of World War II. Immediately after Japan surrendered in August 1945, there was a sweeping cancellation of war contracts. Government economists predicted that unemployment would reach 8 million by the following spring. Nothing of the sort happened. In sum, there is no reason whatever to suppose even in theory that wages and employment should depend primarily on the volume of defense spending, or government spending for any other purpose. If the government spends $10 billion less on defense and reduces taxes by the same amount, then the taxpayers have as much more to spend as the government has less. The total volume of spending is unchanged. It would be a monstrous as well as a foolish doctrine that we must increase the volume of wasteful expenditure on armament, not for the sake of defense, but for the sake of "creating prosperity." So far as the inflationary effect is concerned, what counts is not the amount of defense spending or total government spending, but the size of the deficit and, even more directly, the amount of new money supply. Even the NPA statement at one point seemed willing to settle for a deficit achieved through civilian public works or even a cut in taxes. It even recognized at one point that private plant and equipment modernization might help to create employment. But it paid scant attention to the fact that only the continuing prospect of profits, and only the ability of the profit-earners 65

WHAT YOU SHOULD KNOW ABOUT INFLATION

to retain enough of these from the income-tax collector, can make possible that continued investment of new capital which is essential to put better and better tools in the hands of the workers and constantly to increase their real wages. What was typical of the NPA statement was that its proposed statist remedies for unemployment utterly ignored the effects of wage rates. No matter how much we are inflating, no matter how high the absolute level of national income or "purchasing power," we can always bring about unemployment by pushing wage rates too high in relation to prices and productivity. This points to the error in the Keynesian propensity to look only at such huge over-all money aggregates as "national income" and "purchasing power." Maintenance of employment depends on expectation of profits in each industry. This expectation depends on the relationship of costs to prices, which means the relationship of prices to each other and wage rates to prices.

66

21 "Selective" Credit Control

In January 1956, the President's annual Economic Report suggested the restoration of the government's power to regulate the terms of consumer installment credit. The then Secretary of the Treasury, George M. Humphrey, showed political courage as well as excellent sense when he refused to endorse the suggestion. The Secretary also gave the right reasons why such stand-by powers would be inadvisable. They would put too much discretion in the hands of whoever was to administer them: "You take a great responsibility on yourself when you tell 160 million people what they can afford to buy." Chairman Martin of the Federal Reserve Board also pointed out that: "Selective controls of this nature are at best supplements and not substitutes for the general over-all credit and monetary instruments." The most eminent advocate at that time of the imposition of stand-by controls on installment credit was Allan Sproul, then president of the Federal Reserve Bank of New York. In a speech on December 29,1955, he declared: "I do believe that there is a temptation to abuse consumer credit in boom times, that it can thus become a serious source of instability 67

WHAT YOU SHOULD KNOW ABOUT INFLATION

in our economy, and that we would not jeopardize our general freedom from direct controls by giving the Federal Reserve System permanent authority to regulate consumer credit." But Sproul's argument indirectly admitted that he wished this power in order to avoid a sufficiently firm control over general interest rates and the total volume of credit: "If there has grown up a form of credit extension which . . . is introducing a dangerous element of instability in our economy, and if it is difficult to reach this credit area by general credit measures without adversely affecting any of the less avid users of credit, is there not a case for a selective credit control?" What Sproul was saying in effect is that a handful of government monetary managers should be given the power to discriminate among borrowers; to say which are "legitimate" and which not; to say just who should have credit and on what terms. No government body should have such power. It becomes an implement for political favoritism. President Eisenhower declared in a press conference on February 8, 1956, that if the government were granted stand-by powers over consumer credit they would not be abused. But the record shows that the "selective" powers over credit which already existed had already been abused. Our Federal Reserve authorities complained of "inflationary pressures." Yet at the very time they were suggesting "selective" credit powers they were keeping the official discount rate down to only 2l/2 per cent. (Within a year and a half they were forced to raise it three times, to 3% per cent. In that same year—1957—the Bank of England, to stop British 68

"SELECTIVE" CREDIT CONTROL

inflation, had to raise its discount rate to 7 per cent.) Early in 1956, also, our Federal Reserve authorities had allowed and encouraged a $12 billion increase in the total volume of money and bank credit since the beginning of 1954. Government authorities discriminate against purchase of corporate securities by compelling a minimum down payment of 70 or even 90 per cent. They have discriminated in favor of purchase of houses by pledging the taxpayers* money to allow such purchases for a down payment of only 7 per cent or perhaps only 2 per cent. A Congressional subcommittee, in 1956, raised a storm about even these tiny down payments. It asked for a return to the conditions under which a veteran could buy a f 10,000 house without putting up even the $200 cash. The belief that government agencies are above the political pressures which lead to> such discriminations among borrowers has been disproved everywhere. In sum, if general interest rates are allowed to rise to their appropriate level, and if there is a sufficiently firm rein on the total quantity of credit, "selective" credit controls are unnecessary. But if there is not a sufficiently firm rein on the total quantity of money and credit, "selective" controls are largely futile. If a man has $2,500 cash, for example, but can buy a $10,000 house for only $500 down,, then he can also buy a $2,000 car with his "own" cash, whereas if he had to pay down his $2,500 for the house he couldn't buy a car even on pretty loose credit terms. This elementary principle of the shifting or substitution of credit seems to have been overlooked by the champions of "selective" credit controls. 69

22 Must We Ration Credit?

The proposal to restore "selective" or "qualitative" credit controls is revived so often by persons who are regarded as monetary authorities, and is so frequently referred to by them as "one of the necessary weapons to combat inflation," that some further analysis is desirable. The proposal has the sanction of precedent, for whatever that is worth. Our government used "selective" credit controls at various times between 1941 and 1952. They have been widely imposed in Europe. But the results hardly warrant emulation. Selective credit control is merely one more step along the road toward a command economy. It leads logically back to investment control and to price control. Selective credit controls are, in fact, government control of short-term investments. The pressure for them comes from special groups of borrowers who want to be favored at the expense of the rest. It comes from monetary managers who lack the courage to refuse such demands; who lack the courage to let general interest rates rise to the point where they will halt inflation. When the price of any commodity is held down by government control, the demand soon ex70

MUST WE RATION CREDIT?

ceeds the supply, and the commodity is then rationed. Selective credit controls are merely government rationing of credit. To ration credit is, of course, to discriminate among would-be borrowers. The decision is thrown into politics and determined by political pressures. This has already happened. Buying a house, even if you can't afford it, is considered so laudable that the taxpayers have been forced to guarantee 95 per cent of the purchase price for you. Buying a refrigerator to put into the house, or a car to get to work from it, is considered much less laudable, so that the terms on which the seller was allowed to extend credit even at his own risk were tightened or "liberalized" by bureaucratic decree. Buying shares in Wall Street (i.e., investing in largescale industries that increase production and create jobs) is considered so antisocial that the government forbids the seller or the lender to accept less than a down payment of 90 per cent of the full price. Government "selective" credit decisions are made, in short, on the basis of popular pressures and prejudices. Even if the record were better than this, what are we to say of a system which gives a group of government bureaucrats power to encourage borrowing for one purpose and to discourage it for another; to decide that there should be a boom in industry X but that industry Y should be choked to death? The only reason why "selective" credit controls, here and abroad, have not proved intolerably disruptive is that (for reasons explained in the preceding chapter) such controls seldom achieve their aims. I shall deal here with only one or two of the many argu-

WHAT YOU SHOULD KNOW ABOUT INFLATION

ments that have recently been put forward in favor of selective credit schemes. It is contended, for example, that ""over-all quantitative credit control" is "a pretty crude weapon." The truth is that it would be hard to conceive of a more precise and truly selective instrument for allocating the supply of real savings among credit-worthy borrowers than over-all market interest rates that are allowed to reflect the real conditions of supply and demand. It is nonsense to say that a general rise in interest rates hits only "the little fellow" and favors "the big corporations." One might just as well argue that a general rise in wage rates hits only the little project and helps the big project. Any general rise in costs merely shuts off the marginal projects, regardless of size, that do not seem likely to earn the higher costs. This is the meaning and function of free markets, in the price of loanable funds as in the price of raw materials and in wages.

23 Money and Goods

Among the popular ideas which make the inflation of our era so hard to combat is the belief that the supply of money ought to be constantly increased "in order to keep pace with the increase in the supply of goods." This idea, on analysis, turns out to be extremely hazy. How does one equate the supply of money with the supply of goods? How can we measure, for instance, the increase in the total supply of goods and services? By tonnages? Do we add a ton of gold watches to a ton of sand? We can measure the total supply of goods and services, it is commonly assumed, by values. But all values are expressed in terms of money. If we assume that in any period the supply of goods and services remains unchanged, while the supply of money doubles, then the money value of these goods and services may approximately double. But if we find that the total monetary value of goods and services has doubled during a given period, how can we tell (except by a priori assumption) how much of this is due to an increase of production, and how much to an increase in the money supply? And as the money price (i.e., the "value") of each good is constantly changing in relation to all the rest, how

73

WHAT YOU SHOULD KNOW ABOUT INFLATION

can we measure with exactness the increase of "physical production" in the aggregate? Yet there are economists who not only think that they can answer such questions, but that they can answer them with great precision. The late Dr. Sumner H. Slichter of Harvard recommended a 2)4 per cent annual increase in the money supply in order to counterbalance the pricedepressing effect of an assumed annual 2% per cent increase in "productivity." Dean Arthur Upgren of the Tuck School of Business Administration at Dartmouth wrote in 1955: "Businessmen, bankers, and economists estimate that the nation requires a money supply growth of 4 or 5 per cent a year." He arrived at this remarkable figure by adding "a 1 % per cent a year population growth, a 2*4 per cent yearly gain in productivity, and a gain of 1 per cent in the money supply needed to service the more specialized industries." This looked like counting the same thing two or three times over. In any case, it is questionable whether such estimates and calculations, which vary so widely, have any scientific validity. Yet a lot of people have come to believe sincerely that unless the supply of money can be increased "proportionately" to the supply of goods and services there will not only be a decline in prices, but that this will bring on "deflation" and depression. This idea will not stand analysis. If the quantity and quality of money remained fixed, and per capita industrial and agricultural productivity showed a constant tendency to rise, there would, it is true, be a tendency for money prices to fall. But it does not at all follow that this would bring about more net unemployment or a

74

MONEY AND GOODS

depression, for money prices would be falling because real (and money) costs of production were falling. Profit margins would not necessarily be threatened. Total demand would still be sufficient to buy total output at lower prices. The incentive and guide to production is relative profit margins. Relative profit margins depend, not on the absolute level of prices, but on the relationship of different prices to each other and of costs of production (factor prices) to prices of finished goods. An outstanding example of prosperity with falling prices occurred between 1925 and 1929, when full industrial activity was maintained with an average drop in wholesale prices of more than 2 per cent a year. The idea that the supply of money must be constantly increased to keep pace with an increased supply of goods and services has led to absence of concern in the face of a constant increase in the money supply in the last twelve years. From the end of 1947 to the end of 1959 the supply of bank deposits and currency increased $79 billion, or 46 per cent. And since the end of 1947 average wholesale prices have increased nearly 24 per cent, in spite of an increase in the industrial production index of 60 per cent.

75

24 The Great Swindle

I present in this chapter a table compiled by the First National City Bank of New York (published in its monthly economic letter of July, 1964) showing the shrinkage in purchasing power of the currencies of 42 countries over the ten-year period 1953-1963. The shrinkage is calculated inversely from the increases in cost-of-living or consumer price index as reported by governments. It is important to keep this appalling worldwide picture constantly before our minds. It reminds us that inflation is nothing but a great swindle, and that this swindle is practiced in varying degrees, sometimes ignorantly and sometimes cynically, by nearly every government in the world. This swindle erodes the purchasing power of everybody's income and the purchasing power of everybody's savings. It is a concealed tax, and the most vicious of all taxes. It taxes the incomes and savings of the poor by the same percentage as the incomes and savings of the rich. It falls with greatest force precisely on the thrifty, on the aged, on those who cannot protect themselves by speculation or by demanding and getting higher money incomes to compensate for the depreciation of the monetary unit. Why does this swindle go on? It goes on because gov-

76

THE GREAT SWINDLE

ernrnents wish to spend, partly for armaments and in most cases preponderantly for subsidies and handouts to various pressure groups, but lack the courage to tax as much as they spend. It goes on, in other words, because governments wish to buy the votes of some of us while concealing from the rest of us that those votes are being bought with our own money. It goes on because politicians (partly through the second- or third-hand influence of the theories of the late Lord Keynes) think that this is the way, and the only way, to maintain "full employment," the present-day fetish of the self-styled progressives. It goes on because the international gold standard has been abandoned, because the world's currencies are essentially paper currencies, adrift without an anchor, blown about by every political wind, and at the mercy of every bureaucratic caprice. And the very governments that are inflating profess solemnly to be "fighting" inflation. Through cheap-money policies, or the printing press, or both, they increase the supply of money and credit and affect to deplore the inevitable result. Indexes of Value of Money 1958 1963 1953 Guatemala Ceylon £1 Salvador Venezuela United States Belgium Canada Portugal Pakistan Ecuador

Annual Rates of D
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