THE MIRAGE OF INFLATION
I HAVE found it necessary to warn the reader from time to time
that a certain result would necessarily follow from a certain
policy "provided there is no inflation." In the chapter on
public works and on credit I said that a study of the complications
introduced by inflation would have to be deferred. But
money and monetary policy form so intimate and sometimes so
inextricable a part of every economic process that this separation,
even for expository purposes, was very difficult; and in
the chapters on the effect of various government or union wage
policies on employment, profits and production, some of the
effects of differing monetary policies had to be considered
immediately.
Before we consider what the consequences of inflation are in
specific cases, we should consider what its consequences are in
general. Even prior to that, it seems desirable to ask why
inflation has been constantly resorted to, why it has had an
immemorial popular appeal, and why its siren music has
tempted one nation after another down the path to economic
disaster.
The most obvious and yet the oldest and most stubborn
error on which the appeal of inflation rests is that of confusing
"money" with wealth. "That wealth consists in money, or in
gold and silver," wrote Adam Smith more than two centuries
ago, "is a popular notion which naturally arises from the double
function of money, as the instrument of commerce, and as the
measure of value. . . . To grow rich is to get money, and wealth
and money, in short, are, in common language, considered as in
every respect synonymous."
Real wealth, of course, consists in what is produced and
consumed: the food we eat, the clothes we wear, the houses we
live in. It is railways and roads and motor cars; ships and planes
and factories; schools and churches and theaters; pianos, paintings
and books. Yet so powerful is the verbal ambiguity that
confuses money with wealth, that even those who at times
recognize the confusion will slide back into it in the course of
their reasoning. Each man sees that if he personally had more
money he could buy more things from others. If he had twice as
much money he could buy twice as many things; if he had three
times as much money he would be "worth" three times as
much. And to many the conclusion seems obvious that if the
government merely issued more money and distributed it to
everybody, we should all be that much richer.
These are the most naive inflationists. There is a second
group, less naive, who see that if the whole thing were as easy as
that the government could solve all our problems merely by
printing money. They sense that there must be a catch somewhere;
so they would limit in some way the amount of additional
money they would have the government issue. They
would have it print just enough to make up some alleged
"deficiency," or "gap."
Purchasing power is chronically deficient, they think, because
industry somehow does not distribute enough money to
producers to enable them to buy back, as consumers, the
product that is made. There is a mysterious "leak" somewhere.
One group "proves" it by equations. On one side of their
equations they count an item only once; on the other side they
unknowingly count the same item several times over. This
produces an alarming gap between what they call "A payments"
and what they call "A + B payments." So they found a
movement, put on green uniforms, and insist that the govern-
ment issue money or "credits" to make good the missing B
payments.
The cruder apostles of "social credit" may seem ridiculous;
but there are an indefinite number of schools of only slightly
more sophisticated inflationists who have "scientific" plans to
issue just enough additional money or credit to fill some alleged
chronic or periodic deficiency, or gap, which they calculate in
some other way.
The more knowing inflationists recognize that any substantial
increase in the quantity of money will reduce the purchasing
power of each individual monetary unit—in other words,
that it will lead to an increase in commodity prices. But this
does not disturb them. On the contrary, it is precisely why they
want the inflation. Some of them argue that this result will
improve the position of poor debtors as compared with rich
creditors. Others think it will stimulate exports and discourage
imports. Still others think it is an essential measure to cure a
depression, to "start industry going again," and to achieve "full
employment."1
There are innumerable theories concerning the way in which
increased quantities of money (including bank credit) affect
prices. On the one hand, as we have just seen, are those who
imagine that the quantity of money could be increased by
almost any amount without affecting prices. They merely see
this increased money as a means of increasing everyone's "purchasing
power," in the sense of enabling everybody to buy
more goods than before. Either they never stop to remind
themselves that people collectively cannot buy twice as much
goods as before unless twice as much goods are produced, or
they imagine that the only thing that holds down an indefinite
1Stripped down to its essentials, this is the theory of the Keynesians. In The
Failure of the "New Economics" (New Rochelle, N. Y.: Arlington House, 1959)
I analyze this theory in detail.
increase in production is not a shortage of manpower, working,
hours or productive capacity, but merely a shortage of monetary
demand: if people want the goods, they assume, and have
the money to pay for them, the goods will almost automatically
be produced.
On the other hand is the group — and it has included some
eminent economists — that holds a rigid mechanical theory of
the effect of the supply of money on commodity prices. All the
money in a nation, as these theorists picture the matter, will be
offered against all the goods. Therefore the value of the total
quantity of money multiplied by its "velocity of circulation"
must always be equal to the value of the total quantity of goods
bought. Therefore, further (assuming no change in velocity of
circulation), the value of the monetary unit must vary exactly
and inversely with the amount put into circulation. Double the
quantity of money and bank credit and you exactly double the
"price level"; triple it, and you exactly triple the price level.
Multiply the quantity of money n times, in short, and you must
multiply the prices of goods n times.
There is not space here to explain all the fallacies in this
plausible picture.2 Instead we shall try to see just why and how
an increase in the quantity of money raises prices.
An increased quantity of money comes into existence in a
specific way. Let us say that it comes into existence because the
government makes larger expenditures than it can or wishes to
meet out of the proceeds of taxes (or from the sale of bonds paid
for by the people out of real savings). Suppose, for example,
that the government prints money to pay war contractors.
Then the first effect of these expenditures will be to raise the
prices of supplies used in war and to put additional money into
the hands of the war contractors and their employees. (As, in
our chapter on price-fixing, we deferred for the sake of simplicity
some complications introduced by an inflation, so, in
1The reader interested in an analysis of them should consult B. M. Anderson,
The Value of Money (1917; new edition, 1936); Ludwig von Mises, The
Theory of Money and Credit (American editions, 1935, 1953); or the present
writer's Inflation Crisis, and How to Resolve It (New Rochelle, N.Y.: Arlington
House, 1978).
now considering inflation, we may pass over the complications
introduced by an attempt at government price-fixing. When
these are considered it will be found that they do not change the
essential analysis. They lead merely to a sort of backed-up or
"repressed" inflation that reduces or conceals some of the earlier
consequences at the expense of aggravating the later ones.)
The war contractors and their employees, then, will have
higher money incomes. They will spend them for the particular
goods and services they want. The sellers of these goods and
services will be able to raise their prices because of this increased
demand. Those who have the increased money income
will be willing to pay these higher prices rather than do without
the goods; for they will have more money, and a dollar will have
a smaller subjective value in the eyes of each of them.
Let us call the war contractors and their employees group A,
and those from whom they directly buy their added goods and
services group B. Group B, as a result of higher sales and prices,
will now in turn buy more goods and services from a still
further group, C. Group C in turn will be able to raise its prices
and will have more income to spend on group D, and so on,
until the rise in prices and money incomes has covered virtually
the whole nation. When the process has been completed, nearly
everybody will have a higher income measured in terms of
money. But (assuming that production of goods and services
has not increased) prices of goods and services will have increased
correspondingly. The nation will be no richer than
before.
This does not mean, however, that everyone's relative or
absolute wealth and income will remain the same as before. On
the contrary, the process of inflation is certain to affect the
fortunes of one group differently from those of another. The
first groups to receive the additional money will benefit the
most. The money incomes of group .A, for example, will have
increased before prices have increased, so that they will be able
to buy almost a proportionate increase in goods. The money
incomes of group B will advance later, when prices have al-
ready increased somewhat; but group B will be better off in
terms of goods. Meanwhile, however, the groups that have still
had no advance whatever in their money incomes will find
themselves compelled to pay higher prices for the things they
buy, which means that they will be obliged to get along on a
lower standard of living than before.
We may clarify the process further by a hypothetical set of
figures. Suppose we divide the community arbitrarily into four
main groups of producers, A, B, C and D, who get the money
income benefit of the inflation in that order. Then when money
incomes of group A have already increased 30 percent, the
prices of the things they purchase have not yet increased at all.
By the time money incomes of group B have increased 20
percent, prices have still increased an average of only 10 percent.
When money incomes of group C have increased only 10
percent, however, prices have already gone up 15 percent. And
when money incomes of group D have not yet increased at all,
the average prices they have to pay for the things they buy have
gone up 20 percent. In other words, the gains of the first groups
of producers to benefit by higher prices or wages from the
inflation are necessarily at the expense of the losses suffered (as
consumers) by the last groups of producers that are able to raise
their prices or wages.
It may be that, if the inflation is brought to a halt after a few
years, the final result will be, say, an average increase of 25
percent in money incomes, and an average increase in prices of
an equal amount, both of which are fairly distributed among all
groups. But this will not cancel out the gains and losses of the
transition period. Group D, for example, even though its own
incomes and prices have at last advanced 25 percent, will be
able to buy only as much goods and services as before the
inflation started. It will never compensate for its losses during
the period when its income and prices had not risen at all,
though it had to pay up to 30 percent more for the goods and
services it bought from the other producing groups in the
community, A, B and C.
So inflation turns out to be merely one more example of our
central lesson. It may indeed bring benefits for a short time to
favored groups, but only at the expense of others. And in the
long run it brings ruinous consequences to the whole community.
Even a relatively mild inflation distorts the structure of
production. It leads to the overexpansion of some industries at
the expense of others. This involves a misapplication and waste
of capital. When the inflation collapses, or is brought to a halt,
the misdirected capital investment—whether in the form of
machines, factories or office buildings--cannot yield an adequate
return and loses the greater part of its value.
Nor is it possible to bring inflation to a smooth and gentle
stop, and so avert a subsequent depression. It is not even
possible to halt an inflation, once embarked upon, at some
preconceived point, or when prices have achieved a previously
agreed upon level; for both political and economic forces will
have got out of hand. You cannot make an argument for a 25
percent advance in prices by inflation without someone's contending
that the argument is twice as good for an advance of 50
percent, and someone else's adding that it is four times as good
for an advance of 100 percent. The political pressure groups
that have benefited from the inflation will insist upon its continuance.
It is impossible, moreover, to control the value of money
under inflation. For, as we have seen, the causation is never a
merely mechanical one. You cannot, for example, say in advance
that a 100 percent increase in the quantity of money will
mean a 50 percent fall in the value of the monetary unit. The
value of money, as we have seen, depends upon the subjective
valuations of the people who hold it. And those valuations do
not depend solely on the quantity of it that each person holds.
They depend also on the quality of the money. In wartime the
value of a nation's monetary unit, not on the gold standard, will
rise on the foreign exchanges with victory and fall with defeat,
regardless of changes in its quantity. The present valuation will
often depend upon what people expect the future quantity of
money to be. And, as with commodities on the speculative
exchanges, each person's valuation of money is affected not
only by what he thinks its value is but by what he thinks is going
to be everybody else's valuation of money.
All this explains why, when hypeririflation has once set in,
the value of the monetary unit drops at a far faster rate than the
quantity of money either is or can be increased. When this stage
is reached, the disaster is nearly complete; and the scheme is
bankrupt.
Yet the ardor for inflation never dies. It would almost seem as
if no country is capable of profiting from the experience of
another and no generation of learning from the sufferings of its
forebears. Each generation and country follows the same mirage.
Each grasps for the same Dead Sea fruit that turns to dust
and ashes in its mouth. For it is the nature of inflation to give
birth to a thousand illusions.
In our own day the most persistent argument put forward for
inflation is that it will "get the wheels of industry turning," that
it will save us from the irretrievable losses of stagnation and
idleness and bring "full employment." This argument in its
cruder form rests on the immemorial confusion between money
and real wealth. It assumes that new "purchasing power" is
being brought into existence, and that the effects of this new
purchasing power multiply themselves in ever-widening circles,
like the ripples caused by a stone thrown into a pond. The
real purchasing power for goods, however, as we have seen,
consists of other goods. It cannot be wondrously increased
merely by printing more pieces of paper called dollars. Fundamentally
what happens in an exchange economy is that the
things that A produces are exchanged for the things that B
produces.3
What inflation really does is to change the relationships of
prices and costs. The most important change it is designed to
bring about is to raise commodity prices in relation to wage
rates, and so to restore business profits, and encourage a resumption
of output at the points where idle resources exist, by
restoring a workable relationship between prices and costs of
production.
It should be immediately clear that this could be brought
about more directly and honestly by a reduction in unworkable
wage rates. But the more sophisticated proponents of inflation
believe that this is now politically impossible. Sometimes they
go further, and charge that all proposals under any circumstances
to reduce particular wage rates directly in order to
reduce unemployment are "antilabor." But what they are
themselves proposing, stated in bald terms, is to deceive labor by
reducing real wage rates (that is, wage rates in terms of purchasing
power) through an increase in prices.
What they forget is that labor has itself become sophisticated;
that the big unions employ labor economists who know about
index numbers, and that labor is not deceived. The policy,
therefore, under present conditions, seems unlikely to accomplish
either its economic or its political aims. For it is precisely
the most powerful unions, whose wage rates are most likely to
be in need of correction, that will insist that their wage rates be
raised at least in proportion to any increase in the cost-of-living
index. The unworkable relationships between prices and key
wage rates, if the insistence of the powerful unions prevails,
will remain. The wage rate structure, in fact, may become even
more distorted; for the great mass of unorganized workers,
3Cf. John Stuart Mill, Principles of Political Economy (Book 3, Chap. 14, par.
2); Alfred Marshall, Principles of Economics (Book VI, Chap. XIII, sec. 10);
Benjamin M. Anderson, "A Refutation of Keynes' Attack on the Doctrine
that Aggregate Supply Creates Aggregate Demand," in Financing American
Prosperity by a symposium of economists. Cf. also the symposium edited by
the present author: The Critics of Keynesian Economics (New Rochelle, N. Y.:
Arlington House, 1960).
whose wage rates even before the inflation were not out of line
(and may even have been unduly depressed through union
exclusionism), will be penalized further during the transition
by the rise in prices.
The more sophisticated advocates of inflation, in brief, are
disingenuous. They do not state their case with complete candor;
and they end by deceiving even themselves. They begin to
talk of paper money, like the more naive inflationists, as if it
were itself a form of wealth that could be created at will on the
printing press. They even solemnly discuss a "multiplier," by
which every dollar printed and spent by the government becomes
magically the equivalent of several dollars added to the
wealth of the country.
In brief, they divert both the public attention and their own
from the real causes of any existing depression. For the real
causes, most of the time, are maladjustments within the wagecost-
price structure: maladjustments between wages and
prices, between prices of raw materials and prices of finished
goods, or between one price and another or one wage and
another. At some point these maladjustments have removed the
incentive to produce, or have made it actually impossible for
production to continue; and through the organic interdependence
of our exchange economy, depression spreads. Not until
these maladjustments are corrected can full production and
employment be resumed.
True, inflation may sometimes correct them; but it is a heady
and dangerous method. It makes its corrections not openly and
honestly, but by the use of illusion. Inflation, indeed, throws a
veil of illusion over every economic process. It confuses and
deceives almost everyone, including even those who suffer by
it. We are all accustomed to measuring our income and wealth
in terms of money. The mental habit is so strong that even
professional economists and statisticians cannot consistently
break it. It is not easy to see relationships always in terms of real
goods and real welfare. Who among us does not feel richer and
prouder when he is told that our national income has doubled
(in terms of dollars, of course) compared with some preinflationary
period? Even the clerk who used to get $75 a week and
now gets $120 thinks that he must be in some way better off,
though it costs him twice as much to live as it did when he was
getting $75. He is of course not blind to the rise in the cost of
living. But neither is he as fully aware of his real position as he
would have been if his cost of living had not changed and if his
money salary had been reduced to give him the same reduced
purchasing power that he now has, in spite of his salary increase,
because of higher prices. Inflation is the autosuggestion,
the hypnotism, the anesthetic, that has dulled the pain of
the operation for him. Inflation is the opium of the people.
And this is precisely its political function. It is because
inflation confuses everything that it is so consistently resorted
to by our modern "planned economy" governments. We saw in
chapter four, to take but one example, that the belief that public
works necessarily create new jobs is false. If the money was
raised by taxation, we saw, then for every dollar that the
government spent on public works one less dollar was spent by
the taxpayers to meet their own wants, and for every public job
created one private job was destroyed.
But suppose the public works are not paid for from the
proceeds of taxation? Suppose they are paid for by deficit
financing — that is, from the proceeds of government borrowing
or from resort to the printing press? Then the result just
described does not seem to take place. The public works seem
to be created out of "new" purchasing power. You cannot say
that the purchasing power has been taken away from the taxpayers.
For the moment the nation seems to have got something
for nothing.
But now, in accordance with our lesson, let us look at the
longer consequences. The borrowing must some day be repaid.
The government cannot keep piling up debt indefinitely; for if
it tries, it will some day become bankrupt. As Adam Smith
observed in 1776:
When national debts have once been accumulated to
a certain degree, there is scarce, I believe, a single
instance of their having been fairly and completely
paid. The liberation of the public revenue, if it has
even been brought about at all, has always been
brought about by a bankruptcy; sometimes by an
avowed one, but always by a real one, though frequently
by a pretended payment.
Yet when the government comes to repay the debt it has
accumulated for public works, it must necessarily tax more
heavily than it spends. In this later period, therefore, it must
necessarily destroy more jobs than it creates. The extra-heavy
taxation then required does not merely take away purchasing
power; it also lowers or destroys incentives to production, and
so reduces the total wealth and income of the country.
The only escape from this conclusion is to assume (as of
course the apostles of spending always do) that the politicians in
power will spend money only in what would otherwise have
been depressed or "deflationary" periods, and will promptly
pay the debt off in what would otherwise have been boom or
"inflationary" periods. This is a beguiling fiction, but unfortunately
the politicians in power have never acted that way.
Economic forecasting, moreover, is so precarious, and the
political pressures at work are of such a nature, that governments
are unlikely ever to act that way. Deficit spending, once
embarked upon, creates powerful vested interests which demand
its continuance under all conditions.
If no honest attempt is made to pay off the accumulated debt,
and resort is had to outright inflation instead, then the results
follow that we have already described. For the country as a
whole cannot get anything without paying for it. Inflation itself
is a form of taxation. It is perhaps the worst possible form,
which usually bears hardest on those least able to pay. On the
assumption that inflation affected everyone and everything
evenly (which, we have seen, is never true), it would be tantamount
to a flat sales tax of the same percentage on all
commodities, with the rate as high on bread and milk as on
diamonds and furs. Or it might be thought of as equivalent to a
flat tax of the same percentage, without exemptions, on
everyone's income. It is a tax not only on every individual's
expenditures, but on his savings account and life insurance. It
is, in fact, a flat capital levy, without exemptions, in which the
poor man pays as high a percentage as the rich man.
But the situation is even worse than this, because, as we have
seen, inflation does not and cannot affect everyone evenly.
Some suffer more than others. The poor are usually more
heavily taxed by inflation, in percentage terms, than the rich,
for they do not have the same means of protecting themselves
by speculative purchases of real equities. Inflation is a kind of
tax that is out of control of the tax authorities. It strikes wantonly
in all directions. The rate of tax imposed by inflation is
not a fixed one: it cannot be determined in advance. We know
what it is today; we do not know what it will be tomorrow; and
tomorrow we shall not know what it will be on the day after.
Like every other tax, inflation acts to determine the individual
and business policies we are all forced to follow. It
discourages all prudence and thrift. It encourages squandering,
gambling, reckless waste of all kinds. It often makes it more
profitable to speculate than to produce. It tears apart the whole
fabric of stable economic relationships. Its inexcusable injustices
drive men toward desperate remedies. It plants the seeds
of fascism and communism. It leads men to demand totalitarian
controls. It ends invariably in bitter disillusion and
collapse.
I HAVE found it necessary to warn the reader from time to time
that a certain result would necessarily follow from a certain
policy "provided there is no inflation." In the chapter on
public works and on credit I said that a study of the complications
introduced by inflation would have to be deferred. But
money and monetary policy form so intimate and sometimes so
inextricable a part of every economic process that this separation,
even for expository purposes, was very difficult; and in
the chapters on the effect of various government or union wage
policies on employment, profits and production, some of the
effects of differing monetary policies had to be considered
immediately.
Before we consider what the consequences of inflation are in
specific cases, we should consider what its consequences are in
general. Even prior to that, it seems desirable to ask why
inflation has been constantly resorted to, why it has had an
immemorial popular appeal, and why its siren music has
tempted one nation after another down the path to economic
disaster.
The most obvious and yet the oldest and most stubborn
error on which the appeal of inflation rests is that of confusing
"money" with wealth. "That wealth consists in money, or in
gold and silver," wrote Adam Smith more than two centuries
ago, "is a popular notion which naturally arises from the double
function of money, as the instrument of commerce, and as the
measure of value. . . . To grow rich is to get money, and wealth
and money, in short, are, in common language, considered as in
every respect synonymous."
Real wealth, of course, consists in what is produced and
consumed: the food we eat, the clothes we wear, the houses we
live in. It is railways and roads and motor cars; ships and planes
and factories; schools and churches and theaters; pianos, paintings
and books. Yet so powerful is the verbal ambiguity that
confuses money with wealth, that even those who at times
recognize the confusion will slide back into it in the course of
their reasoning. Each man sees that if he personally had more
money he could buy more things from others. If he had twice as
much money he could buy twice as many things; if he had three
times as much money he would be "worth" three times as
much. And to many the conclusion seems obvious that if the
government merely issued more money and distributed it to
everybody, we should all be that much richer.
These are the most naive inflationists. There is a second
group, less naive, who see that if the whole thing were as easy as
that the government could solve all our problems merely by
printing money. They sense that there must be a catch somewhere;
so they would limit in some way the amount of additional
money they would have the government issue. They
would have it print just enough to make up some alleged
"deficiency," or "gap."
Purchasing power is chronically deficient, they think, because
industry somehow does not distribute enough money to
producers to enable them to buy back, as consumers, the
product that is made. There is a mysterious "leak" somewhere.
One group "proves" it by equations. On one side of their
equations they count an item only once; on the other side they
unknowingly count the same item several times over. This
produces an alarming gap between what they call "A payments"
and what they call "A + B payments." So they found a
movement, put on green uniforms, and insist that the govern-
ment issue money or "credits" to make good the missing B
payments.
The cruder apostles of "social credit" may seem ridiculous;
but there are an indefinite number of schools of only slightly
more sophisticated inflationists who have "scientific" plans to
issue just enough additional money or credit to fill some alleged
chronic or periodic deficiency, or gap, which they calculate in
some other way.
The more knowing inflationists recognize that any substantial
increase in the quantity of money will reduce the purchasing
power of each individual monetary unit—in other words,
that it will lead to an increase in commodity prices. But this
does not disturb them. On the contrary, it is precisely why they
want the inflation. Some of them argue that this result will
improve the position of poor debtors as compared with rich
creditors. Others think it will stimulate exports and discourage
imports. Still others think it is an essential measure to cure a
depression, to "start industry going again," and to achieve "full
employment."1
There are innumerable theories concerning the way in which
increased quantities of money (including bank credit) affect
prices. On the one hand, as we have just seen, are those who
imagine that the quantity of money could be increased by
almost any amount without affecting prices. They merely see
this increased money as a means of increasing everyone's "purchasing
power," in the sense of enabling everybody to buy
more goods than before. Either they never stop to remind
themselves that people collectively cannot buy twice as much
goods as before unless twice as much goods are produced, or
they imagine that the only thing that holds down an indefinite
1Stripped down to its essentials, this is the theory of the Keynesians. In The
Failure of the "New Economics" (New Rochelle, N. Y.: Arlington House, 1959)
I analyze this theory in detail.
increase in production is not a shortage of manpower, working,
hours or productive capacity, but merely a shortage of monetary
demand: if people want the goods, they assume, and have
the money to pay for them, the goods will almost automatically
be produced.
On the other hand is the group — and it has included some
eminent economists — that holds a rigid mechanical theory of
the effect of the supply of money on commodity prices. All the
money in a nation, as these theorists picture the matter, will be
offered against all the goods. Therefore the value of the total
quantity of money multiplied by its "velocity of circulation"
must always be equal to the value of the total quantity of goods
bought. Therefore, further (assuming no change in velocity of
circulation), the value of the monetary unit must vary exactly
and inversely with the amount put into circulation. Double the
quantity of money and bank credit and you exactly double the
"price level"; triple it, and you exactly triple the price level.
Multiply the quantity of money n times, in short, and you must
multiply the prices of goods n times.
There is not space here to explain all the fallacies in this
plausible picture.2 Instead we shall try to see just why and how
an increase in the quantity of money raises prices.
An increased quantity of money comes into existence in a
specific way. Let us say that it comes into existence because the
government makes larger expenditures than it can or wishes to
meet out of the proceeds of taxes (or from the sale of bonds paid
for by the people out of real savings). Suppose, for example,
that the government prints money to pay war contractors.
Then the first effect of these expenditures will be to raise the
prices of supplies used in war and to put additional money into
the hands of the war contractors and their employees. (As, in
our chapter on price-fixing, we deferred for the sake of simplicity
some complications introduced by an inflation, so, in
1The reader interested in an analysis of them should consult B. M. Anderson,
The Value of Money (1917; new edition, 1936); Ludwig von Mises, The
Theory of Money and Credit (American editions, 1935, 1953); or the present
writer's Inflation Crisis, and How to Resolve It (New Rochelle, N.Y.: Arlington
House, 1978).
now considering inflation, we may pass over the complications
introduced by an attempt at government price-fixing. When
these are considered it will be found that they do not change the
essential analysis. They lead merely to a sort of backed-up or
"repressed" inflation that reduces or conceals some of the earlier
consequences at the expense of aggravating the later ones.)
The war contractors and their employees, then, will have
higher money incomes. They will spend them for the particular
goods and services they want. The sellers of these goods and
services will be able to raise their prices because of this increased
demand. Those who have the increased money income
will be willing to pay these higher prices rather than do without
the goods; for they will have more money, and a dollar will have
a smaller subjective value in the eyes of each of them.
Let us call the war contractors and their employees group A,
and those from whom they directly buy their added goods and
services group B. Group B, as a result of higher sales and prices,
will now in turn buy more goods and services from a still
further group, C. Group C in turn will be able to raise its prices
and will have more income to spend on group D, and so on,
until the rise in prices and money incomes has covered virtually
the whole nation. When the process has been completed, nearly
everybody will have a higher income measured in terms of
money. But (assuming that production of goods and services
has not increased) prices of goods and services will have increased
correspondingly. The nation will be no richer than
before.
This does not mean, however, that everyone's relative or
absolute wealth and income will remain the same as before. On
the contrary, the process of inflation is certain to affect the
fortunes of one group differently from those of another. The
first groups to receive the additional money will benefit the
most. The money incomes of group .A, for example, will have
increased before prices have increased, so that they will be able
to buy almost a proportionate increase in goods. The money
incomes of group B will advance later, when prices have al-
ready increased somewhat; but group B will be better off in
terms of goods. Meanwhile, however, the groups that have still
had no advance whatever in their money incomes will find
themselves compelled to pay higher prices for the things they
buy, which means that they will be obliged to get along on a
lower standard of living than before.
We may clarify the process further by a hypothetical set of
figures. Suppose we divide the community arbitrarily into four
main groups of producers, A, B, C and D, who get the money
income benefit of the inflation in that order. Then when money
incomes of group A have already increased 30 percent, the
prices of the things they purchase have not yet increased at all.
By the time money incomes of group B have increased 20
percent, prices have still increased an average of only 10 percent.
When money incomes of group C have increased only 10
percent, however, prices have already gone up 15 percent. And
when money incomes of group D have not yet increased at all,
the average prices they have to pay for the things they buy have
gone up 20 percent. In other words, the gains of the first groups
of producers to benefit by higher prices or wages from the
inflation are necessarily at the expense of the losses suffered (as
consumers) by the last groups of producers that are able to raise
their prices or wages.
It may be that, if the inflation is brought to a halt after a few
years, the final result will be, say, an average increase of 25
percent in money incomes, and an average increase in prices of
an equal amount, both of which are fairly distributed among all
groups. But this will not cancel out the gains and losses of the
transition period. Group D, for example, even though its own
incomes and prices have at last advanced 25 percent, will be
able to buy only as much goods and services as before the
inflation started. It will never compensate for its losses during
the period when its income and prices had not risen at all,
though it had to pay up to 30 percent more for the goods and
services it bought from the other producing groups in the
community, A, B and C.
So inflation turns out to be merely one more example of our
central lesson. It may indeed bring benefits for a short time to
favored groups, but only at the expense of others. And in the
long run it brings ruinous consequences to the whole community.
Even a relatively mild inflation distorts the structure of
production. It leads to the overexpansion of some industries at
the expense of others. This involves a misapplication and waste
of capital. When the inflation collapses, or is brought to a halt,
the misdirected capital investment—whether in the form of
machines, factories or office buildings--cannot yield an adequate
return and loses the greater part of its value.
Nor is it possible to bring inflation to a smooth and gentle
stop, and so avert a subsequent depression. It is not even
possible to halt an inflation, once embarked upon, at some
preconceived point, or when prices have achieved a previously
agreed upon level; for both political and economic forces will
have got out of hand. You cannot make an argument for a 25
percent advance in prices by inflation without someone's contending
that the argument is twice as good for an advance of 50
percent, and someone else's adding that it is four times as good
for an advance of 100 percent. The political pressure groups
that have benefited from the inflation will insist upon its continuance.
It is impossible, moreover, to control the value of money
under inflation. For, as we have seen, the causation is never a
merely mechanical one. You cannot, for example, say in advance
that a 100 percent increase in the quantity of money will
mean a 50 percent fall in the value of the monetary unit. The
value of money, as we have seen, depends upon the subjective
valuations of the people who hold it. And those valuations do
not depend solely on the quantity of it that each person holds.
They depend also on the quality of the money. In wartime the
value of a nation's monetary unit, not on the gold standard, will
rise on the foreign exchanges with victory and fall with defeat,
regardless of changes in its quantity. The present valuation will
often depend upon what people expect the future quantity of
money to be. And, as with commodities on the speculative
exchanges, each person's valuation of money is affected not
only by what he thinks its value is but by what he thinks is going
to be everybody else's valuation of money.
All this explains why, when hypeririflation has once set in,
the value of the monetary unit drops at a far faster rate than the
quantity of money either is or can be increased. When this stage
is reached, the disaster is nearly complete; and the scheme is
bankrupt.
Yet the ardor for inflation never dies. It would almost seem as
if no country is capable of profiting from the experience of
another and no generation of learning from the sufferings of its
forebears. Each generation and country follows the same mirage.
Each grasps for the same Dead Sea fruit that turns to dust
and ashes in its mouth. For it is the nature of inflation to give
birth to a thousand illusions.
In our own day the most persistent argument put forward for
inflation is that it will "get the wheels of industry turning," that
it will save us from the irretrievable losses of stagnation and
idleness and bring "full employment." This argument in its
cruder form rests on the immemorial confusion between money
and real wealth. It assumes that new "purchasing power" is
being brought into existence, and that the effects of this new
purchasing power multiply themselves in ever-widening circles,
like the ripples caused by a stone thrown into a pond. The
real purchasing power for goods, however, as we have seen,
consists of other goods. It cannot be wondrously increased
merely by printing more pieces of paper called dollars. Fundamentally
what happens in an exchange economy is that the
things that A produces are exchanged for the things that B
produces.3
What inflation really does is to change the relationships of
prices and costs. The most important change it is designed to
bring about is to raise commodity prices in relation to wage
rates, and so to restore business profits, and encourage a resumption
of output at the points where idle resources exist, by
restoring a workable relationship between prices and costs of
production.
It should be immediately clear that this could be brought
about more directly and honestly by a reduction in unworkable
wage rates. But the more sophisticated proponents of inflation
believe that this is now politically impossible. Sometimes they
go further, and charge that all proposals under any circumstances
to reduce particular wage rates directly in order to
reduce unemployment are "antilabor." But what they are
themselves proposing, stated in bald terms, is to deceive labor by
reducing real wage rates (that is, wage rates in terms of purchasing
power) through an increase in prices.
What they forget is that labor has itself become sophisticated;
that the big unions employ labor economists who know about
index numbers, and that labor is not deceived. The policy,
therefore, under present conditions, seems unlikely to accomplish
either its economic or its political aims. For it is precisely
the most powerful unions, whose wage rates are most likely to
be in need of correction, that will insist that their wage rates be
raised at least in proportion to any increase in the cost-of-living
index. The unworkable relationships between prices and key
wage rates, if the insistence of the powerful unions prevails,
will remain. The wage rate structure, in fact, may become even
more distorted; for the great mass of unorganized workers,
3Cf. John Stuart Mill, Principles of Political Economy (Book 3, Chap. 14, par.
2); Alfred Marshall, Principles of Economics (Book VI, Chap. XIII, sec. 10);
Benjamin M. Anderson, "A Refutation of Keynes' Attack on the Doctrine
that Aggregate Supply Creates Aggregate Demand," in Financing American
Prosperity by a symposium of economists. Cf. also the symposium edited by
the present author: The Critics of Keynesian Economics (New Rochelle, N. Y.:
Arlington House, 1960).
whose wage rates even before the inflation were not out of line
(and may even have been unduly depressed through union
exclusionism), will be penalized further during the transition
by the rise in prices.
The more sophisticated advocates of inflation, in brief, are
disingenuous. They do not state their case with complete candor;
and they end by deceiving even themselves. They begin to
talk of paper money, like the more naive inflationists, as if it
were itself a form of wealth that could be created at will on the
printing press. They even solemnly discuss a "multiplier," by
which every dollar printed and spent by the government becomes
magically the equivalent of several dollars added to the
wealth of the country.
In brief, they divert both the public attention and their own
from the real causes of any existing depression. For the real
causes, most of the time, are maladjustments within the wagecost-
price structure: maladjustments between wages and
prices, between prices of raw materials and prices of finished
goods, or between one price and another or one wage and
another. At some point these maladjustments have removed the
incentive to produce, or have made it actually impossible for
production to continue; and through the organic interdependence
of our exchange economy, depression spreads. Not until
these maladjustments are corrected can full production and
employment be resumed.
True, inflation may sometimes correct them; but it is a heady
and dangerous method. It makes its corrections not openly and
honestly, but by the use of illusion. Inflation, indeed, throws a
veil of illusion over every economic process. It confuses and
deceives almost everyone, including even those who suffer by
it. We are all accustomed to measuring our income and wealth
in terms of money. The mental habit is so strong that even
professional economists and statisticians cannot consistently
break it. It is not easy to see relationships always in terms of real
goods and real welfare. Who among us does not feel richer and
prouder when he is told that our national income has doubled
(in terms of dollars, of course) compared with some preinflationary
period? Even the clerk who used to get $75 a week and
now gets $120 thinks that he must be in some way better off,
though it costs him twice as much to live as it did when he was
getting $75. He is of course not blind to the rise in the cost of
living. But neither is he as fully aware of his real position as he
would have been if his cost of living had not changed and if his
money salary had been reduced to give him the same reduced
purchasing power that he now has, in spite of his salary increase,
because of higher prices. Inflation is the autosuggestion,
the hypnotism, the anesthetic, that has dulled the pain of
the operation for him. Inflation is the opium of the people.
And this is precisely its political function. It is because
inflation confuses everything that it is so consistently resorted
to by our modern "planned economy" governments. We saw in
chapter four, to take but one example, that the belief that public
works necessarily create new jobs is false. If the money was
raised by taxation, we saw, then for every dollar that the
government spent on public works one less dollar was spent by
the taxpayers to meet their own wants, and for every public job
created one private job was destroyed.
But suppose the public works are not paid for from the
proceeds of taxation? Suppose they are paid for by deficit
financing — that is, from the proceeds of government borrowing
or from resort to the printing press? Then the result just
described does not seem to take place. The public works seem
to be created out of "new" purchasing power. You cannot say
that the purchasing power has been taken away from the taxpayers.
For the moment the nation seems to have got something
for nothing.
But now, in accordance with our lesson, let us look at the
longer consequences. The borrowing must some day be repaid.
The government cannot keep piling up debt indefinitely; for if
it tries, it will some day become bankrupt. As Adam Smith
observed in 1776:
When national debts have once been accumulated to
a certain degree, there is scarce, I believe, a single
instance of their having been fairly and completely
paid. The liberation of the public revenue, if it has
even been brought about at all, has always been
brought about by a bankruptcy; sometimes by an
avowed one, but always by a real one, though frequently
by a pretended payment.
Yet when the government comes to repay the debt it has
accumulated for public works, it must necessarily tax more
heavily than it spends. In this later period, therefore, it must
necessarily destroy more jobs than it creates. The extra-heavy
taxation then required does not merely take away purchasing
power; it also lowers or destroys incentives to production, and
so reduces the total wealth and income of the country.
The only escape from this conclusion is to assume (as of
course the apostles of spending always do) that the politicians in
power will spend money only in what would otherwise have
been depressed or "deflationary" periods, and will promptly
pay the debt off in what would otherwise have been boom or
"inflationary" periods. This is a beguiling fiction, but unfortunately
the politicians in power have never acted that way.
Economic forecasting, moreover, is so precarious, and the
political pressures at work are of such a nature, that governments
are unlikely ever to act that way. Deficit spending, once
embarked upon, creates powerful vested interests which demand
its continuance under all conditions.
If no honest attempt is made to pay off the accumulated debt,
and resort is had to outright inflation instead, then the results
follow that we have already described. For the country as a
whole cannot get anything without paying for it. Inflation itself
is a form of taxation. It is perhaps the worst possible form,
which usually bears hardest on those least able to pay. On the
assumption that inflation affected everyone and everything
evenly (which, we have seen, is never true), it would be tantamount
to a flat sales tax of the same percentage on all
commodities, with the rate as high on bread and milk as on
diamonds and furs. Or it might be thought of as equivalent to a
flat tax of the same percentage, without exemptions, on
everyone's income. It is a tax not only on every individual's
expenditures, but on his savings account and life insurance. It
is, in fact, a flat capital levy, without exemptions, in which the
poor man pays as high a percentage as the rich man.
But the situation is even worse than this, because, as we have
seen, inflation does not and cannot affect everyone evenly.
Some suffer more than others. The poor are usually more
heavily taxed by inflation, in percentage terms, than the rich,
for they do not have the same means of protecting themselves
by speculative purchases of real equities. Inflation is a kind of
tax that is out of control of the tax authorities. It strikes wantonly
in all directions. The rate of tax imposed by inflation is
not a fixed one: it cannot be determined in advance. We know
what it is today; we do not know what it will be tomorrow; and
tomorrow we shall not know what it will be on the day after.
Like every other tax, inflation acts to determine the individual
and business policies we are all forced to follow. It
discourages all prudence and thrift. It encourages squandering,
gambling, reckless waste of all kinds. It often makes it more
profitable to speculate than to produce. It tears apart the whole
fabric of stable economic relationships. Its inexcusable injustices
drive men toward desperate remedies. It plants the seeds
of fascism and communism. It leads men to demand totalitarian
controls. It ends invariably in bitter disillusion and
collapse.
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