Do We Need More Money?

April 12, 1965

With either mild or violent inflation taking place year by year in nearly every country, with a currency crisis breaking out somewhere every week, it is obvious that the world monetary system set up at Bretton Woods in 1944 is breaking down. Monetary economists realize that it is breaking down. Almost daily someone puts forward a new plan for world monetary reform.

But the irony is that, though the disease is chronic inflation, nine tenths of the proposed “reforms” are based on the fear that this inflation may suddenly come to a halt, and plunge the world into a deflationary crisis. Therefore all these plans provide for a constant increase in “liquidity”—i.e., a further increase in the volume of credit and of paper money.

It is important to distinguish two schools of currency expansionists. The first are the extreme expansionists who believe that it is necessary to maintain a constant “full employment” boom by constant injections of “new purchasing power” into the economy. But employment does not depend upon the amount of money in existence. What it depends on is a proper coordination of prices with costs and wage rates. If this coordination exists, full employment and production will follow. If this coordination does not exist, if wage rates in key lines race ahead faster than prices and marginal labor productivity, there will be unemployment no matter how much new money is printed.

‘KEEPING PACE’

Yet there is a more subtle and more widespread form of inflationism. It consists in the belief that a constant increase in the money supply is necessary to “keep pace” with the increase in domestic production or the volume of world trade. Hence the chronic fears of a future “shortage of liquidity.” Hence the belief that “there isn’t enough gold in the world to carry on international trade.” Practically all the “world monetary reform” plans are therefore plans for more and more credit expansion and paper money.

Now there is one germ of truth in this belief. If the money supply remains constant, while production and trade expand, there will be a fall in prices. The error in the theory consists in assuming that such a fall in prices will imperil or wipe out profit margins and therefore create stagnation and unemployment. But this assumption overlooks that real costs, and therefore money costs also, will be falling along with final prices. Real profit margins will be retained. The living standards of the workers will be constantly bettered, not primarily through higher money wages, but through a higher purchasing power of their money wages. It is a serious fallacy to assume that a constant money supply would have the same kind of results as a suddenly contracted money supply, combined with inflexible prices and wages.

INVERTED PYRAMIDS

Expansion of the paper-money supply cannot go on forever. Our authorities now think that even a 25 percent gold reserve is an excessive requirement. Yet this 25 percent reserve was only required against Federal Reserve notes and deposits. On top of these notes and deposits (themselves liabilities) we have built another inverted pyramid of commercial bank deposits. Twenty paper dollars are now outstanding against every gold dollar. Foreign central banks count such paper dollars as “reserves,” and have built still another inverted pyramid of money and credit on top of them. Of course under this setup the world’s monetary system is drifting toward a crisis. And this cannot be averted by printing still more paper money.

For an increase of the money supply, in order to increase “liquidity,” is in the end always self-defeating. If a country doubles the amount of its paper money, for example, it merely cuts in half the purchasing power of its monetary unit compared with what it would otherwise have been. It merely does business on a higher price level. But excessive printing of new money discourages saving, unbalances production, and creates instability and uncertainty.

As long as the superstition prevails that the amount of money needs to be constantly increased, the world will never get back to a sound and stable monetary system. Inflation must someday have a stop.