Exporting Inflation

September 9, 1963

One of the great economic puzzles of the last half dozen years is that, though we have been inflating our money-and-credit supply at a disquieting rate, this has not been correspondingly reflected in our price level. Since the end of 1957 our nominal “money supply” (currency outside of banks plus demand deposits) has risen from $136 billion to $150 billion, an increase of about 10 percent. If we include time deposits in the total, the increase has been from $193.4 billion to $254.4 billion, or 31 percent. The Federal Reserve System has engineered this inflation by increasing its purchases and holdings of U.S. Government securities from $23,982,000,000 at the end of 1957 to $32,237,000,000, an increase of $8,255,000,000, or 34 percent.

Yet when we turn to the official price indexes, we find that consumer prices have risen only a little more than 9 percent since the end of 1957, and wholesale prices a bare 1½ percent. Those who measure inflation not by money-and-credit supply but by price levels have therefore argued that there has been no real inflation in the last six years and that the fears of it have been unfounded.

They are wrong. What has happened is that most of our inflation has been exported. Broadly speaking, we have paid the cost of it, and Western Europe and the rest of the world have had the advantage of it.

EASY-MONEY FUTILE

Why and how has this happened? One apparently obvious answer is the $36 billion or so that our government has given in foreign aid and military assistance since the end of 1957. But this is only an indirect cause. The direct reason is that we have not only inflated, but inflated faster than the rest of the world.

More than 200 years ago the British philosopher David Hume pointed out that if a country with a gold currency tried to increase its money supply by bank credit or by added paper money, even if convertible, the only effect, other things unchanged, would be to drive out an equal quantity of gold. Now since the end of 1957 the U.S. has lost a little more than $7 billion gold (which it is interesting to compare with the $8 billion increase in the Federal Reserve’s holdings of government securities). In addition, our short-term dollar liabilities held by foreigners have increased more than $10 billion. In brief, our inflation has been futile. We have, without intending so, inflated mainly for the benefit of foreigners. We have increased our nominal money supply since the end of 1957 by $14 billion. But foreigners now hold $7 billion more in gold, and $13 billion more in liquid dollar assets, or $20 billion more. Our inflation has caused our cumulative balance-of-payments deficit of $22 billion since the end of 1957.

SYMPTOMS VS. CAUSE

All this seems to have escaped the attention not only of our government economists and monetary managers, but of almost our entire banking community. But at least one man, John Exter, vice president of the First National City Bank of New York, for the last two years has been trying to tell his banking colleagues, government economists, and all Keynesian expansionists that it is our easy-money policy that produces our balance-of-payments deficits; that these deficits are a drag on our economy; that our easy money has been in vain; that its economic consequences have been a massive movement of reserves to other countries from our own, where they increase foreign money supplies, not our own; stimulate foreign economies, not our own; employ foreign labor, not our own.

He has also been pointing out that our efforts to plug up specific channels of gold and dollar outflow—such as prohibiting Americans from holding gold, reducing the customs-free tourist allowance, tying our foreign aid to purchases in the United States, bringing or keeping military dependents home, taxing foreign investment are all futile, because they attack the symptoms of the disease and not its cause.

It is our inflation, created through budget deficits, easy money, and Federal Reserve money creation, that is the cause of our balance-of-payments problem. Until it is stopped, the dollar must continue to weaken.