Inflation Is Government-Made

March 12, 1951

The Treasury’s announcement that it will offer “non-marketable” bonds bearing 2¾ percent in exchange for issues of its outstanding 2½ percent bonds maturing in 1967–72 must be warmly welcomed as at least a step in the right direction and the first crack in the 2½ percent fetish.

The sole cause of inflation is an increase in volume of money and credit in relation to volume of goods. This has gone steadily forward. At the end of 1939, both demand deposits and currency outside of banks totaled $36,000,000,000. Wholesale prices in 1939 stood at an index number of 77. At the end of May 1950, money- and-credit volume had increased to $109,000,000,000. Wholesale prices in May 1950, had risen to an average of 156. In December 1950, money-and-credit volume had reached a total of $118,000,000,000. Wholesale prices had soared to an average of 175.

This general rise of prices cannot be attributed to any general “shortage of goods.” On the contrary, the index of industrial production, which stood at 109 in 1939, had risen by May of 1950 to 195 and by December to 216. This rise in production was the chief reason, in fact, why wholesale prices between 1939 and the end of 1950 did not rise more than 127 percent, though the volume of money and bank credit increased by 228 percent.

The chief cause for the increase in the volume of money and credit all through this period was the government’s own cheap-money policy, maintained mainly through the device of pegging outstanding government bonds above par. The Federal Reserve Banks were forced to buy the bonds, which were then made the basis for the creation of more money and credit. At the end of 1939 Federal Reserve Banks held $2,484,000,000 of U.S. Government obligations and the commercial banks $16,316,000,000 worth. At the end of 1950 Federal Reserve Banks held $20,800,000,000 worth and the commercial banks $62,390,000,000 worth. Thus a total of $64,390,000,000 out of the whole increase of $82,000,000,000 in money and bank credit since the end of 1939 in effect represents the “monetization” of government securities acquired by the nation’s banking system.

Mr. Truman’s memorandum of Feb. 26 on government debt and general credit policies wrongly identified “stability” of government securities with “full confidence in the public credit,” and this in turn with an artificial parity. Yet obviously the government cannot create real confidence in its own credit by forcing its left hand to buy the bonds that it “sells” with its right. It has managed to keep up the nominal quotation of the bonds only by a process that has led since 1939 to a depreciation in their real purchasing power of 44 percent. In a self-defeating effort to prevent further inflation, while still preserving the fetish of a 2½ percent long-term interest rate for government securities, the President’s memorandum in effect proposed still further direct government control of the entire economy.

The March 3 Treasury announcement is the first clear recognition that its efforts to hold yields on its long-term securities down to 2½ percent have been inflationary. But the new measure does not on its face seem adequate to solve the problem. The banking system could have been much better protected against a halt in the bond-pegging policy, for example, by allowing holders of outstanding long-term government bonds to convert them into bonds bearing a variable-coupon rate (see Business Tides, Newsweek, Oct. 4, 1948).

The inflation, in brief, has been government-created. And the alleged remedy of price-and-wage control (even if there had been no union-leader insurrection) is completely spurious. If the volume of money and bank credit were prevented from expanding, price control would be unnecessary. But as long as money and bank credit are being substantially increased in relation to the volume of goods, price control will continue to be worse than futile; for it distorts and disrupts production at the same time as it destroys economic freedom.