Inflation Head; H. Sennholz

People often believe that high prices are inflation. This is putting the cart before the horse. Inflation is legalized counterfeiting. High prices are merely the effect of inflation. In ages gone by, governments often indulged in clip ping coins. Today the methods are more complicated, but the effects are the same. Today the federal govern ment goes into the red at a rate of 10 to 15 billion dol lars and covers all or part of this deficit with new money. In the language of the economist, which sounds much less conspicuous, the government calls on the Federal Reserve System, which is its monetary agency, "to pro vide the bank reserves for the nation's growing-monetary needs." This article was written for initial distribution through the Deposit Guaranty Bank & Trust Company of Jackson, Mississippi, and ap pears here with their permission. 132 INFLATION AHEAD 133 What are the inevitable effects of such federal govern ment deficits and inflationary methods of government financing? The most important although least perceptible effect is the loss and consumption of capital.

When the money supply is rapidly inflated, interest rates are artificially low. Many projects and expansion programs then started depend on these low rates for profit ability. Therefore, when the interest rates rise again be cause people begin to take the monetary depreciation in to consideration, these new production facilities may prove to be unprofitable. In other words, they are then called "excess capacity." Economically, they are malin vestments that cause some capital losses. But this is not the only situation resulting in capital consumption. Through inflation the federal government consumes an ever larger part of our income and reduces our capacity to accumulate capital. Inflation lifts us into higher and higher income brackets subject to progressive income taxes. Although my income may not increase in purchasing power, inflation will lift me into higher in come brackets where the government's share will be larger in percentage. Thus my real income will decline which will reduce both my consumption and my ability to save.

The government may even levy taxes on "profits" that in reality constitute no income at all. Inventory profits may be purely inflationary. And yet, the government de mands a "share" which must be paid out of the net worth of the company. The inflationary profit may even hide some real losses in which case the government actually 134 HANS F. SENNHOLZ taxes the losses. In all cases capital is consumed and pro duction impeded by the amount of the capital lost. The inflationary profits and improvements in income may also deceive the recipient. They may induce him to increase his consumption, which of course reducessav ing. Thus income is consumed that otherwise would have enhanced the capital supply. Those Hurt by Inflation This inflation-induced consumption, however, is par tially offset by the "forced savings" of all those who must restrict their consumption on account of the inflation.

The price of consumers' goods tends to rise which fact forces some people to reduce their consumption, espe cially all fixed-income receivers such as the aged living on pensions and fixed benefits or people with stable sal aries or interest income. But this offsetting effect is only partial because it does not offset the capital consumption but merely the additional spending by the holders of the inflationary money. The "forced savings" clearly reveal that inflation in flicts losses on all fixed-income receivers. In ,addition, there is another important class of people that suffers losses: the creditors. They have claims on future money income which inflation reduces in purchasing power. For instance, a bondholder loses if the money he re ceives in the future is of lower value than he himself paid for the purchase of the bond some time in the past. The same is true of all owners of money and claims to money, INFLATION AHEAD 135 such as time and demand deposits, life insurance policies, mortgages, and so forth.

Many people don't feel concern about these losses of creditors because they erroneously believe that the rich are the creditors and therefore suffer the losses. This may have been true during the Middle Ages when the large majority of the people earned very little as compared with today and consequently also saved very little. In present-day America, however, the large majority of the people own some savings in the form of life insurance, savings accounts, government savings bonds, etcetera. Consequently, it is the masses of the people who are apt to suffer from policies of monetary depreciation. The rich in general are the owners of businesses, corporate stock, real estate, and other claims to real wealth. The fact that the majority of the American public is suffering from the effects of monetary depreciation has far-reaching consequences. The provident are penalized when their thrift and sacrifice come to naught. Deprived of the full worth of their savings and jeered at by the spendthrifts, they turn improvident themselves. They become desperate and re ceptive to radical ideas. Along with the spendthrifts they learn to throw themselves on the State for security and support. Thus self-reliance and independence become rare virtues and people are conditioned to life under the Welfare State. Our present trend towards socialism clearly feeds on inflation.

While monetary depreciation robs millions of people of their hard-earned savings, it enriches some people at 136 HANS F. SENNHOLZ the expense of all others. Who are these beneficiaries of inflation? There are the immediate recipients of the inflation-created money. Let us assume that the federal government spends it on arms and ammunition. Then the armament producers and their workers have more money and purchasing power than they would have otherwise. Or, the government may increase the salaries of its army of employees, the handouts to its favored groups, or its payments to public works contractors, in which case these groups are the recipients and benefici aries of the new money. Whoever fir~t receives the money that is newly created gains from the money creation. But these groups of people are not the only benefici aries. There are two others. When the first recipients of the new money have spent it and consequently have caused the prices of some goods to rise, the sellers of these goods profit from higher prices. While the rest of the economy has not yet adjusted to the inflation, the sellers of the inflation-affected goods obtain higher prices al though they may still be able to buy their goods and ma terials at pre-inflation prices. The difference is the infla tion gain.

In other words, a person profits from inflation if his position in the economy is such that he can sell his prod ucts or services at higher prices and buy the products and services he needs at the old prices. On the other hand, a person loses if he must buy in the inflated market but sell in a market that remains temporarily unaffected by the inflation. It is obvious that these situations are only temporary. They come to an end when the new money INFLATION AHEAD 137 supply has reached all sectors of the economy and the necessary economic adjustment has run its course. Finally, there is the large class of debtors who gain from monetary depreciation. As the federal government is the greatest debtor in the country, it is also the greatest inflation profiteer. It gains billions of dollars through monetary depreciation of its debts. And the bondholders who have entrusted their savings to the government an nually lose the very amount the government gains. Mone tary depreciation in fact amounts to gradual repudiation of the government debt.

Another disastrous effect of a policy of monetary de preciation is the recurrence of economic booms followed by sudden busts. The inflation at first makes for feverish economic activity. Prices rise and business profits are at tractive. But soon also labor and other costs tend to rise. They soar until business becomes unprofitable at which point the recession begins. If the government through its monetary agency, the Federal Reserve System, accelerates the inflation, the downturn can be avoided temporarily. For as long as product prices rise faster than business costs, business will stay profitable. Of course, the ultimate outcome of such a policy of accelerated inflation must be the total destruc tion of the currency. If, however, the money is stabilized and the Federal Reserve refrains from further inflation, the currency is .saved but a recession sooner or later sets in. The recession usually develops one to two years after the inflationary policy has been abandoned. There are 138 HANS F. SENNHOLZ two reasons for this delay. First, business costs are slow in catching up with product prices. Wages and salaries, for instance, react to inflation more slowly than the prices of consumers' goods. If business costs rose simultaneously and to the same extent as product prices, if for instance, all wages were immediately adjusted to the cost of living, the recession would follow the inflation immediately.

Accelerated Spending The second reason for the delay is what in bad eco nomic terminology is called Hthe rising velocity of money." During the period of active inflation people realize that prices are rising. They now begin to reduce their cash holdings. They buy readily and quickly in anticipation of higher prices. They may even go into the red in order to take advantage of present prices before they rise again. Consumers' indebtedness increases by leaps and bounds, and billions of dollars of savings ac cumulated by banks and other savings institutions are channeled toward consumption. It is obvious that consumers' prices must rise because of such an inflationary sentiment which constitutes a natural reaction to the actual inflation. And it is also understandable that this reaction may even continue after the Federal Reserve inflation has come to a halt. Thus we can· witness a short period in which our mone tary authorities refrain from inflation but prices con tinue to rise and the economy evidences all symptoms of inflation. The inevitable recession and readjustment INFLATION AHEAD 139 finally sets in as soon as more and more people realize that the inflation has temporarily come to a halt.

This slow reaction to a policy of monetary stabiliza tion, which constitutes the source of many economic errors and fallacies, could actually be witnessed in the years 1956 and 1957. The active Federal Reserve infla tion was abandoned in ·1955, and yet, prices continued to rise on account of people's reduction of cash holdings and increase in consumers' indebtedness. When, during the latter part of 1957, it became clear to more and more people that the inflationary policies had been abandoned, cash holdings began to increase again and the increase in consumers' indebtedness began to slow down. This de velopment together with the other recession reasons mentioned above then led to the recent business down trend. Some people erroneously believe that inflation affects the economy simultaneously and uniformly. The notion prevails that inflation increases prices like rainfall raises the water level of a pond. This notion is as fallacious as it is popular. In reality inflation causes price upheavals.

It affects prices and wages differently and at different times. As has been pointed out, some industries and their workers may actually benefit from inflation if their money income increases before other prices have risen. Other industries are bound to suffer losses if they must continue to sell their products and services in markets still unaffected by inflation but buy products whose prices have already risen on account of the inflation. People often don't realize this. Especially are our labor 140 HANS F. SENNHOLZ leaders prone to forget it when they clamor for wage increases regardless of inflationary effects. They observe wage improvements in other industries that benefit from inflation and consequently feel obliged to obtain the same improvements for their own members. If· this hap pens in an industry that actually suffers from inflation, the ensuing union demands merely add to the woes and troubles of the industry. And labor dissatisfaction and unrest usually result.

The product prices of some industries such as rail roads and public utilities are controlled by various gov ernment regulatory bodies. Experience shows that these industries suffer greatly from inflation. While their costs of operation, especially labor and material, rise on ac count of inflation or union pressure, their own prices are subject to government supervision. The regulatory bodies, however, like to keep prices stable often in order to "counteract" inflation. Consequently, such an indus try is squeezed. between rising operating costs and stable prices of its own products or services, which of course results in losses and consumption of capital. Usually these difficulties then lead to more government regula tion and supervision. The most tragic of all inflation effects is our tendency to advance further toward socialism. When prices rise and people suffer through no fault of their own, they clamor for government protection from inflation. But they often mistake the symptoms of inflation, the rising prices, for the real inflation which is the Federal Reserve increase of the money supply and of bank reserves. Thus INFLATION AHEAD 141 they favor remedies that would merely attack the symp toms while the roots of the evil are left untouched.

This mistake is often made during the period that im mediately follows the active Federal Reserve inflation when people continue to decrease their cash holdings and increase their indebtedness. During this period of rising prices our monetary authorities correctly point to their idle printing presses but mistakenly deny all responsi bility for the inflation. The Hair of the Dog The public cry for government protection from infla tion appeals to the very institution that alone can inflate and depreciate our money. Only the federal government through its agency, the Federal Reserve system, can print money and inflate the money supply. You and I would be held punishable for counterfeiting if we were to pro duce a single dollar bill. But while we appeal to the government for protection from inflation, we condone the very policies that are in flationary. We condone the budgetary deficits of 10 to 15 billion dollars and the "stimulation" of the economy through Federal Reserve credit expansion. This contradic tion obviously must lead to government policies that continue to be inflationary. And it must lead to a "fight"

that is aimed at the symptoms rather than at the infla tion itself. But according to all rules of semantics, when the government fights rising prices through price con trols, wage controls, and a series of other controls, our 142 HANS F. SENNHOLZ system of economy ceases to be free. It falls into the abyss of socialism. What are the causes that induce our monetary authori ties to embark again and again upon inflationary adven tures? Most people pretend to oppose inflation. And yet they clamor for the things that make inflation inevitable. In an analysis of the present-day American predilection for policies that make inflation inevitable, the following two groups must especially be mentioned as having suc cessfully pressured our monetary authorities into easy money policies on their behalf. The first pressure group consists of those people who continuously clamor for federal aid and spending for their own special interests. There is the Farm Bloc insist ing on farm supports, government buying and storing of food, giving it away to foreign nations, or throwing it on the world market at lower prices than we Americans have to pay. There is the soil bank which is a scheme of government subsidy for work not done.

If all these funds were raised by taxing the people, no inflation would result-merely a shift of spending power from the pockets of all taxpayers to those of the farmers. Often, however, our government is afraid to present us with the true bill for its lavish spending on the pressure groups. Running deficits, .it borrows the funds from the banks which in turn have received the necessary reserves from the Federal Reserve. This, then, constitutes inflation. But there are not only the farmers who constantly clamor for federal aid and support even if the money INFLATION AHEAD 143 must first be created, but also many other groups in high public repute. There are the veterans' organizations con stantly pressuring the government for more liberal pen sions and other costly benefits with utter disregard for the source of the money. Hundreds of thousands of healthy veterans are still receiving government educa tional help. The Veterans' Administration has guaran teed or insured $23 billion worth of home, farm, or busi ness loans. It has loaned more than $700 million directly.

All in all, total federal spending for veterans .amounts to approximately $5 billion annually, or about seven cents of each tax dollar. Nearly one-fifth of all federal spending other than for rearmament goes to the veterans and their families. If all this money is raised through taxation, no infla tion results, merely a transfer of $5 billion from the pockets of all taxpayers to those of veterans and their families who make up approximately one-half the Ameri can population.·· But whenever the federal government operates at a deficit on account of these and many other spending programs, the necessary funds usually are made available through currency expansion. The fact that the veterans' organizations nevertheless insist on costly bene fits regardless of the effects on the nation's currency and economy, makes them a dangerous pressure group for inflation. There are the pressure groups advocating multibillion dollar foreign aid programs, federal road construction programs, public utility programs, federal housing pro grams, and many others. Again, all these schemes would 144 HANS F. SENNHOLZ not be inflationary if all the money were raised by tax ation. But in most years since 1930 the federal govern ment operated with large deficits, the funds for which were made available through credit expansion.

The Social Security Burden There is one spending program standing high in the public mind that in the future will constitute a powerful reason and excuse for inflation, although in the past it even counteracted inflationary ambitions. This is the so cial security program. Since January 1, 1937, an ever greater part of the working population has been taxed to finance the Federal Old-Age and Survivors Insurance. For more than 20 years the annual intake of the Social Security Administration exceeded the benefits paid out. Consequently, a surplus of more than $20 billion resulted that was merged with other tax revenues and spent by the government. It is obvious that this amount helped to pay for the various New Deal programs and thus pre vented the government from inflating the nation's cur rency by this very amount. In the future the situation will be quite different. An ever larger number of taxpayers is reaching retirement age and drawing old-age benefits. But this is not the only reason for an expected rise in outlays. Since -1939 the benefits were broadened to provide for wives, widows, and dependent children of retired workers. Payments were increased repeatedly in order to assure adequate support. Each worker's old-age claim is no longer based INFLATION AHEAD 145 on the amount of his contribution, but on our politi cians' definition of need and adequacy.

This criterion for benefits has led, and must lead in the future, to costly revisions of the program, especially when the costs of living are rising. Each political party is tempted to bid for the votes of the aged through higher old-age benefits. Consequently, rising expenditures will require much higher taxes and, in case the revenue should not be forthcoming promptly and sufficiently, al-" so monetary expansion. The social security program, which in the present fiscal year is expected to suffer its first deficit, therefore will constitute another reason for inflation and monetary depreciation. Our labor unions comprise the second important pres sure group advocating inflationary measures. Through collective bargaining, strikes, and many other methods of coercion they tend to lift wages above the rates deter mined by a free labor market. But whenever wages are forced above those determined by competition in the market, unemployment inevitably results. This in itself constitutes no inflation, merely a maladjustment. But then the very unions that bring about these harmful ef fects begin to clamor for federal aid and easy-money policies. Through their influence on public opinion and their connections in Congress they pressure the Board of Governors into inflationary money policies to provide relief for their depressed industries. We can observe this phenomenon in all industries in which there are power ful labor unions.

Until recently the American residential building indus146 HANS F. SENNHOLZ try, for instance, has been working at less than 70 per cent of capacity. For years powerful unions have pushed building industry wages far above free market wages, which fact raised housing prices considerably.· And -while prices were rising, the demand for houses declined. Un employment of capital and labor resulted. Now, instead of shouldering the responsibility for this maladjustment, the labor unions clamor for easy-money policies which would supply the mortgage money needed to sell more homes at higher prices. In other words, they ask for inflation as a cure for maladjustment. Even during recessions when business suffers from un profitableness labor unions continuously raise business costs. Consequently, they increase unemployment. A comparison between the unionized North and the South with its less harassed labor relations clearly demonstrates this causal connection. Where are the 5 million workers who presently are unemployed? They live in the indus trial North that is plagued by union activities. They live especially iIi the union strongholds, in Chicago, Detroit, Pittsburgh, New York, New England, and so forth. And where did the last recession have its most depressive im pact? Every objective observer will agree that it is the unionized North that breeds recessions.

Facing the dilemma of mass unemployment, our Wash ington administration is called upon to remedy the situ ation. It has two alternative policies at its disposal. It may oppose the multiplicity of coercive labor union prac tices through revoking the legal sanctity which New Deal legislation has bestowed upon unions. Unfortunately, INFLATION AHEAD 147 this alternative is not open to the large number of con gressional representatives who owe their election to the labor leaders. The other alternative is much more popular. When ever the country suffers from unemployment due to co ercive union practices, our government immediately comes to the rescue of the labor unions and their domi nated industries through easy-money policies. It rescues the building and construction unions, for instance, through more government guarantees, easier terms of payment, lower rates of interest, and other "stimulating"

measures all of which result in inflation. In this respect inflation is a political expedient re sorted to by weak administrations. It is a device that hides temporarily the evil effects of coercive union prac tices. But while it does this, it bears its own formidable effects.