The Causes of Inflation; H. Sennholz

The Causesof HANS F. SENNHOLZ IT IS NOT MONEY, as is sometimes said, but the depreciation of money - the cruel and crafty destruction of money - that is the root of many evils. For it destroys in dividual thrift and self-reliance as it gradually erodes personal sav ings. It benefits debtors at the ex pense of creditors as it silently transfers wealth and income from the latter to the former. It gen erates the business cycles, the stop-and-go boom-and-bust move ments of business that inflict in calculable harm on millions of peo ple. For money is not only the me diurn for all economic exchanges, but as such also the lifeblood of the economy_ When money suffers depreciations and devaluations it invi tes government price and wage Dr. Sennholz heads the Department of Eco nomics at Grove City College and is a noted writer and lecturer on monetary and economic principles and practices.

controls, compulsory. distribution through official allocation and ra tioning, restrictive quotas on im ports, rising tariffs and sur charges, prohibition of foreign travel and investment, and many other government restrictions on individual activities. Monetary de struction breeds not only poverty and chaos, but also government tyranny. Few policies are more calculated to destroy the existing basis of a free society than the debauching of its currency. And few tools, if any, are more im portant to the champion of free dom than a sound monetary sys tem. Inflation is defined here as the creation of new money by mone tary authorities. In more tradi tional usage, it is that creation of money that visibly raises goods prices and lowers the purchasing power of money. It may be creep284 1972 THE CAUSES OF INFLATION 285 ing, trotting or galloping, depend ing on the rate of money creation by the authorities. It may take the form of "simple inflation," in which case the proceeds of the new money issues accrue to the govern ment for deficit spending. Or it may appear as "credit expansion,"

in which case the authorities chan nel the newly created money into the loan market. The government may balance its budget, but in order to stimulate business and promote full employment it may inject new credits into the bank ing system. Both forms are infla tion in the broader sense and asi such are willful and deliberate policies conducted by government. Ours is the age of inflation. 1 All national currencies have suf fered serious depreciations in our lifetime. The British pound ster ling, the shining example of hard money for one hundred years, has lost almost 90 per cent of its pur chasing power and suffered four devaluations since 1931. The pow erful U.S. dollar of yesteryear has lost at least two-thirds of its pur chasing power and continues to shrink at accelerating rates. In the world of national currencies there have been nearly 400 full or partial devaluations since World War II. Many currencies have suf1 Cf. Jacques Rueff, The Age of Infla tion (Gateway Editions, Henry Regnery Company, Chicago, Ill., 1964).

fered total destruction and their replacements are eroding again. Ideas Shape Policies To inquire into the causes that induce governments the world over to embark upon such monetary policies is to search for the mone tary theories and doctrines that guide their policy makers. Ideas control the world, and monetary ideas shape monetary policies. Several distinct economic and monetary doctrines have combined their forces to make our age one of inflation. One doctrine in par ticular enjoys nearly universal ac ceptance: the doctrine that gov ernment needs to control the money. Even many of the champions of private property and individual freedom stop short at money. They are convinced that money cannot be left to the vagaries of the mar ket order, but must be controlled by government. Money must be supplied and regulated by govern ment or its central bank. That money should be free is incon ceivable to typical twentieth-cen tury man. He depends on govern ment to mint his coins, issue his notes, define "legal tender," estab lish central banks, conduct mone tary policy, and then stabilize the price level. In short, he wholly re lies on government regulation of money. But this trust in monopo286 THE FREEMAN May listie monetary authori ty operating through political processes inevi tably gives rise to monetary de struction. In fact, money is in flated,. depreciated, and ultimately destroyed wherever government holds monopolistic power over it.

Government Control of Money Throughout the history of civili zation, governments have been the chief cause of monetary deprecia tion. It is true, variations in the supply of metallic money, due to new gold and silver discoveries, occasionally affected the value of money. But these changes were rather moderate when compared with those caused by government coin debasements or note infla tions. Especially since the rise of statism and the "redistributive so ciety," governments all over the world have embarked upon un precedented inflations the disas trous effects of which can only be surmised. To entrust our money to government is like leaving our canary in trust with a hungry cat. From the Roman caesars and the Medieval princes to contempo rary presidents and prime minis ters, their governments have this in common: the urgent need for more revenue. The large number of spending programs such as war or preparation for war, care of veter ans and civil servants, health, edu cation, welfare, urban renewal, and the like, places a heavy burden on the public treasury, which is finally tempted to provide the necessary funds through currency expansion.

True, government at first may merely endeavor to· tax wealth and income - tax Peter to pay Paul. But this convenient and popular source of government sup port is practically exhausted when Peter's income tax reaches one hundred per cent. At this point, for additional revenue, the govern ment must either raise everyone's taxes or turn to currency expan sion. But the former is rather un popular and therefore inexpedient politically. To win elections, the taxes may even be lowered and the inevitable deficits covered through currency creation, I.e., inflation. The Steps Toward Monopoly The first step toward full devel opment of this source of revenue was the creation of a government monopoly of the mint. To secure possession of the precious metals that circulated as coins, the sover eign prohibited all private issues and established his own monopoly. Minting became a special preroga tive of the sovereign power. Coins either carried the sovereign's pic ture or were stamped with his fa vorite emblems. But above all, his mint could now charge any price for the coins it manufactured. Or it could reduce the precious metal 1972 THE CAUSES OF INFLATION 287 content of the coins and thus ob tain princely revenues through coin debasement. Once this pre rogative of sQvereignty was safely established, the right to· clip, de grade, or debase the coinage was no longer. questioned. It became a "crown right" that was one of the chief sources of revenue. 2 An essential step toward gradual debasement of the coinage was the separation of the name of the monetary unit from its weight.

While the original names of the coins designated a certain weight and thus afforded a ready concep tion of their gold or silver con tents - pound, libra or livre, shil ling, mark, and soon-the new names were void of any reference to weight. The pound sterling was no longer a pound of fine silver, but anything the sovereign might designate as the national monetary unit. This change in terminology widely opened the door to coin de basement. The next step toward full gov ernment control over money was the passage of legal tender laws, which dictates to people what their legal money can be. Such laws are obviously meaningless and super fluous wherever the ordinary law of contract is respected. But where government wants to issue inferior 2 Cf. Elgin Groseclose, Money and M(Ln (Frederick Unger Publishing Co., New York, 1961), p. 55 et seq. coins or depreciated paper notes, it must use coercion in the form of legal tender legislation. Then it can circulate worn or· debased coins side-by-side with the origi nal coins, falsify the exchange ratios between gold and silver coins, .and discharge its debt with the overvalued coins, or make payments in greatly depreciated fiat money. In fact, once legal tender laws were safely estab lished, debt repudiation through monetary depreciation could be come one of the great inj ustices of our time. Contemporary juris prudence and jurisdiction were ut terly paralyzed in their defense and administration of justice once they accepted legal tender laws. A debt of a million gold marks thus could be legally discharged with one million paper marks that bought less than one U.S. penny.

And a government debt of fifty billion 1940 dollars can now be paid or refunded with a 1971 dol lar issue that is worth less than one-third of the original amount. With the blessings of the courts, millions of creditors can now be swindled out of their rightful claims, their property legally con fiscated. 3 But absolute government con trol over money was only estab3 LudWig von Mises, Human Action (Yale University Press, New Haven, 1949), PP. 432, 444.

288 THE FREEMAN May Jished when money substitutes in the form of paper notes and de mand deposits came into promi nence. As long as governments had to make payments in commodity money, inflationary policies were limited to the primitive methods of coin debasement. With the ad vent of paper money and demand deposits, however, the power of government was greatly strength ened, and the scope of inflation vastly extended. At first, people were made familiar with paper money as mere substitutes for money proper, which was gold or silver. Government then proceeded to withdraw the precious coins from individual cashholdings and concentrate them in its treasury or central bank, thus replacing the classical. gold-coin standard with a gold-bullion standard. And finally, when the people had grown ac customed to paper issues, govern ment could deny all claims for redemption and establish its own fiat standard. All checks on infla tion had finally been removed.

The Role 01 the Central Bank The executive arm of govern ment that conducts the inflation usually is the central bank. It does not matter who legally owns this bank, whether private investors or the government itself. Legal own ership always becomes empty and meaningless when government assumes total control. The Federal Reserve System which is legally owned by the member banks is the monetary arm of the U.S. Govern ment and its engine of inflation. It enjoys a monopoly of the note issue which alone is endowed with legal tender characteristics. Com mercial banks are forced to hold their reserves as deposits with the central bank, which becomes the "banker's bank" with all the re serves of the country. The central bank then conducts its own infla tion by expanding its notes and deposits while maintaining a de clining reserve ratio of gold to its own liabilities, and directs the bank credit expansion by regulat ing the legal reserve requirements the commercial banks must main tain with the central bank. En dowed with such powers, the cen tral bank now can finance any government deficit, either through a direct purchase of treasury obli gations or through open-market purchase of such obligations, which creates the needed reserves for commercial banks to buy the new treasury issues.

The final step toward absolute government control over money, and its ultimate destruction, is the suspension of international gold payments, which is the step Presi dent Nixon took on August 15, 1971. When a central bank is hope lessly overextended at home and 1972 THE CAUSES OF INFLATION 289 abroad, its currency may be de valued, which is a partial default in its international obligations to make payment in gold; or, in an outburst of. abuse against foreign ers and speculators, the govern ment may cease to honor any pay ment obligations, as in the case of the U.S. default. All over the world, government paper now forms 120 national fiat standards that are managed and depreciated at will. The decline of monetary free dom and the concomitant rise of government power over money gave birth to our age of inflation. Step by step, government assumed control over money, not only as an important source of government revenue but also as a vital com mand post over our economy. The result is continuing inflation. Only monetary freedom can impart stability.4 Welfarism and Inflation Even the noblest politicians and civil servants can no longer be ex pected to resist the public clamor for social benefits and welfare.

The political pressure that is 4 Cf. Ludwig von Mises. The T he01"'J1 of Money and Credit (FEE, Irvington, N. Y., 1971), pp. 413 et seq.; Murray N. Rothbard, Man, Economy, and State (D. Von Nostrand Co., Princeton, 1962), p. 661 et seq.; also his concise What Has Government Done to Our Money? (Pine Tree Press, 1963). brought to bear on democratic governments is rooted in the popu larr'ideology of government welfa.re and economic redistribution. It inevitably leads to a large number of spending .programs that place heavy burdens on the public treas ury. By popular demand, weak administrations seeking to pro long their power embark upon massive spending and inflating in order to build a "new society" or provide a "better. deal." The peo ple are convinced that government spending can give them full em ployment, prosperity, and economic growth. When the results fall far short of expectations, new pro grams are demanded and more government spending is initiated.

When social and economic condi tions grow even worse, the dis appointments breed more radical ism, cynicism, nihilism, and above all, bitter social and economic con flict. And all along, the enormous increase in government spending causes an enormous increase of taxes, chronic budget deficits and rampant inflation. 5 The "redistributive" aspirations of the voting public often induce their political representatives in Congress to authorize and appro priate even more money than the President requests. Such programs 5 Henry Hazlitt, Man V8. The Welfare State (Arlington House, New Rochelle, N. Y., 1969), p. 57 et seq.

290 THE FREEMAN May as social security, medicare, anti poverty, housing, economic devel opment, aid to education, environ mental improvement, and pay in creases for civil servants are so popular that few politicians dare to oppose them. The government influences per sonal incomes by virtually every budget decision that is made. Certainly its grants, subsidies, and contributions to private individu als and organizations aim to im prove the material incomes of the beneficiaries. The loans and ad vances to private individuals arid organizations have the same ob jective. Our foreign aid program is redistributive in character as it red uces American incomes in order to improve the material condition of foreign recipients. The agri cultural programs, veteran's bene fits, health, labor and welfare ex penditures, housing and commun ity development, Federal expendi tures on education, and last, but not least, the social insurance and medicare programs directly affect the incomes of both beneficiaries and taxpayers. As the benefits generally are not based on tax payment, but rather on considera tions of social welfare, these pro grams constitute redistribution on a nationwide scale. Foreign aid programs have extended the prin ciple of redistribution to many parts of the world.

Whenever government expendi tures exceed tax collections and the government deficit is covered by currency and credit expansion, we suffer inflation and its effects. The monetary unit is bound to de preciate and goods prices must rise. Large increases in the quan tity of money also induce people to reduce their savings and cash holdings which, in the terminology of mathematical economists, in creases money "velocity" and re duces money value even further. It is futi,Je to call these people "irresponsible" as· long as the government continues to increase the money stock. Labor Union Pressures A very potent cause of inflation is the unrelenting wage pressure exerted by labor unions. It is true, labor unions do not directly en hance the quantity of money and credit and thus cause the depreci ation. But their policy of raising production costs inevitably causes stagnation and unemployment.

This is why the union strongholds are the centers of unemployment. Faced with serious stagnation, the labor leaders are likely to become spokesmen for all schemes of easy money and credit that promise to alleviate the unemployment plight. The democratic government in turn does not dare to oppose the unions for political reasons. On 1972 THE CAUSES OF INFLATION. the contrary, it does everything in its power to reduce the pressure which mass unemployment exerts on the union wage rates. It grants ever larger unemployment bene fits and embarks upon public works in the depressed unionized areas. At the same time it expands credit, which tends to reduce real wages and to encourage employment. The demand for labor is de termined by labor costs.. Rising costs reduce the demand, falling costs raise it. Inasmuch as infla tion reduces the real costs of labor, it actually creates employment. When goods prices rise while wages stay the same, or prices rise faster than wages, labor be comes more profitable to employers.

Many workers, whose employment costs heretofore had exceeded the value of their productivity so that they were unemployable, now can be profitably re-employed. Of course, this employment-creating policy is then counteracted by such unemployment factors as rising minimum wage rates, higher un employment benefits and welfare doles, and rising union wage scales and fringe-benefit costs. In many industries, the labor unions have introduced "cost-of-living clauses" that aim to prevent the decline of real· wages through monetary de preciation. Or their wage demands take into consideration the rising rates of monetary depreciation. Their demands may become "ex orbitant," their strikes longer and uglier, and the economic losses in flicted on business .and the public ever more damaging until busi nessmen clamor for government wage controls. With wage controls come price controls and the whole paraphernalia of the command system.

The "New Economics" To give "scientific" justification to the policy of inflation, a host of contemporary. economists have de veloped intricate theories, com monly known as the new econom ics. Basically, they all ascribe to government .the magic power of creating real wealth out of noth ing, of raising the "national in come" through minute efforts of the central bank and its printing presses. They are unanimous in their condemnation of the gold standard, which to them means domination by "external forces" and denial of national independ ence in economic policies. Of course, the "independence" they so jealously uphold is tantamount to government control over money matters. They want "fiat money," i.e., government money without re straint by a commodity such as gold. Though some would allow us the freedom to buy and hold gold coins or bullion, they know very well tha t the legal tender laws 292 THE FREEMAN May that support the fiat standard deny us the right to use gold in economic exchanges, which rele gates all coins to hoards and coin collections.

Only free money is sound money. This is why one should be suspi cious of any and all proposals that would enhance the power of gov ernment over money. A currency reform, whether domestic or in ternational, that does not endeavor to dismantle this power, cannot provide monetary stability. It is destined to lead to more inflation and depreciation, to· economic up heaval and decline. Sound money means the gold-coin standard; it makes the value of money inde pendent of government, as the quantity of gold is independent of the wishes and manipulations of government officials and politi cians. It needs no "rules of the game," no arbitrary rules people must learn or government must observe. It is born in freedom and follows inexorable economic law.6 6 Hans F. Sennholz, Inflation or Gold Standard, Constitutional Alliance, Inc., Lansing, Michigan. .. ~ -x- * Frugality and Economy Manifestly nothing is more vital to our supremacy as a nation and to the beneficent purposes of our Government than a sound and sta ble currency_ Its exposure to deg radation should at once arouse to activity the most enlightened statesmanship, and the danger of depreciation in the purchasing power of the wages paid to toil should furnish the strongest in centi ve to prompt and conserva tive precaution.

In dealing with our present em barrassing situation as related to this subject we will be wise if we temper our confidence and faith in our national strength and re sources with the frank concession that even these will not permit us to defy with impunity the inexor able laws of finance and trade .... Closely related to the exagger ated confidence in our country's greatness which tends to a disre gard of the rules of national safe ty, another danger confronts us not less serious. I refer to the prevalence of a popular disposi tion to expect from the operation of the Government especial and direct individual advantages. GROVER CLEVELAND Second Inaugural address, March 4,1893 RAY L. COLVARD PERCEPTIVE S'fUDENTS of the free dom philosophy will note the ab surdity of my title. Freedom and equality are opposed and contra dictorypoints of the political econ omy. One extreme is the un shackled and unmuzzled· autono my of personal independence. The other is the leveling tit-for-tat security of collectivism. As indi viduals or as a nation we cannot have it both ways. One extreme is anarchy. The. other is regimenta tion.