Inflation; L. von Mises

Ludwig von Mises Inflation IF the supply of caviar were as plen tiful as the supply of potatoes, the price of caviar-that is, the ex change ratio between caviar and money or caviar and other com modities-would change considera bly. In that case, one could obtain caviar at a much smaller sacrifice than is required today. Likewise, if the quantity of money is increased, the purchasing power of the mone tary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also. When, in the sixteenth century, American resources of gold and silver were discovered and ex ploited, enormous quantities of the precious metals were trans ported to Europe. The result of this increase in the quantity of money was a general tendency toward an upward movement of prices. In the same way, today, when a govern ment increases the quantity of paper money, the result is that the pur chasing power of the monetary unit begins to drop, and so prices rise.

This is called inflation. Unfortunately, in the United States, as well as in other countries, some people prefer to attribute the cause of inflation not to an increase in the quantity of money but, rather, to the rise in prices. However, there has never been any serious argument against the economic interpretation of the rela tionship between prices and the quantity of money, or the exchange ratio between money and other goods, commodities, and services. Under present day technological conditions there is nothing easier than to manufacture pieces of paper upon which certain monetary amounts are printed. In the United States, where all the notes are of the same size, it does not cost the gov ernment more to print a bill of a thousand dollars than it does to print a bill of one dollar. It is purely a printing procedure that requires the same quantity of paper and ink. 151 152 THE FREEMAN March Ludwig von Mises, 1881-1973, was one of the great defenders of a rational economic science, and perhaps the sin gle most creative mind at work in this field in our century.

Found among the papers of Dr. Mises were transcripts of lectures he delivered in Argentina in 1959. These have now been edited by his widow and are avail able as a Regnery/Gateway paper backed book. This article, one of the lectures, is here reprinted by permission of the publishers. All rights reserved. The book, Economic Policy: Thoughts for Today and Tomorrow, also may be purchased at $4.95 from The Foundation for Economic Education, Inc., Irving ton-on-Hudson, N.Y. 10533. In the eighteenth century, when the first attempts were made to issue bank notes and to give these bank notes the quality of legal tender-that is, the right to be hon ored in exchange transactions in the same way that gold and silver pieces were honored-the governments and nations believed that bankers had some secret knowledge enabling them to produce wealth out of noth ing. When the governments of the eighteenth century were in financial difficulties, they thought all they needed was a clever banker at the head of their financial management in order to get rid of all their dif ficulties.

Some years before the French Revolution, when the royalty of France was in financial trouble, the king of France sought out such a clever banker, and appointed him to a high position. This man was, in every regard, the opposite of the people who, up to that time, had ruled France. First of all he was not a Frenchman, he was a foreigner-a Genevese. Secondly, he was not a member of the aristocracy, he was a simple commoner. And what counted even more in eighteenth centu!y France, he was not a Catholic, but a Protestant. And so Monsieur Necker, the father of the famous Madame de StaiH, became the minister of finance, and everyone expected him to solve the financial problems of France. But in spite of the high degree ofconfidence Monsieur Necker enjoyed, the royal cashbox remained empty-Necker's greatest mistake having been his attempt to finance aid to the Ameri can colonists in their war of inde pendence against England without raising taxes. That was certainly the wrong way to go about solving France's financial troubles.

No Secret Source of Funds There can be no secret way to the solution of the financial problems of a government; if it needs money, it has to obtain the money by taxing its citizens (or, under special condi tions, by borrowing it from people who have the money). But many governments, we can even say most governments, think there is another 1980 INFLATION 153 method for getting the needed money; simply to print it. If the government wants to do something beneficial-if, for exam ple, it wants to build a hospital-the way to find the needed money for this project is to tax the citizens and build the hospital out of tax reve nues. Then no special Hprice revolu tion" will occur, because when the government collects money for the construction of the hospital, the citi zens-having paid the taxes-are forced to reduce their spending. The individual taxpayer is forced to re strict either his consumption, his investments or his savings. The government, appearing on the mar ket as a buyer, replaces the individ ual citizen: the citizen buys less, but the government buys more. The government, of course, does not al ways buy the same goods which the citizens would have bought; but on the average there occurs no rise in prices due to the government's con struction of a hospital.

I choose this example of a hospital precisely because people sometimes say: HIt makes a difference whether the government uses its money for good or for bad purposes." I want to assume that the government always uses the money which it has printed for the best possible purposes purposes with which we all agree. For it is not the way in which the money is spent, it is the way in which the government obtains this money that brings about those con sequences we call inflation and which most people in the world today do not consider as beneficial. For example, without inflating, the government could use the tax collected money for hiring new em ployees or for raising the salaries of those who are already in govern ment service. Then these people, whose salaries have been increased, are in a position to buy more. When the government taxes the citizens and uses this money to increase the salaries of government employees, the taxpayers have less to spend, but the government employees have more. Prices in general will not in crease.

But if the government does not use tax money for this purpose, if it uses freshly printed money instead, it means that there will be people who now have more money while all other people still have as much as they had before. So those who re ceived the newly-printed money will be competing with those people who were buyers before. And since there are no more commodities than there were previously, but there is more money on the market-and since there are now people who can buy more today than they could have bought yesterday-there will be an additional demand for that same quantity of goods. Therefore prices will tend to go up. This cannot be avoided, no matter what the use of 154 THE FREEMAN March this newly-issued money will be. And most importantly, this ten dency for prices to go up will develop step by step; it is not a .general upward movement of what has been called the ((price level." The metaphorical expression ((price level" must never be used.

When people talk of a ((price level," they have in mind the image of a level of a liquid which goes up or down according to the increase or decrease in its quantity, but which, like a liquid in a tank, always rises evenly. But with prices, there is no such thing as a ((level." Prices do not change to the same extent at the same time. There are always prices that are changing more rapidly, ris ing or falling more rapidly than other prices. There is a reason for this. Early Beneficiaries Consider the case of the govern ment employee who received the new money added to the money sup ply. People do not buy today pre cisely the same commodities and in the same quantities as they did yes terday. The additional money which the government has printed and in troduced into the market is not used for the purchase of all commodities and services. It is used for the pur chase of certain commodities, the prices of which will rise, while other commodities will still remain at the prices that prevailed before the new money was put on the market.

Therefore, when inflation starts, dif ferent groups within the population are affected by this inflation, in dif ferent ways. Those groups who get the new money first, gain a tempo rary benefit. When the government. inflates in order to wage a war, it has to buy munitions, and the first to get the additional money are the munition industries and the workers within these industries. These groups are now in a very favorable position. They have higher profits and higher wages; their business is moving. Why? Because they were the first to receive the additional money. And having now more money at their disposal, they are buying. And they are buying from other people who are manufacturing and selling the commodities that these munition makers want. These other people form a second group. And this second group con siders inflation to be very good for business. Why not? Isn't it. wonder ful to sell more? For example, the owner of a restaurant in the neighborhood of a munitions factory says: ((It is really marvelous! The munition workers have more money; there are many more of them now than before; they are all patronizing my restaurant; I am very happy about it." He does not see any reason to feel otherwise.

The situation is this: those people 1980 INFLATION 155 to whom the money comes first now have a higher income, and they can still buy many commodities and ser vices at prices which correspond to the previous state of the market, to the condition that existed on the eve of inflation. Therefore, they are in a very favorable position. And thus inflation continues step by step, from one group of the population to another. And all those to whom the additional money comes at the early stage of inflation are benefited be cause they are buying some things at prices still corresponding to the previous stage of the exchange ratio between money and commodities. Others Must Lose But there are other groups in the population to whom this additional money comes much, much later. These people are in an unfavorable position. Before the additional money comes to them they are forced to pay higher prices than they paid before for some~r for practi cally all-of the commodities they wanted to purchase, while their in come has remained the same, or has not increased proportionately with prices.

Consider for instance a country like the United States during the Second World War; on the one hand, inflation at that time favored the munitions workers, the munition industries, the manufacturers of guns, while on the other hand it worked against other groups of the population. And the ones who suf fered the greatest disadvantages from inflation were the teachers and the ministers. As you know, a minister is a very modest person who serves God and must not talk too much about money. Teachers, likewise, are dedi cated persons who are supposed to think more about educating the young than about their salaries. Consequently, the teachers and ministers were among those who were most penalized by inflation, for the various schools and churches were the last to realize that they must raise salaries. When the church elders and the school corpo rations finally discovered that, after all one should also raise the salaries of those dedicated people, the earlier losses they had suffered still re mained.

For a long time, they had to buy less than they did before, to cut down their consumption of better and more expensive foods, and to restrict their purchase of cloth ing-because prices had already ad justed upward, while their income, their salaries, had not yet been raised. (This situation has changed considerably today, at least for teachers.) There are therefore always differ ent groups in the population being affected differently by inflation. For some of them, inflation is not so bad; 156 THE FREEMAN March they even ask for a continuation of it, because they are the first to profit from it. We will see, in the next lecture, how this unevenness in the consequences of inflation vitally af fects the politics that lead toward inflation. Under these changes brought about by inflation, we have groups who are favored and groups who are directly profiteering. I do not use the term ~(profiteering" as a reproach to these people, for if there is some one to blame, it is the government that established the inflation. And there are always people who favor inflation, because they realize what is going on sooner than other people do. Their special profits are due to the fact that there will necessarily be unevenness in the process of in flation.

Inflation as a Tax The government may think that inflationas a method of raising funds-is better than taxation, which is always unpopular and dif ficult. In many rich and great na tions, legislators have often dis cussed, for months and months, the various forms of new taxes that were necessary because the parliament had decided to increase expendi tures. Having discussed various methods of getting the money by taxation, they finally decided that perhaps it was better to do it by inflation. But of course, the word Hinflation" was not used. The politician in power who proceeds toward inflation does not announce: ~~I am proceeding to ward inflation." The technical methods employed to achieve the inflation are so complicated that the average citizen does not realize in flation has begun. During one of the biggest infla tions in history, in the German Reich after the First World War, the inflation was not so momentous dur ing the war. It was the inflation after the war that brought about the catastrophe. The government did not say: ~(We .are proceeding toward inflation." The government simply borrowed money very indirectly from the central bank. The govern ment did not have to ask how the central bank would find and deliver the money. The central bank simply printed it.

Today the techniques for inflation are complicated by the fact that there is checkbook money. It in volves another technique, but the result is the same. With the stroke of a pen, the government creates fiat money, thus increasing the quantity of money and credit. The govern ment simply issues the order, and the fiat money is there. The government does not care, at first, that some people will be losers, it does not care that prices will go up. The legislators say: ((This is a wonderful system!" But this wonder1980 INFLATION 157 ful system has one fundamental weakness: it cannot last. If inflation could go on forever, there would be no point in telling governments they should not inflate. But the certain fact about inflation is that, sooner or later, it must come to an end. It is a policy that cannot last. In the long run, inflation comes to an end with the breakdown of the currency-to a catastrophe, to a situation like the one in Germany in 1923. On August 1, 1914, the value of the dollar was four marks and twenty pfennigs. Nine years and three months later, in November 1923, the dollar was pegged at 4.2 trillion marks. In other words, the mark was worth nothing. It no longer had any value.

Some years ago, a famous author wrote: ~~In the long run we are all dead." This is certainly true, I am sorry to say. But the question is, how short or long will the short run be? In the eighteenth century there was a famous lady, Madame de Pom padour, who is credited with the dictum: ~~Apres nous Ie deluge" C~Af ter us will come the flood"). Madame de Pompadour was happy enough to die in the short run. But her succes sor in office, Madame du Barry, out lived the short run and was be headed in the long run. For many people the ~~long run" quickly becomes the ~~short run" -and the longer inflation goes on the sooner the Hshort run." How long can the short run last? How long can a central bank con tinue an inflation? Probably as long as people are convinced that the government, sooner or later, but cer tainly not too late, will stop printing money and thereby stop decreasing the value of each unit of money.

The Flight from Money When people no longer believe this, when they realize that the gov ernment will go on and on without any intention of stopping, then they begin to understand that prices to morrow will be higher than they are today. Then they begin buying at any price, causing prices to go up to such heights that the monetary sys tem breaks down. I refer to the case of Germany, which the whole world was watch ing. Many books have described the events of that time. (Although I am no German, but an Austrian, I saw everything from the inside: in Au stria, conditions were not very dif ferent from those in Germany; nor were they much different in many other European countries.) For sev eral years, the German people be lieved that their inflation was just a temporary affair, that it would soon come to an end. They believed it for almost nine years, until the summer of 1923. Then, finally, they began to doubt. As the inflation continued, people thought it wiser to buy every thing available, instead of keeping 158 THE FREEMAN March money in their pockets. Further more, they reasoned that one should not give loans of money, but on the contrary, that it was a very good idea to be a debtor. Thus inflation continued feeding on itself.

And it went on in Germany until exactly August 28, 1923. The masses had believed inflation money to be real money, but then they found out that conditions had changed. At the end of the German inflation, in the fall of 1923, the German fac tories paid their workers every morning in advance for the day. And the workingman who came to the factory with his wife, handed his wages-all the millions he got~ over to her immediately. And the lady immediately went to a shop to buy something, no matter what. She realized what most people knew at that time-that overnight, from one day to another, the mark lost 50% of its purchasing power. Money, like chocolate on a hot oven, was melting in the pockets of the people. This last phase of German inflation did not last long; after a few days, the whole nightmare was over: the mark was valueless and a new cur rency had to be established. Lord Keynes, the same man who said that in the long run we are all dead, was one of the long line of inflationist authors of the twentieth century. They all wrote against the gold standard. When Keynes at tacked the gold standard, he called it a Hbarbarous relic." And most people today consider it ridiculous to speak of a return to the gold stan dard. In the United States, for in stance, you are considered to be more or less a dreamer if you say: ((Sooner or later, the United States will have to return to the gold stan dard."

Yet the gold standard has one tremendous virtue: the quantity of the money supply, under the gold standard, is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against SPend thrift governments. If, under the gold standard, a government is asked to spend money for something new, the minister of finance can say: ((And where do I get the money? Tell me, first, how I will find the money for this additional expenditure." A Restraint on Spending Under an inflationary system, nothing is simpler for the politicians to do than to order the government printing office to provide as much money as they need for their projects. Under a gold standard, sound gov ernment has a much better chance; its leaders can say to the people and to the politicians: ((We can't do it unless we increase taxes." But under inflationary conditions, people acquire the habit of looking upon the government as an institu tion with limitless means at its dis1980 INFLATION 159 posal: the state, the government, can do anything. If, for instance, the nation wants a new highway sys tem, the government is eXPected to build it. But where will the govern ment get the money?

One could say that in the United States today-and even in the past, under McKinley-the Republican party was more or less in favor of sound money and of the gold stan dard, and the Democratic party was in favor of inflation. Of cours~ not a paper inflation, but of silver. It was, however, a Democratic president of the United States, Pres ident Cleveland, who at the end of the 1880s vetoed a decision of Con gress, to give a small sum-about $10,OOO-to help a community that had suffered some disaster. And President Cleveland justified his veto by writing: ((While it is the duty of the citizens to support the gov ernment, it is not the duty of the government to support the citizens." This is something which every statesman should write on the wall of his office to show to people who come asking for money. I am rather embarrassed by the necessity to simplify these problems. There are so many complex prob lems in the monetary system, and I would not have written volumes about them if they were as simple as I am describing them here. But the fundamentals are precisely these: if you increase the quantity of money, you bring about the lowering of the purchasing power of the monetary unit. This is what people whose pri vate affairs are unfavorably affected do not like. People who do not bene fit from inflation are the ones who complain.

A Worldwide Plague If inflation is bad and if people realize it, why has it become almost a way of life in all countries? Even some of the richest countries suffer from this disease. The United States today is certainly the richest coun try in the world, with the highest standard of living. But when you travel in the United States, you will discover that there is constant talk about inflation and about the neces sity to stop it. But they only talk; they do not act. To give you some facts: after the First World War, Great Britain re turned to the prewar gold parity of the pound. That is, it revalued the pound upward. This increased the purchasing power of every worker's wages. In an unhampered market the nominal money wage would have fallen to comPensate for this and the workers' real wage would not have suffered. We do not have time here to discuss the reasons for this. But the unions in Great Britain were unwilling to accept an adjust ment of wage rates to the higher purchasing power of the monetary unit, therefore real wages were 160 THE FREEMAN March raised considerably by this mone tary measure. This was a serious catastrophe for England, because Great Britain is a predominantly industrial country that has to im port its raw materials, half-finished goods, and food stuffs in order to live, and has to export manufac tured goods to pay for these imports.

With the rise in the international value of the pound, the price of British goods rose on foreign mar kets and sales and exports declined. Great Britain had, in effect, priced itself out of the world market. The unions could not be defeated. You know the power of a union to day. It has the right, practically the privilege, to resort to violence. And a union order is, therefore, let us say, not less important than a gov ernment decree. The government decree is an order for enforcement for which the enforcement ap paratus of the government-the police-is ready. You must obey the government decree, otherwise you will have difficulties with the police. The Impact of Unions Unfortunately, we have now, in almost all countries all over the world, a second power that is in a position to exercise force: the labor unions. The labor unions determine wages and the strikes to enforce them in the same way in which the government might decree a minimum wage rate. I will not discuss the union question now; I shall deal with it later. I only want to establish that it is the union policy to raise wage rates above the level they would have on an unhampered market. As a result, a considerable part of the potential labor force can be employed only by people or indus tries that are prepared to suffer losses. And, since businesses are not able to keep on suffering losses, they close their doors and people become unemployed. The setting of wage rates above the level they would have on the unhampered market always results in the unemployment of a considerable part of the poten tial labor force.

In Great Britain, the result of high wage rates enforced by the labor unions was lasting un employment, prolonged year after year. Millions of workers were un employed, production figures dropped. Even experts were perplexed. In this situation the British government made a move which it considered an indispensa ble, emergency measure: it devalued its currency. The result was that the purchas ing power of the money wages, upon which the unions had insisted, was no longer the same. The real wages, the commodity wages, were reduced. Now the worker could not buy as much as he had been able to buy before, even though the nominal wage rates remained the same. In 1980 INFLATION 161 this way, it was thought, real wage rates would return to free market levels and unemployment would disappear. This measure-devaluation-was adopted by various other countries, by France, the Netherlands, and Belgium. One country even resorted twice to this measure within a period of one year and a half. That country was Czechoslovakia. It was a surreptitious method, let us say, to thwart the power of the unions. You could not call it a real success, how ever.

Indexation After a few years, the people, the w.orkers, even the unions, began to understand what was going on. They came to realize that currency devaluation had reduced their real wages. The unions had the power to oppose this. In many countries they inserted a clause into wage con tracts providing that money wages must go up automatically with an increase in prices. This is called in dexing. .The unions became index conscious. So, this method of reduc ing unemployment that the gov ernment of Great Britain started in 1931-which was later adopted by almost all important govern ments-this method of ((solving unemployment" no longer works today. In 1936, in his General Theory of Employment, Interest and Money, Lord Keynes unfortunately elevated this method-those emergency mea sures of the period between 1929 and 1933-to a principle, to a fun damental system of policy. And he justified it by saying, in effect: ((Un employment is bad. If you want un employment to disappear you must inflate the currency."

He realized very well that wage rates can be too high for the market, that is, too high to make it profitable for an employer to increase his work force, thus too high from the point of view of the total 'working popula tion, for with wage rates imposed by unions above the market level, only a part of those anxious to earn wages can obtain jobs. And Keynes said, in effect: ((Cer tainly mass unemployment, pro longed year after year, is a very unsatisfactory condition." But in stead of suggesting that wage rates could and should be adjusted to market conditions, he said, in effect: ((If one devalues the currency and the workers are not clever enough to realize it, they will not offer resis tance against a drop in real wage rates, as long as nominal wage rates remain the same." In other words, Lord Keynes was saying that if a man gets the·same amount of ster ling today as he got before the cur rency was devalued, he will not realize that he is, in fact, now get ting less.

In old fashioned language, Keynes proposed cheating the workers. In162 THE FREEMAN March stead of declaring openly that wage rates must be adjusted to the condi tions of the market-because, ifthey are not, a part of the labor force will inevitably remain unemployed-he said, in effect: ((Full employment can be reached only if you have infla tion. Cheat the workers." The most interesting fact, however, is that when his General Theory was pub lished, it was no -longer possible to cheat, because people had already become index conscious. But the goal of full employment remained. Full Employment What does Hfull employment" mean? It has to do with the unham pered labor market, which is not manipulated by the unions or by the government. On this market, wage rates for every type of labor tend to reach a level where everybody who wants a job can get one and every employer can hire as many workers as he needs. If there is an increase in the demand for labor, the wage rate will tend to be greater, and if fewer workers are needed, the wage rate will tend to fall.

The only method by which a Hfull employment" situation can be brought about is by the mainte nance of an unhampered labor mar ket. This is valid for every ·kind of labor and for every kind of commod ity. What does a businessman do who wants to sell a commodity for five dollars a unit? When he cannot sell it at that price, the technical busi ness expression in the United States is, ((the inventory does not move." But it must move. He cannot retain things because he must buy some thing new; fashions are changing. So he sells at a lower price. If he cannot sell the merchandise at five dollars, he must sell it at four. If he cannot sell it at four, he must sell it at three. There is no other choice as long as he stays in business. He may suffer losses, but these losses are due to the fact that his anticipation of the market for his product was wrong. It is the same with the thousands and thousands of young people who come every day from the agricul tural districts into the city, trying to earn money. It happens so in every industrial nation. In the United States they come to town with the idea that they should get, say, a hundred dollars a week. This may be impossible. So if a man cannot get a job for a hundred dollars a week, he must try to get a job for ninety or eighty dollars, and perhaps even less. But if he were to say-as the unions do- ((one hundred dollars a week or nothing," then he might have to remain unemployed. (Many do not mind being unemployed, be cause the government pays un employment benefits-out of special taxes levied on the employers which are sometimes nearly as high 1980 INFLATION 163 as the wages the man would receive if he were employed.) Because a certain group of people believes that full employment can be attained only by inflation, infla tion is accepted in the United States.

But people are discussing the ques tion: Should we have a sound cur rency with unemployment, or infla tion with full employment? This is in fact a very vicious analysis. Clarifying the Problem To deal with this problem we must raise the question: How can one im prove the condition of the workers and of all other groups of the popula tion? The answer is: by maintaining an unhampered labor market and thus achieving full employment. Our dilemma is, shall the market determine wage rates or shall they be determined by union pressure and compulsion? The dilemma is not ((shall we have inflation or un employment?" This mistaken analysis of the problem is argued in England, in European industrial countries and even in the United States. And some people say: HNow look, even the United States is inflating. Why should we not do it also." To these people one should answer first of all: HOne of the privileges of a rich man is that he can afford to be foolish much longer than a poor man." And this is the situation of the United States. The financial policy of the United States is very bad and is getting worse. Perhaps the United States can afford to be foolish a bit longer than some other countries.

The most important thing to re member is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a dis ease that comes like a plague. Infla tion is a policy -a deliberate policy of people who resort to inflation be cause they consider it to be a lesser evil than unemployment. But the fact is that, in the not very long run, inflation does not cure unemploy ment. Inflation is a policy. And a policy can be changed. Therefore, there is no reason to give in to inflation. If one regards inflation as an evil, then one has to stop inflating. One has to balance the budget of the govern ment. Of course, public opinion must support this; the intellectuals must help the people to understand. Given the support of public opinion, it is certainly possible for the peo ple's elected representatives to abandon the policy of inflation. We must remember that, in the long run, we may all be dead and certainly will be dead. But we should arrange our earthly affairs, for the short run in which we have to live, in the best possible way. And one of the measures necessary for this purpose is to abandon inflation ary policies. @ Donald L. Kemmerer THE ROTTING FABRIC OF TRUST 164 As we drove from New Delhi to Agra to see India's famous Taj Mahal, we passed through extremely primitive villages. There was not a petrol can, broken umbrella or empty bottle to be seen. We thought, HPerhaps a Time Machine has carried us back 1000 years or more." In one dusty hamlet we saw an Indian woman wearing a crude anklet of silver. The reason for this abysmal squalor struck us. That silver was all her savings and no one was going to take it from her. She didn't trust her neighbors and they didn't trust any one either. There could be no banks, and businessmen found it almost impossible to borrow. Progress was at a standstill and had been for centuries because an all-important ingredient was missing in that economy, the fabric of trust between men, that enables them to work to gether willingly toward productive ends.