The Tragedy of Inflation; B. B. Greaves

However, most who deplore it think of it simply as rising prices. But prices of goods and services may rise for many reasons: shortages due to destruction by pests, drought, flood, or increased demands when fashions change or a war breaks out. Thus, to define inflation as rising prices is far from helpful. In fact, it leads to se rious error by directing attention to individuals who raise specific prices (businessmen) and wages (workers). This definition of inflation ne glects the real cause ofgenerally ris ing prices-an increase in the quan tity of money and/or credit. Once inflation is defined as monetary ex pansion, it becomes clear that only Mrs. Greaves is a member of the staff of The Founda tion for Economic Education. A longtime student of Professor Ludwig von Mises, she translated from the German several Of his' essays on monetary theory, published in 1978 as On the Manipulation of Money and Credit.

598 the government and government privileged banks can be responsible. Only they may print money and/or create new dollar credit. Anyone else who tried to do so would be branded a counterfeiter. Inflation, by which we mean mon etary expansion, may proceed in several ways. The government may spend more money than it collects in taxes or borrows from individuals, filling the deficit (a) by printing pa per money, or (b) by borrowing, through the Federal Reserve Bank ing system, new money or bank credit created by the "Fed" for this express purpose. With the sanction, active encour agement and protection of govern ment, private commercial banks may also increase the quantity of money by lending many times as much as the sums deposited by their cus tomers in checking accounts. ComTHE TRAGEDY OF INFLATION 599 mercial and savings banks are also able to expand the quantity of money and credit by an even greater ratio on the basis of savings and time de posits. Thus, the creation of new money, permitted and encouraged by government and government promoted Federal Reserve policy, builds on itself and the number of dollars snowballs. Only by defining inflation as monetary expansion may we understand its more complex and.

far-ranging consequences. A great deal has been written about the pressures produced on prices by a monetary expansion, shoving prices inevitably upward in an irregular and ragged fashion. Some prices are affected sooner, oth ers later, some more, others less. Prices are not all affected equally, or proportionately to the monetary expansion. Because the effect of in flation on prices is uneven, its other consequences are serious, long-last ing and irreversible. It is these other consequences of inflation which we shall be considering here, conse quences which make conditions worse, even from the point of view of the backers of the programs result ing in monetary expansion. Some Win: Others Lose There is no way to issue new dol lars or bank credit so that everyone will benefit equally and simultane ously. Some politically favored per sons always receive the newly-created money and bank credit sooner than others. Having more money gives these people a decided advan tage in making purchases. They may buy more than they could have be fore. Or they may offer higher prices for what they want. Thus they can outbid other would-be purchasers who find less in the stores to buy at previously prevailing prices. Stocks of what the other would-be buyers would have purchased have been bought up by the new dollar holders.

In this way, the first recipients of the new money "win," but always at the expense of others. In time the new money will work its way through the market, from the first beneficiaries to those from whom they buy-merchants, sup pliers, and so on-as each in turn receives some of the new dollars. But at each step in this sequence of transactions the advantage of hav ing more dollars sooner than others is watered down a bit. Many who re ceive some of the new money much later will find they must pay higher prices without higher incomes. Thus inevitably those who receive some of the new money considerably later, or receive none at all, will lose. Each transfer of dollars repre sents an irreversible shift of goods, services, wealth and income. The "winners" gain at the permanent expense of the "losers." Although the losers are never easy to identify, their loss is real enough. They must 600 THE FREEMAN October struggle to adjust to a market in which the things they want are in creasingly scarce and more expen sive. Circumstances will change, of course. Attempts may be made to re verse the respective roles of "win ners" and "losers." But compensa tion after the fact can never undo the harm done earlier. It can only set in operation a similar sequence of uneven, irregular and ragged price shifts, creating different winners and losers.

Illusory Profits Anyone whose selling prices are boosted by the issue of new dollars receives an unanticipated surplus. He gains due to the inflation. But this gain may not be a real gain. His increased income pushes him into a higher tax bracket. Then govern ment promptly takes a greater por tion than before. He may also have to pay higher prices to replace mer chandise bought by the inflation created "winners." In anticipation of increased sales, merchants may order more of the particular items the new dollar holders are demanding. To fill these bigger orders, suppliers must also change their plans. To speed up or expand production of these particu lar commodities, they will have to offer more money to workers and to the owners of needed resources. Thus, the new dollars are passed further along throughout the economy, pushing up one wage here, another there, one price here, another there, and so on, adding to business costs along the line and reducing the gain merchants, suppliers and producers had received from the inflation and on which they had paid taxes.

As a result of the inflation, enter prisers will also discover that the funds set aside for depreciation are insufficient to replace their equip ment when it is worn out. With prices rising throughout the economy, new plants and new machinery, like al most everything else, cost more than before. Funds just aren't available for replacing them. If enterprisers are to continue operating, they must buy their new equipment out of ei ther (a) current income or (b) bor rowed funds. If they supplement in sufficient depreciation allowances from current income, they will be using funds they should be accumu lating to maintain their investment in the future, thus putting their en terprise in jeopardy. If they borrow additional funds from the banks, they will be helping to push interest rates up, thus increasing their business costs still more and further reducing their gain. In time, what looks like an enter priser's gain in dollar terms may be no gain at all. Receipts that seem exceptionally high in depreciating dollars are thus deceptive. It is ex tremely difficult to keep operating and maintain a profitable business 1981 THE TRAGEDY OF INFLATION 601 during an inflation. If enterprisers fail to recognize that a dollar profit may be an illusory profit, if they fail to take this into consideration in planning, calculating and allowing for depreciation, they will soon suf fer losses that are not illusory but real! Yet through it all their books could still show dollar "profits," de ceiving them into believing their enterprises are financially sound.

"Illusory profits" may easily lure them into spending more than they can afford and consuming capital they cannot replace. Thus "profits" in terms of inflation-depreciated dollars mislead many an enterprise past the point of no return, down the road to bankruptcy. Production Patterns Shifted The new dollar holders spend their money for whatever they want most. If the new money goes first as bene fits to unemployed workers or wel fare recipients for instance, or as higher salaries to government em ployees, teachers, postmen, soldiers, and so on, it will probably be spent on consumer goods. If the new money goes first as loans to new car buyers and home owners, it will be trans ferred to car salesmen, automobile workers, carpenters, electricians, and the like. If the new money goes first as bank credit to producers-build ers, farmers, ship owners, automo bile manufacturers, producers of military weapons, owners of radio and TV stations, and so on-it will probably go next to those who build tools, machines, factories, electronic equipment, and the like, and then later to those who extract and trans port raw materials and other re sources.

In any event, those who sell to the "winners" promptly enjoy an unex pected "boom" in that phase of their business. When they place orders with their suppliers to refill ex hausted inventories of those partic ular items, the pattern of production starts to shift-toward producing more of the things requested by the new dollar spenders and less of what was being produced before. Step by step, producers respond to the de mands of the new dollar holders and those who receive the new dollars. As resources, capital, labor and energy shift production to satisfy the demands of the inflation "winners," the wants of the inflation "losers" are neglected. Those who receive none of the new money, or do not receive any until much later, are at a serious disadvantage in making purchases. They find in the stores fewer of the things they want to buy, because the "winners" bought more; they also find that prices are higher though their incomes are not. More over, the resources, capital, labor and energy which were used in pro ducing for the politically-favored "winners" are no longer available, having been transformed into spe602 THE FREEMAN October cialized tools and machines for sup plying an artificial, government subsidized market.

Malinvestment If the monetary expansion is not halted, enterprisers will continue making adjustments to serve the consumer wants of new dollar hold ers. Some enterprisers will tum next to making tools and machines for their production and others will seek to expand the supplies of the needed raw materials. Under our monetary system, the banks are encouraged by government policy to supply a large part of the funds needed to make shifts in production possible. They issue new credit through bank loans, creating additional dollars in the process, enabling the favored borrowers to spend more than be fore. But no more resources are available. The borrowers of the new credit must compete with other en terprisers for the available supplies. They soon discover that to hire ad ditional workers and to buy more raw materials and tools and ma chines for their new projects, they must offer higher prices. Thus as they seek to fulfill their plans, they help to pass the new dollars along in the form of rising prices. In time the patterns of prices and of production will deviate more and more from what they would have been in the absence of inflation.

In this world of ours, change is inevitable. It is the role of enterprisers to watch the market closely and to try to adjust to new conditions. If they succeed they make profits; if they fail, losses. What people are buying and refusing to buy at var ious prices gives producers and would-be producers important clues as to what to make and how much to make. Clusters of Errors Enterprisers sometimes misjudge the market and miscalculate con sumer wants. On a free market, the mistakes of some enterprisers are usually counteracted, at least in part, by the correct judgments and suc cessful calculations of others. But when government is introducing new dollars and/or encouraging the banks to expand credit, most enterprisers are influenced by the same mislead ing factor-the expectation of con tinuing monetary expansion. Many enterprisers, misled by the infla tion, shift production in the same di rection. "Clusters of errors" appear.

Throughout the monetary expan sion, producers are committing themselves and their resources more and more irretrievably to their var ious projects. Their investments be come more specialized and less eas ily convertible to other uses. The longer the monetary expansion con tinues the greater the deviation from free market production and the more malinvestment occurs.

1981 THE TRAGEDY OF INFLATION 603 Inflation-instigated markets are notoriously unreliable. Government policy inevitably vacillates in re sponse to the changing political cli mate. Without warning, the quan tity of money and credit may be increased or decreased-political fa vors shifted. Once the flow of new dollars and/or cheap credit declines or is halted, inflation-induced de mands cannot be sustained. At one moment enterprisers are spurred to expand production in one direction. Then a shift in government policy leads unexpectedly to a drop in de mand for their products. The market on which they had counted declines or disappears. They have produced too much of some things, not enough of others. Mountainsof Waste When the inflation is slowed down or stopped, some consumer goods produced but not yet consumed may be sold to other customers. But many of the items intended for previously subsidized consumers cannot be sold for more than their inflation-boosted costs. Factories, tools and machines, which cannot be converted to other uses, will be abandoned. Thus, the sooner inflation can be stopped the better, for the longer it continues, misdirecting production, the more resources will have been wasted and lost to future generations.

The vacillations of government intervention exaggerate the uncertainties of doing business. As the money spigot is turned on at one moment and off the next, many en terprisers swing back and forth be tween eagerness and reluctance in making commitments. In this way, the stops/goes, ons/offs of govern ment interference lead in time to the ups and downs of business, the boomlbust sequence of the "trade cycle." However, economic suffering can not be avoided by continuing to in flate. For if monetary expansion is not halted, it must lead in time to a complete breakdown of the money and the market. If the inflation goes on until the monetary unit becomes worthless, business will come to a standstill. With no reliable medium of exchange, no trades except simple barter deals can be made. Inflation induced investments will fall into unemployment or serious under employment. Economic calcula tions, contractual agreements and production plans of any complexity will become impossible. Even those who, with the best of intentions, ad vocated the government programs that led to inflation must consider such conditions worse than those they were trying to improve.

Saving Discouraged Saving is the principal source of increasing production. Only as peo ple save can they have spare time and energy to devote to pleasure, 604 THE FREEMAN October learning new skills or developing and improving their tools, so as to be able to produce and have more tomorrow. It is out of savings that students may eat while acquiring knowledge and new skills. It is out of savings that inventors may live while devoting time to developing and producing new tools. It is out of savings too that workers and inves tors may survive while producing things for others to consume. Most of what we have and enjoy in the world today-the many mod ern conveniences, complex tools and machines, remarkably efficient means of transportation, specialized electronic equipment, almost mirac ulous medical developments, and so on-we owe to past savers who set something aside out of what they produced and invested it in produc tion. Thus our ancestors contributed to present day living standards.

Our ancestors saved out of the de sire to try to improve their produc tivity, to become financially inde pendent and beholden to no one, to provide for themselves in old age, to care for their families in emergen cies and to improve conditions for their children and their children's children. The greater their confi dence that savings and property would be fairly safe, the more incen tive they had to forgo some immedi ate consumption for the sake of their own and their families' future wel fare. Their savings and investments also helped support others while learning new skills, developing new technologies, inventing new ma chines and producing new factories. Thus their savings and investments are still contributing to our welfare today. But our living standards are now in jeopardy. To meet the rising costs of government's rapidly increasing handouts, it increased taxes and re sorted to inflation, both of which dis courage saving. Fearful of losing their property and savings through inflation, producers have little in centive to save and invest in produc tion. With less saved and invested, less is produced. With less produced, there is less to consume or to save and to invest. With less saved and invested today, there will be less for future generations to enjoy tomor row.

Conclusion: Prolonged Inflation Means EconomicDisaster In summary, generally rising prices are one consequence of infla tion, but by no means the most seri ous. Monetary expansion's other consequences are more destructive, long-lasting and irreversible. It leads to injustices. Some persons "win" at the expense of others who "lose," never to be fully compensated for their inflation losses. Production is misdirected so that scarce resources are wasted on unwanted enter prises. "Illusory profits" deceive pro1981 THE TRAGEDY OF INFLATION 605 ducers into economic miscalcula tions, malinvestments and capital consumption, often placing their op erations in jeopardy and perhaps forcing them into bankruptcy. Infla tion adds to the uncertainties of doing business. Expansionist monetary policy is to blame for fostering un healthy economic booms based on artificially stimulated malinvest ments.

When political policies shift, arti ficial boom turns to economic bust with widespread economic losses and unemployment. Future generations will be poorer because inflation and credit expansion are discouraging saving and investment today. Infla tion and credit expansion also dis courage respect for private property, individual effort and family respon sibility. Why work for a living if the government is handing out benefits? Why save if every dollar loses pur chasing power from day to day? Why invest in production if earnings are penalized by steeply rising taxes? Why strive for economic and family independence if there is no disgrace in benefiting from the wealth of others, taken from them by force through taxes and inflation? Many malinvestments undoubt edly exist today due to past mone tary expansion. However, the economic suffering such malinvestments bring about could be kept to the minimum if government were to re nounce all further inflation and credit expansion immediately, not just try to slow them down. Left to their own devices, enterprisers would find ways in time to absorb and/or pass over and beyond most past losses and malinvestments. Confident that their economic calculations would not be upset by a depreciating cur rency, erratically rising prices and illusory profits, they could return to producing goods and services for a non-artificial market. They would then be willing once more to save and invest, thus improving condi tions for themselves, their families and future generations.

But if government continues to of fer benefits to some at the expense of others, financing them through higher taxes and monetary expan sion, serious economic disaster must be expected. New evidence will then demonstrate once more the truth of Ludwig von Mises' statement that government interference with the economy, no matter how well inten tioned, "produces results contrary to its purpose, that it makes conditions worse, not better, from the point of view of the government and those backing its interference." @ Dwight R. Lee THE BLUE WHALE is being driven to ward extinction and the federal gov ernment is spending far too much of our nation's wealth. The connection between these two problems may not be immediately obvious. But if you believe that blue whales have been slaughtered excessively (and they have), then logic also compels you to see the need to limit the growth in government. Too many blue whales have been killed and the govern ment has grown too large because both the blue whale and the govern ment provide opportunities for some people to receive benefits by impos ing costs on others.