Some Evils of Inflation; H. Sennholz

scures economic reality, pointing at the visible effects of inflation and its victims; it does not call attention to the essence of inflation, the inflating of the money quantity. The popular confusion about the meaning of inflation is more than just unfamiliarity with definition. It is a root cause of inflation itself with out which it could not persist. It com pletely reverses cause-and-effect re lationships and thereby indicts the victims for perpetrating the crime while it exculpates the monetary au thorities who willfully and openly are creating ever more money. Thought makes the word, and the word makes thought. Inflation breeds great evil, whether you de fine it as rising goods prices, as an increase in available currency and credit, or as an abnormal increase beyond available goods, resulting in a visible rise in prices. Of all injus tice, inflation is one of the greatest as it devours the possessions of mil lions of hardworking people. And no 283 284 THE FREEMAN May matter who is perpetrating it, the courts of law actively collaborate with the perpetrators by upholding the evil and declaring it constitu tional, equitable and fair. A dollar is a dollar, they proclaim, you shall ac cept a lO-cent dollar in payment of a lOO-cent debt.

Political Injustice It is easier to endure the losses that are suffered as a result of error and misjudgment than the damage sustained by injustice. Inflation ministers unbearable injustice, de frauding some people and enriching others. It impoverishes some social classes while it bestows comfort and wealth on others. There cannot· be any doubt that inflation derives aid and comfort from its many beneficiaries. Political injustice is committed from a great many motives and rea sons and often makes use of legis lation that goes under the name of legal tender, a perfectly innocent la bel for hideous wrongs. It appears to be harmless, indeed, when defined as "a currency which may be law fully tendered and offered in pay ment of money debts and which may not be refused by creditors." In real ity, legal tender is no offer at all, but a forced acceptance, no tender that may be freely refused, but a legal ob ligation to accept a currency no mat ter how much its purchasing power has fallen or is expected to fall. Legal tender actually denies the free dom of contract and the right to re fuse acceptance of deteriorated means of payment.

Legal tender legislation grants government unlimited power over the monetary affairs of the people just as the coinage monopoly of the state did in antiquity and the feu dalization of the coinage right dur ing the Middle Ages. It creates this power in democratic societies as it does in the command societies under socialism and communism. Govern ment, by way of legal tender legis lation, forces people to accept its own currency, grants it monopolistic po sition, and prohibits its discount no matter how it may depreciate. In short, legal tender legislation out laws monetary freedom and paves the way for great injustice. It is difficult to fathom anything more unjust than legal tender leg islation. It permits monetary au thorities to inflate and depreciate their money and then force the peo ple to accept it at face value and in full payment. It gives special privi lege not only to the government but also to all debtors. They need not pay their debts in full but can discharge them by giving inferior money in ex change. Legal tender destroys the property rights of creditors. Under the pretense of creating order and stability, it turns every credit trans action into speculation on the future purchasing power of the medium of 1985 SOME EVILS OF INFLATION 285 payment. It is immoral to the high est degree.

Legal tender legislation permits government to tax its people without having to seek their consent first. It enables government to issue any quantity of fiat money, declare it le gal tender, and spend it for political ends. It is a tool of expropriation of property owners and creditors, in cluding all sellers of goods, services and labor. It forces them to accept le gal tender currency at face value no matter how much it has deteriorated and how low its purchasing power has fallen. The legal tender evil has come to the U.S. through both legislation and jurisdiction. Under the plea of ab solute necessity, the Continental Dollar was made legal tender in 1776 until its demise in March of 178l. During the Civil War, Union green backs were given legal tender force. In 1933 all Federal Reserve notes and U.S. Treasury currency were given coercive powers. In every case the courts sanctioned the action and ignored the evils. The U.S. Supreme Court confirmed the monetary pow ers of government in a number of conspicuous decisions. From John Marshall, Chief Justice for 35 years (1801-1835), to Charles Evans Hughes, Chief Justice during Pres ident Roosevelt's monetary mach inations, most justices made the best of government control over the peo ple's money. On June 5, 1933, a Joint Congressional Resolution voided the "gold clause" in all contracts and ob ligations. In 1935 the Supreme Court concurred. In the words of Chief Jus tice Hughes, "parties cannot remove their transactions from the reach of dominant constitutional power."

(Henry Mark Holzer, Government's Money Monopoly, New York: Books in Focus, 1981, p. 185.) Unearned Income and Loss Inflation causes displacements in the distribution of income and prop erty. As lenders and borrowers, most people do not take into account var iations in the objective exchange value of money. If the monetary value should decline, the lenders are bound to suffer losses in purchasing power while the borrowers gain a corresponding amount. There are longterm contracts that do not have to be fulfilled until a later point in time. There are longterm employ ment contracts or contracts for the supply of materials, all of which in volve money payments over time. They all face inflationary risks. It is a popular, although erro neous, belief that inflation affects only wealthy individuals because they are said to be the money lend ers. This may have been true during the Middle Ages when economic wealth was concentrated with a few wealthy noblemen and merchants, while the masses of people were struggling for mere survival. But 286 THE FREEMAN May ever since the nations of the West emerged from feudalism and mer cantilism, and tried individual free dom and enterprise, an ever-growing number of people were able to save some part of their rising incomes, permitting most people to become lenders on net balance. There are millions of creditors of life insurance companies, pension funds, savings banks, and similar institutions. Mil lions of people own government sav ings bonds and other money assets.

It is true, they may have charge ac counts and other consumer debt. But in most cases savings probably ex ceed obligations, which suggests the conclusion that the American people are vitally interested in sound money. The disastrous nature of inflation becomes apparent when we contem plate the magnitude of the losses which inflation is inflicting on mil lions of American creditors every year. Even at the modest rate of five per cent annual depreciation, the an nuallosses to creditors and gains to debtors amount to more than $100 billion a year. The economic and psy chological impact of this silent transfer of wealth on millions of in dividuals surpasses all imagination. Considering such staggering losses on the part of the thrifty and prov ident, the rising clamor for entitle ment and transfer is not surprising. The losses strengthen the demand for social security, aged health care, and governmental controls over prices and rents. They foster Federal aid and subsidies and otherwise pro vide a chief argument for an exten sion of government power.

LongTerm Contracts Longterm employment contracts permit inflation to inflict painful losses on millions of working people. Within a few years of employment they may lose a part of their pur chasing-power income through mon etary depreciation. Their relative economic and social position in so ciety may decline when inflation ravishes them more than others. There cannot be any ~ doubt that teachers, ministers, priests, and rab bis are primary victims of inflation. But they also are thought leaders who significantly affect the moral, political and economic trends of the future. Their losses in income and social position during the age of in flation may have contributed to the fact that many are more frustrated in political and economic outlook than other groups of society. Monetary depreciation inflicts spe ciallosses also on industries that are controlled politically, in particular, public utilities. Being subject to commission control, their rates are fixed by decree in accordance with authoritative judgments of fairness and adequacy; but their costs keep on rising in reaction to inflationary pressures. American railroads and 1985 SOME EVILS OF INFLATION 287 public utilities are eminent exam ples. In competition with other in dustries for capital, labor and sup plies, their costs are rising; but their own rates are determined by govern ment committees and commissions that are known to grant relief only after lengthy public hearings and long after inflation has raised pro duction costs. Moreover, public au thorities are tempted to "fight" in flation and "hold the line" by denying price adjustments. Squeezed by the vise of rising costs and rigid rates, the financial position of public utilities deteriorates considerably. In the end they stagnate and cease to function efficiently.

Booms and Busts It is the course of every evil that it brings forth more evil. Unbeknown to most people, including most econ omists, inflation breeds business cycles with destructive booms and depressions. Indeed, what has been more damaging to individual free dom and the enterprise system than the recurrence of recessions and depressions! During the Great Depression government interven tionism made its greatest strides. Each new recession gives new im petus to political power. Inflation at first produces condi tions that appear favorable to every one. Businessmen earn extraordi nary profits; there are few, if any, business failures. Employment conditions improve and wage rates rise, for which labor unions and allied politicians loudly claim credit. The general atmosphere is one of confi dence and prosperity until the infla tion-induced activity tends to raise business costs. In time costs soar un til profits turn into losses and a recession takes the place ofthe boom.

Recession is a time for readjust ment to the demands of the market. Loss-inflicting operations are aban doned, and business costs are re duced. Businessmen correct their mistakes made during the boom; the worst offenders are forced to sell out or face liquidation and bankruptcy. Even labor may need to readjust to market demands or face unemploy ment. In short, a recession or depres sion is a time of recovery from the excesses and blunders of the boom. Business cycles have plagued this country from its beginning. In every cycle the U.S. government tried its hand in money and banking. Whether the debauchery of the Con tinental Dollar by the Continental Congress, the issue of U.S. Treasury obligations during the British American War and the Civil War, the financial adventures of the First and Second Banks of the United States, the silver legislation, the World War I inflation-they all con stituted preludes for the depressions that followed. Similarly, the Great Depression had its beginnings in the bursts of credit expansion by the 288 THE FREEMAN May Federal Reserve System in 1924-25 and again in 1927-28. Without them there could have been no stock mar ket boom and no crash of October 24, 1929. Since World War II, Federal Reserve credit expansion kindled seven booms and seven recessions.

Full employment through deficit spending and currency expansion is the official doctrine that guides the economic policies of Federal Admin istrations. Whether it is deficit fi nancing or easy bank credit, the ul timate consequences are always the same. But each depression is bound to be deeper and more painful than the preceding one, and each boom more feverish than the preceding boom, because maladjustment, if not corrected, is cumulative. Recessions turn into depressions and booms into "crack-up booms" with panicky flights into gold and other real val ues. In the end, booms and depres sions become "stagflations" that combine both evils: the destruction of currency and the depression with mass unemployment. Rising Tax Exactions The federal government is the greatest beneficiary of inflation; pol iticians, government officials and their proteges its greatest profiteers. When inflation raises money in comes it lifts taxpayers into pro gressively higher income tax brack ets and thus allocates an increasing share of their incomes to governmente It pushes them all toward the top rate. Similarly, it boosts govern ment exactions through state and lo cal income taxes, corporate income taxes, estate taxes, and other levies with progression features.

Business income and taxation are especially affected by monetary de preciation. When prices rise, a dis tortion in profits takes place. They are made to appear larger than they actually are. Inflation drives the cost of replacing plant and equipment above the original cost, but for tax purposes government recognizes only the original costs and thus forces business to overstate its ac tual earnings. It levies income taxes on imaginary profits which, in real ity, are inflationary costs of maintenance. The great popularity of inflation rests on its benefits to government. The federal government as a giant debtor reaps vast fortunes from mon etary depreciation. On its nearly two-trillion-dollar debt it reaps gains of tens of billions of dollars every year. It may add new debt through budgetary deficits, and yet, the mountain of debt, in terms of pur chasing power, may not rise at all be cause inflation may melt it away even faster.

In a modern transfer system gov ernment exists for the purpose of promoting the prosperity of those who run it-politicians and officials. Inflation permits them to spend vast 1985 SOME EVILS OF INFLATION 289 amounts that directly and indirectly benefit them. Their remuneration usually exceeds the amount they can earn in productive employment., Their perks and fringes are much to be desired, their power over others to be feared. In order to secure their benefits and sustain their power, they need the votes of their constit uents. Multibillion-dollar expendi tures for group entitlements may buy the votes. And the power to buy votes with entitlement legislation depends on their power to inflate. Without it, a Federal deficit of $200 billion annually would be inconceiv able, as would be the myriad of transfer programs and the huge bu rea ucracy administering the pro grams. The transfer state builds on the power to tax and to inflate, the effects of which in turn give rise to ever more transfer demands.

The Dollar Standard Inflation creates problems not only at home but also abroad. Until 1971, when gold was the international money and the U.S. dollar was pay able in gold, inflation generally caused an outflow of gold from the country with the highest rate of in flation. Threatening inability to pay in gold tended to restrain the coun try from inflating any further, or force it to devalue its currency to ward gold. But in 1971, the United States refused to honor its growing foreign obligations to redeem its currency in gold. Fearing more losses, President Nixon declared gold to be "unsuited for use as money," and vowed to remove gold from the mon etary system of the world. When other major countries followed suit the transition from the traditional gold standard to irredeemable paper issues was completed. -. The U.S. dollar emerged as the pri mary international currency serv ing trade and commerce the world over. It already had acquired a lead ing position under the Bretton Woods system that had made the U.S. dollar the international reserve money payable in gold at a price of $35 per ounce. When, in August 1971, President Nixon repudiated the agreement the world continued to use the U.S. dollar without its re deemability. After all, the world's merchants and bankers had grown accustomed to it. It afforded access to the markets of the most produc tive country in the world, and its record of relative stability was one of the best in recent monetary his tory despite its devaluations in 1934 and 1971. But above all, the official repudiation of gold created a void which no other fiat currency could possibly fill. It left the U.S. dollar in the most prominent position for be coming the world medium of ex change and reserve asset.

The world desperately needs a common money that facilitates for eign trade and international trans290 THE FREEMAN May actions. For hundreds of years gold served as the universal money unit ing the world in peaceful coopera tion and trade. Today the U.S. dollar is called upon to assume the very functions of gold. But in contrast to the gold standard, which was rather independent of anyone government, the dollar standard depends com pletely upon the wisdom and discre tion of the U.S. government. That is, the world monetary standard now rests solely on the political forces that shape the monetary policies of a single country-the United States. We can think of no greater respon sibility for any country than that of the United States to the world. Every day assumes a fearful responsibility when we view the fate of the free world that rests on the U.S. But un fortunately, the dollar standard is a political standard in which the pur est motives are mixed with the most sordid interests and fiercest passions of the electorate. The dollar stan dard itself is the outgrowth of an ide ology that placed government in charge of the national monetary or der. It is the handiwork of govern ments and their apparatus of poli tics. To expect much of such a creation is to invite bitter disappointment.

The world fiat standard leads to temptations which no contemporary government can be expected to re sist. The world demand for a reserve currency constitutes an extraordinary demand that tends to support and strengthen its purchasing power. It affords the country of issue a rare opportunity to inflate its cur rency and export its inflation with out immediately suffering the dire consequences of currency debase ment. In particular, it presents an opportunity to the administration in power to indulge in massive deficit spending, which hopefully bolsters its popularity with the electorate, while its inflation is exported to all corners of the world. The country that provides the world reserve asset can, for a while, live comfortably be yond its means, enjoy massive im ports from abroad while it is export ing its newly created money in payment of such imports. In short, it can raise its level of living at the ex pense of the rest of the world.

Government as Beneficiary For more than a decade the U.S. government has been the benefi ciary of this ominous situation. It en gages in massive deficit spending and currency expansion with mini mal inflationary effects as the dollar inflation is exported to foreign coun tries. For several years the foreign dollar holders even financed most of the budgetary deficits which the U.S. government was incurring. Inevita bly they suffered staggering losses on their dollar holdings which they had earned in exchange for real wealth. And yet, they are coming 1985 SOME EVILS OF INFLATION 291 back again and again because their own currencies are worse than the U.S. dollar. The greatest factor of dollar strength is the chronic weakness of other currencies. Leading European. currencies do poorly in foreign ex change markets because their banks of issue are pursuing policies of easy money and credit. European central banks are undermining confidence in European currencies and thereby generating an extraordinary de mand for U.S. dollars.

The exchange rate between var ious currencies is determined by their purchasing power .. It is ex plained by the purchasing-power parity theory, according to which the rate of exchange between currencies tends to adjust to their purchasing powers. If the exchange rate were to deviate from parity and a discrep ancy were to appear, it would be come profitable to buy one and sell the other until the discrepancy would disappear. If the exchange rate of the U.S. dollar versus the _Swiss franc were to favor the U.S. dollar it would be profitable to sell the dollar and buy the franc until the disparity would disappear. Foreign-exchange rate changes anticipate relative changes in goods prices. But it is safe to assume that a rise in foreign exchange rates is unlikely to signal an anticipated rise in purchasing power. After all, in this age of inflation every currency is losing purchasing power most of the time. "Strength" in foreign ex change rates merely means relative strength in terms of other currencies that are losing purchasing power even faster. The U.S. dollar may be the strongest currency around al though it, too, is losing purchasing power. It may rise to spectacular heights versus other currencies al though it is sinking to new lows in purchasing power.

Exporting Inflation Foreign inflation is giving the dol lar a boost; every foreign attempt at prosperity through credit expansion is giving it new strength. On the other hand, every U.S. government effort at expansion is sapping the dollar strength, every new attempt at financial stimulation through Federal Reserve credit expansion is weakening the dollar vis-a-vis all other currencies. U.S. monetary authorities now are orchestrating the international flow of funds. During the 1970s they gen erated the greatest credit boom the world has ever seen. There had been some credit expansion before August 15, 1971, when President Nixon uni laterally abolished the last vestiges of the gold standard. But it acceler ated dramatically thereafter when the U.S. government showered the world with U.S. dollars. Central bank reserves consisting primarily of paper dollars expanded from $92 292 THE FREEMAN billion in 1970 to more than $800 bil lion in 1983. The Eurodollar market, which recycles the flood of petrodol lar deposits to debtors all over the globe, grew from some $100 billion in 1970 to nearly $2 trillion today.