What You Should Know About Inflation

Henry S. Hazlitt

• Publisher: Golden Springs Publishing
• Year: 2016
• ISBN:
  9781787200524
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

A noted economist exposes the truth behind our shrinking dollars…What precisely is inflation? What is its cause? Its cure? How long will it last? Is there any way you can take advantage of inflation? If not, how can you protect yourself against further erosion in the value of your savings?Henry Hazlitt gives his answers to these questions and many more in this clear, readable book. He exposes the fallacies by which some people have come to justify inflation, and he discusses the role of governments in creating the very inflation that they claim to be combatting. For this paper-bound edition Mr. Hazlitt has added new statistics and information, and in a new preface he comments on the current economic situation.What You Should Know About Inflation is required reading for anyone who wants to know why his money is worth less and what he can do about it."A keen economic mind...provides an incisive primer on the subject."—THE WALL STREET JOURNAL"This concise little book explains the elements of the subject in simplest terms, and takes the mystery out of the technical jargon in which it is too often buried. Henry Hazlitt answers...questions with logic and lucidity."—INVESTMENT DEALER'S DIGEST

 

1—What Inflation Is

No subject is so much discussed today—or so little understood—as inflation. The politicians in Washington talk of it as if it were some horrible visitation from without, over which they had no control—like a flood, a foreign invasion, or a plague. It is something they are always promising to “fight”—if Congress or the people will only give them the “weapons” or “a strong law” to do the job.

Yet the plain truth is that our political leaders have brought on inflation by their own money and fiscal policies. They are promising to fight with their right hand the conditions brought on with their left.

Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit. If you turn to the American College Dictionary, for example, you will find the first definition of inflation given as follows r “Undue expansion or increase of the currency of a country, esp. by the issuing of paper money not redeemable in specie.”

In recent years, however, the term has come to be used in a radically different sense. This is recognized in the second definition given by the American College Dictionary: “A substantial rise of prices caused by an undue expansion in paper money or bank credit.” Now obviously a rise of prices caused by an expansion of the money supply is not the same thing as the expansion of the money supply itself. A cause or condition is clearly not identical with one of its consequences. The use of the word “inflation” with these two quite different meanings leads to endless confusion.

The word “inflation” originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended. It is not mere pedantry to insist that the word should be used only in its original meaning. To use it to mean “a rise in prices” is to deflect attention away from the real cause of inflation and the real cure for it.

Let us see what happens under inflation, and why it happens. When the supply of money is increased, people have more money to offer for goods. If the supply of goods does not increase—or does not increase as much as the supply of money—then the prices of goods will go up. Each individual dollar becomes less valuable because there are more dollars. Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before. A “price” is an exchange ratio between a dollar and a unit of goods. When people have more dollars, they value each dollar less. Goods then rise in price, not because goods are scarcer than before, but because dollars are more abundant.

In the old days, governments inflated by clipping and debasing the coinage. Then they found they could inflate cheaper and faster simply by grinding out paper money on a printing press. This is what happened with the French assignats in 1789, and with our own currency during the Revolutionary War. Today the method is a little more in-direct. Our government sells its bonds or other IOU’s to the banks. In payment, the banks create “deposits” on their books against which the government can draw. A bank in turn may sell its government IOU’s to the Federal Reserve Bank, which pays for them either by creating a deposit credit or having more Federal Reserve notes printed and paying them out. This is how money is manufactured.

The greater part of the “money supply” of this country is represented not by hand-to-hand currency but by bank deposits which are drawn against by checks. Hence when most economists measure our money supply they add demand deposits (and now frequently, also, time deposits) to currency outside of banks to get the total. The total of money and credit, including commercial time deposits, was $51 billion at the end of 1939 and $365 billion at the end of 1967. This increase of 612 per cent in the supply of money was overwhelmingly the reason why wholesale prices rose 153 per cent in the same period.

 

2—Some Qualifications

It is often argued that to attribute inflation solely to an increase in the volume of money is “oversimplification.” This is true. Many qualifications have to be kept in mind.

For example, the “money supply” must be thought of as including not only the supply of hand-to-hand currency, but the supply of bank credit—especially in the United States, where most payments are made by check.

It is also an oversimplification to say that the value of an individual dollar depends simply on the present supply of dollars outstanding. It depends also on the expected future supply of dollars. If most people fear, for example, that the supply of dollars is going to be even greater a year from now than at present, then the present value of the dollar (as measured by its purchasing power) will be lower than the present quantity of dollars would otherwise warrant.

Again, the value of any monetary unit, such as the dollar, depends not merely on the quantity of dollars but on their quality. When a country goes off the gold standard, for example, it means in effect that gold, or the right to get gold, has suddenly turned into mere paper. The value of the monetary unit therefore usually falls immediately, even if there has not yet been any increase in the quantity of money. This is because the people have more faith in gold than they have in the promises or judgment of the government’s monetary managers. There is hardly a case on record, in fact, in which departure from the gold standard has not soon been followed by a further increase in bank credit and in printing-press money.

In short, the value of money varies for basically the same reasons as the value of any commodity. Just as the value of a bushel of wheat depends not only on the total present supply of wheat but on the expected future supply and on the quality of the wheat, so the value of a dollar depends on a similar variety of considerations. The value of money, like the value of goods, is not determined by merely mechanical or physical relationships, but primarily by psychological factors which may often be complicated.

In dealing with the causes and cure of inflation, it is one thing to keep in mind real complications; it is quite another to be confused or misled by needless or non-existent complications.

For example, it is frequently said that the value of the dollar depends not merely on the quantity of dollars but on their “velocity of circulation.” Increased “velocity of circulation,” however, is not a cause of a further fall in the value of the dollar; it is itself one of the consequences of the fear that the value of the dollar is going to fall (or, to put it the other way round, of the belief that the price of goods is going to rise). It is this belief that makes people more eager to exchange dollars for goods. The emphasis by some writers on “velocity of circulation” is just another example of the error of substituting dubious mechanical for real psycho-logical reasons.

Another blind alley: in answer to those who point out that inflation is primarily caused by an increase in money and credit, it is contended that the increase in commodity prices often occurs before the increase in the money supply. This is true. This is what happened immediately after the outbreak of war in Korea. Strategic raw materials began to go up in price on the fear that they were going to be scarce. Speculators and manufacturers began to buy them to hold for profit or protective inventories. But to do this they had to borrow more money from the banks. The rise in prices was accompanied by an equally marked rise in bank loans and deposits. From May 31, 1950, to May 30, 1951, the loans of the country’s banks increased by $12 billion. If these increased loans had not been made, and new money (some $6 billion by the end of January 1951) had not been issued against the loans, the rise in prices could not have been sustained. The price rise was made possible, in short, only by an increased supply of money.

 

3—Some Popular Fallacies

One of the most stubborn fallacies about inflation is the assumption that it is caused, not by an increase in the quantity of money, but by a “shortage of goods.”

It is true that a rise in prices (which, as we have seen, should not be identified with inflation) can be caused either by an increase in the quantity of money or by a shortage of goods—or partly by both. Wheat, for example, may rise in price either because there is an increase in the supply of money or a failure of the wheat crop. But we seldom find, even in conditions of total war, a general rise of prices caused by a general shortage of goods. Yet so stubborn is the fallacy that inflation is caused by a “shortage of goods,” that even in the Germany of 1923, after prices had soared hundreds of billions of times, high officials and millions of Germans were blaming the whole thing on a general “shortage of goods”—at the very moment when foreigners were coming in and buying German goods with gold or their own currencies at prices lower than those of equivalent goods at home.

The rise of prices in the United States since 1939 is constantly being attributed to a “shortage of goods.” Yet official statistics show that our rate of industrial production in 1959 was 177 per cent higher than in 1939, or nearly three times as great. Nor is it any better explanation to say that the rise in prices in wartime is caused by a shortage in civilian goods. Even to the extent that civilian goods were really short in time of war, the shortage would not cause any substantial rise in prices if taxes took away as large a percentage of civilian income as rearmament took away of civilian goods.

This brings us to another source of confusion. People frequently talk as if a budget deficit were in itself both a necessary and a sufficient cause of inflation. A budget deficit, however, if fully financed by the sale of government bonds paid for out of real savings, need not cause inflation. And even a budget surplus, on the other hand, is not an assurance against inflation. This was shown in the fiscal year ended June 30, 1951, when there was substantial inflation in spite of a budget surplus of $3.5 billion. The same thing happened in spite of budget surpluses in the fiscal years 1956 and 1957. A budget deficit, in short, is inflationary only to the extent that it causes an increase in the money supply. And inflation can occur even with a budget surplus if there is an increase in the money supply notwithstanding.

The same chain of causation applies to all the so-called “inflationary pressures”—particularly the so-called “wage-price spiral.” If it were not preceded, accompanied, or quickly followed by an increase in the supply of money, an increase in wages above the “equilibrium level” would not cause inflation; it would merely cause unemployment. And an increase in prices without an increase of cash in people’s pockets would merely cause a falling off in sales. Wage and price rises, in brief, are usually a consequence of inflation. They can cause it only to the extent that they force an increase in the money supply.

4—A Twenty-Year Record

I present in this chapter a chart comparing the increase in the cost of living, in wholesale commodity prices, and in the amount of bank deposits and currency, for the twenty-year period from the end of 1939 to the end of 1959.

Taking the end of 1939 as the base, and giving it a value of 100, the chart shows that in 1959 the cost of living (consumer prices) had increased 113 per cent over 1939, wholesale prices had increased 136 per cent, and the total supply of bank deposits and currency had increased 270 per cent.

The basic cause of the increase in wholesale and consumer prices was the increase in the supply of money and credit. There was no “shortage of goods.” As we noticed in the preceding chapter, our rate of industrial production in the twenty-year period increased 177 per cent. But though the rate of industrial production almost tripled, the supply of money and credit almost quadrupled. If it had not been for the increase in production, the rise in prices would have been much greater than it actually was.

Nor, as we also saw in the last chapter, can the increase in prices be attributed to increased wage demands—to a “cost push.” Such a theory reverses cause and effect. “Costs” are prices—prices of raw materials and services—and go up for the same reason as other prices do.

If we were to extend this chart to a total of 29 years—that is, to the end of 1967—it would show that, taking 1939 as a base, the cost of living increased 144 per cent, wholesale prices in-creased 153 per cent, and the total supply of bank deposits and currency increased 612 p...