20. Inflation: An Unworkable Fiscal Policy

In dealing with problems concerned with the economics of mobilization, it is first of all necessary to realize that fiscal policies have reached a turning point.

In recent decades all nations have looked upon the income and the wealth of the more prosperous citizens as an inexhaustible reserve which could be freely tapped. Whenever there was need for additional funds, one tried to collect them by raising the taxes to be paid by the upper-income brackets. There seemed to be enough money for any suggested expenditure because there seemed to be no harm in “soaking the rich” a bit more. As the votes of these rich do not count much in elections, the members of the legislative bodies were always ready to increase public spending at their expense. There is a French dictum: Les affaires, c’est l’argent des autres. “Business is other people’s money.” In these last 60 years political and fiscal affairs were virtually “other people’s money.” Let the rich pay, was the slogan.

End of an Era

Now this period of fiscal history has come to an end. With the exception of the United States and some of the British Dominions, what has been called the ability-to-pay of the wealthy citizens has been completely absorbed by taxes. No further funds of any significance can be collected from them. Henceforth all government spending will have to be financed by taxing the masses.

The European nations concerned are not yet fully aware of this fact because they have found a substitute. They are getting Marshall Plan aid; the U. S. taxpayer fills the gap.

In this country things have not yet gone as far as they have in other countries. It is still possible to raise an additional $2 or $3 billion, or perhaps even $4 billion, by increasing corporation taxes, and “excess profits” taxes, and by rendering the personal income tax more progressive. But under present conditions, even $4 billion would be only a fraction of what the Treasury needs. Thus, in this country we are also at the end of a period of fiscal policies. The whole philosophy of public finance must undergo a revision. In considering the pros and cons of a suggested expenditure the members of Congress will no longer be able to think: The rich have enough; let them pay. In the future, the voters on whose ballots the Congressmen depend will have to pay.

Inflation, an increase in money and credit, is certainly not a means to avoid or to postpone for more than a short time the need to resort to taxes levied on people other than those belonging to the rich minority. If, for the sake of argument, we leave aside all the objections which may be raised against any inflationary policy, we must take into account the fact that inflation can never be more than a temporary makeshift. Inflation cannot be continued over a long period of time without defeating its fiscal purpose and ending in a complete debacle as was the case in this country with the Continental currency, in France with the mandats territoriaux and in Germany with the mark in 1923.

What makes it possible for a government to increase its funds by inflation is the ignorance of the public. The people must ignore the fact that the government has chosen inflation as a fiscal system and plans to go on with inflation endlessly. It must ascribe the general rise in prices to other causes than to the policy of the government and must assume that prices will drop again in a not-too-distant future. If this opinion fades away, inflation comes to a catastrophic breakdown.

The Housewife’s Behavior

If the housewife who needs a new frying pan reasons: “Now prices are too high; I will postpone the purchase until they drop again,” inflation can still fulfill its fiscal purpose. As long as people share this view, they increase their cash holdings and bank balances, and a part of the newly created money is absorbed by these additional cash holdings and bank balances; prices on the market do not rise in proportion to the inflation.

But then?sooner or later?comes a turning point. The housewife discovers that the government expects to go on inflating and that consequently prices will continue to rise more and more. Then she reasons: “I do not need a new frying pan today; I shall only need one next year. But I had better buy it now because next year the price will be much higher.” If this insight spreads, inflation is done for, Then all people rush to buy. Everybody is anxious to reduce his holding of cash because he does not want to be hurt by the drop in the monetary unit’s purchasing power. The phenomenon then appears which, in Europe was called the “flight into real values.” People rush to exchange their depreciating paper money for something tangible, something real. The knell sounds of the currency system involved.

In this country we have not yet reached this second and final stage of every protracted inflation. But if the authorities do not very soon abandon any further attempt to increase the amount of money in circulation and to expand credit, we shall one day come to the same unpleasant result. It is not a matter of choosing between financing the increased government expenditure by collecting taxes and borrowing from the public on the one hand and financing it by inflation on the other hand. Inflation can never be an instrument of fiscal policy over a long period of time. Continued inflation inevitably leads to catastrophe.

Therefore, we should not waste our time in discussing methods of price control. Price control cannot prevent the rise in prices if inflation is going on. Even capital punishment could not make price control work in the days of Emperor Diocletian or during the French Revolution. Let us concentrate our efforts on the problem of how to avoid inflation, not upon useless schemes of how to conceal its inexorable consequences.

Taxation the Key

What is needed in wartime is to divert production and consumption from peacetime channels toward military goals. In order to achieve this, it is necessary for the government to tax the citizens, to take away from them the money, which they would otherwise spend for things they must no longer buy and consume, so the government can spend it for the conduct of the war.

At the breakfast table of every citizen in wartime sits an invisible guest, as it were, a GI who shares his meal. Parked in the citizen’s garage is not only the family car, but also?invisibly?a tank or a plane. The important fact is that a GI needs more in food, clothing, and other things than he used to consume as a civilian. And military equipment wears out much more quickly than civilian equipment. The costs of a modern war are enormous.

The adequate method of providing the funds the government needs for war is, of course, taxation. Part of the funds may also be provided by borrowing from the public, the citizens. But if the Treasury increases the amount of money in circulation or borrows from the commercial banks, it inflates. Inflation can do the job for a limited time. But it is the most expensive method of financing a war; it is socially disruptive and should be avoided.

Inflation: A Convenient Makeshift

There is no need to dwell upon the disastrous consequences of inflation. All people agree in this regard. But inflation is a very convenient makeshift for those in power. It is a handy means to divert the resentment of the people from the government. In the eyes of the masses, big business, the “profiteers,” the merchants,?not the Administration?appear responsible for the rise in prices and the ensuing need to restrict consumption.

Perhaps somebody will consider what I am saying here as anti-democratic, reactionary, and economic royalism. But the truth is that inflation is a typically anti-democratic measure. It is a policy of governments that do not have the courage to tell the people honestly what the real costs of their conduct of affairs are.

A truly democratic government would have to tell the voters openly that they must pay higher taxes because expenses have risen considerably. But it is much more agreeable for a government to present only a part of the bill to the people and to resort to inflation for the rest of its expenditures. What a triumph if they can say: Everybody’s income is rising, everybody has now more money in his pocket, business is booming.

Deficit spending is not a new invention. During the greater part of the 19th century it was the preferred fiscal method of precisely those governments that were not then considered democratic and progressive?Austria, Italy, and Russia. Austria’s budget showed a deficit yearly from 1781 on, until the late ‘80s of the 19th century, when an orthodox professor of economics, Dunajewski, as Minister of Finance, restored the budgetary equilibrium. There is no reason to be proud of deficit spending, nor to call it progress.

Going After Lower Brackets

If one wants to collect more taxes, it will be necessary to lay a burden greater than hitherto on the lower income brackets, the strata of society whose members consume the much greater part of the total amount consumed in this country. Up to now it has been customary to tax predominantly corporations and individuals with higher incomes. But even the outright confiscation of these revenues would only cover a fraction of the additional funds the country needs today.

Some experts have declared that it is necessary to tax the people until it hurts. I disagree with these sadists. The purpose of taxation is not to hurt, but to raise the money the country needs to rearm and to fight in Korea. It is a sad fact that world affairs now make it necessary for the government to force people who used to buy nylon stockings and shirts to shift to other du Pont products, namely munitions.

In his book on Eternal Peace, the German philosopher Immanuel Kant (1724-1804) suggested that government should be forbidden to finance wars by borrowing. He expected that the warlike spirit would dwindle if all countries had to pay cash for their wars. However, no serious objection can be raised against borrowing from the public, from people who have saved and are prepared to invest in government bonds. But borrowing from the commercial banks is tantamount to printing additional bank notes and expanding the amount of deposits subject to check. That is inflation.

Semantic Confusion

There is nowadays a very reprehensible, even dangerous, semantic confusion that makes it extremely difficult for the non-expert to grasp the true state of affairs. Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term “inflation” to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. It follows that nobody cares about inflation in the traditional sense of the term. As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this technological confusion is not entirely wiped out, there cannot be any question of stopping inflation.

Look at the silly term, “inflationary pressures.” There is no such thing as an “inflationary pressure.” There is inflation or there is the absence of inflation. If there is no increase in the quantity of money and if there is no credit expansion, the average height of prices and wages will by and large remain unchanged. But if the quantity of money and credit is increased, prices and wages must rise, whatever the government may decree. If there is no inflation, price control is superfluous. If there is inflation, price control is a sham, a hopeless venture.

It is the government that makes our inflation. The policy of the Treasury, and nothing else.

We have been told a lot about the need for, and the virtues of, direct controls.

We have learned that they preserve the individual’s liberty to choose the grocer he prefers. I do not want to examine what value may be attached to direct controls from a metaphysical point of view. I only want to stress one fact: As a means for preventing and fighting inflation or its consequences, direct controls are absolutely useless.

Transcript of remarks before the Conference on the Economics of Mobilization, held at White Sulphur Springs, West Virginia, April 6-8, 1951, under the sponsorship of the University of Chicago Law School. Reprinted from The Commercial and Financial Chronicle, April 26, 1951.