Money and Inflation

What, then, does this resurgent Austrian theory have to say about our problem?2  The first thing to point out is that inflation is not ineluctably built into the economy, nor is it a prerequisite for a growing and thriving world. During most of the nineteenth century (apart from the years of the War of 1812 and the Civil War), prices were falling, and yet the economy was growing and industrializing. Falling prices put no damper whatsoever on business or economic prosperity.

Thus, falling prices are apparently the normal functioning of a growing market economy. So how is it that the very idea of steadily falling prices is so counter to our experience that it seems a totally unrealistic dreamworld? Why, since World War II, have prices gone up continuously, and even swiftly, in the United States and throughout the world? Before that point, prices had gone up steeply during World War I and World War II; in between, they fell slightly despite the great boom of the 1920s, and then fell steeply during the Great Depression of the 1930s. In short, apart from wartime experiences, the idea of inflation as a peacetime norm really arrived after World War II.

The favorite explanation of inflation is that greedy businessmen persist in putting up prices in order to increase their profits. But surely the quotient of business “greed” has not suddenly taken a great leap forward since World War II. Weren’t businesses equally “greedy” in the nineteenth century and up to 1941? So why was there no inflation trend then? Moreover, if businessmen are so avaricious as to jack up prices 10% per year, why do they stop there? Why do they wait; why don’t they raise prices by 50%, or double or triple them immediately? What holds them back?

A similar flaw rebuts another favorite explanation of inflation: that unions insist on higher wage rates, which in turn leads businessmen [p. 175] to raise prices. Apart from the fact that inflation appeared as long ago as ancient Rome and long before unions arrived on the scene, and apart from the lack of evidence that union wages go up faster than nonunion or that prices of unionized products rise faster than of nonunionized, a similar question arises: Why don’t businesses raise their prices anyway? What is it that permits them to raise prices by a certain amount, but not by more? If unions are that powerful, and businesses that responsive, why don’t wages and prices rise by 50%, or 100%, per year? What holds them back?

A government-inspired TV propaganda campaign a few years ago got a bit closer to the mark: consumers were blamed for inflation by being too “piggy,” by eating and spending too much. We have here at least the beginning of an explanation of what holds businesses or unions back from demanding still higher prices: consumers won’t pay them. Coffee prices zoomed upward a few years ago; a year or two later they fell sharply because of consumer resistance — to some extent from a flashy consumer “boycott” — but more importantly from a shift in consumer buying habits away from coffee and toward lower-priced substitutes. So a limit on consumer demand holds them back.

But this pushes the problem one step backward. For if consumer demand, as seems logical, is limited at any given time, how come it keeps going up, year after year, and validating or permitting price and wage increases? And if it can go up by 10%, what keeps it from going up by 50%? In short, what enables consumer demand to keep going up, year after year, and yet keeps it from going up any further?

To go any further in this detective hunt we must analyze the meaning of the term “price.” What exactly is a price? The price of any given quantity of a product is the amount of money the buyer must spend on it. In short, if someone must spend seven dollars on ten loaves of bread, then the “price” of those ten loaves is seven dollars, or, since we usually express price per unit of product, the price of bread is seventy cents per loaf. So there are two sides to this exchange: the buyer with money and the seller with bread. It should be clear that the interaction of both sides brings about the ruling price in the market. In short, if more bread comes onto the market, the price of bread will be bid down (increased supply lowers the price); while, on the other hand, if the bread buyers have more money in their wallets, the price of bread will be bid higher (increased demand raises the price).

We have now found the crucial element that limits and holds back the amount of consumer demand and hence the price: the amount of money in the consumers’ possession. If the money in their pockets increases [p. 176] by 20%, then the limitation on their demand is relaxed by 20%, and, other things remaining equal, prices will tend to rise by 20% as well. We have found the crucial factor: the stock or the supply of money.

If we consider prices across-the-board for the entire economy, then the crucial factor is the total stock or supply of money in the whole economy. In fact, the importance of the money supply in analyzing inflation may be seen in extending our treatment from the bread or coffee market to the overall economy. For all prices are determined inversely by the supply of the good and directly by the demand for it. But the supplies of goods are, in general, going up year after year in our still growing economy. So that, from the point of view of the supply side of the equation, most prices should be falling, and we should right now be experiencing a nineteenth-century-style steady fall in prices (”deflation”). If chronic inflation were due to the supply side — to activities by producers such as business firms or unions — then the supply of goods overall would necessarily be falling, thereby raising prices. But since the supply of goods is manifestly increasing, the source of inflation must be the demand side — and the dominant factor on the demand side, as we have indicated, is the total supply of money.

And, indeed, if we look at the world past and present, we find that the money supply has been going up at a rapid pace. It rose in the nineteenth century, too, but at a much slower pace, far slower than the increase of goods and services; but, since World War II, the increase in the money supply — both here and abroad — has been much faster than in the supply of goods. Hence, inflation.

The crucial question then becomes who, or what, controls and determines the money supply, and keeps increasing its amount, especially in recent decades? To answer this question, we must first consider how money arises to begin with in the market economy. For money first arises on the market as individuals begin to choose one or several useful commodities to act as a money: the best money-commodities are those that are in high demand; that have a high value per unit-weight; that are durable, so they can be stored a long time, mobile, so they can be moved readily from one place to another, and easily recognizable; and that can be readily divisible into small parts without losing their value. Over the centuries, various markets and societies have chosen a large number of commodities as money: from salt to sugar to cowrie shells to cattle to tobacco down to cigarettes in POW camps during World War II. But over all these centuries, two commodities have always won out in the competitive race to become moneys when they have been available: gold and silver. [p. 177]

Metals always circulate by their weight — a ton of iron, a pound of copper, etc. — and their prices are reckoned in terms of these units of weight. Gold and silver are no exception. Every one of the modern currency units originated as units of weight of either gold or silver. Thus, the British unit, the “pound sterling,” is so named because it originally meant simply one pound of silver. (To see how the pound has lost value in the centuries since, we should note that the pound sterling is now worth two-fifths of an ounce of silver on the market. This is the effect of British inflation — of the debasement of the value of the pound.) The “dollar” was originally a Bohemian coin consisting of an ounce of silver. Later on, the “dollar” came to be defined as one-twentieth of an ounce of gold.

When a society or a country comes to adopt a certain commodity as a money, and its unit of weight then becomes the unit of currency — the unit of reckoning in everyday life — then that country is said to be on that particular commodity “standard.” Since markets have universally found gold or silver to be the best standards whenever they are available, the natural course of these economies is to be on the gold or silver standard. In that case, the supply of gold is determined by market forces: by the technological conditions of supply, the prices of other commodities, etc.

From the beginning of market adoption of gold and silver as money, the State has been moving in to seize control of the money-supply function, the function of determining and creating the supply of money in the society. It should be obvious why the State should want to do so: this would mean seizing control over the money supply from the market and turning it over to a group of people in charge of the State apparatus. Why they should want to do so is clear: here would be an alternative to taxation which the victims of a tax always consider onerous.

For now the rulers of the State can simply create their own money and spend it or lend it out to their favorite allies. None of this was easy until the discovery of the art of printing; after that, the State could contrive to change the definition of the “dollar,” the “pound,” the “mark,” etc., from units of weight of gold or silver into simply the names for pieces of paper printed by the central government. Then that government could print them costlessly and virtually ad lib, and then spend or lend them out to its heart’s content. It took centuries for this complex movement to be completed, but now the stock and the issuance of money is totally in the hands of every central government. The consequences are increasingly visible all around us.

Consider what would happen if the government should approach one [p. 178] group of people — say the Jones family — and say to them: “Here, we give you the absolute and unlimited power to print dollars, to determine the number of dollars in circulation. And you will have an absolute monopoly power: anyone else who presumes to use such power will be jailed for a long, long time as an evil and subversive counterfeiter. We hope you use this power wisely.” We can pretty well predict what the Jones family will do with this newfound power. At first, it will use the power slowly and carefully, to pay off its debts, perhaps buy itself a few particularly desired items; but then, habituated to the heady wine of being able to print their own currency, they will begin to use the power to the hilt, to buy luxuries, reward their friends, etc. The result will be continuing and even accelerated increases in the money supply, and therefore continuing and accelerated inflation.

But this is precisely what governments — all governments — have done. Except that instead of granting the monopoly power to counterfeit to the Jones or other families, government has “granted” the power to itself. Just as the State arrogates to itself a monopoly power over legalized kidnapping and calls it conscription; just as it has acquired a monopoly over legalized robbery and calls it taxation; so, too, it has acquired the monopoly power to counterfeit and calls it increasing the supply of dollars (or francs, marks, or whatever). Instead of a gold standard, instead of a money that emerges from and whose supply is determined by the free market, we are living under a fiat paper standard. That is, the dollar, franc, etc., are simply pieces of paper with such names stamped upon them, issued at will by the central government — by the State apparatus.

Furthermore, since the interest of a counterfeiter is to print as much money as he can get away with, so too will the State print as much money as it can get away with, just as it will employ the power to tax in the same way: to extract as much money as it can without raising too many howls of protest.

Government control of money supply is inherently inflationary, then, for the same reason that any system in which a group of people obtains control over the printing of money is bound to be inflationary.

• 2A brief introduction to Austrian business cycle theory can be found in Murray N. Rothbard, Depressions: Their Cause and Cure (Lansing, Mich.: Constitutional Alliance, March 1969). The theory is set forth and then applied to the Great Depression of 1929-1933, and also used briefly to explain our current stagflation, in Rothbard, America’s Great Depression, 3rd ed. (Kansas City, Kans.: Sheed and Ward, 1975).