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By Steven Baker MP, on 11 August 10
Over at CentreRight, I have set out briefly the mistake presently being made by policymakers in the US, which I expect to be mirrored in the UK later this morning. For example:
Injecting more new money, whether through QE or credit expansion in excess of real savings, will not “fight recession”. It will merely delay and worsen the eventual downturn, because injecting new money is bound to shift activity from sustainable economic action to action supported only by that new money.
Sooner or later, the mainstream economic paradigm must shift to accept the importance of time and hence a robust capital theory. Everyone’s prosperity depends upon it.
By Ewen Stewart, on 6 August 10
Tim Congdon’s recent article, for the excellent Critical Reaction website, illustrates only too clearly the MPC’s complacent disregard for its remit to target inflation at 2%.
Congdon wrote
Even if (Andrew) Sentance is right, a relaxed monetary stance serves the useful purpose at present of making it easier for the UK government to press on with necessary fiscal consolidation. Admittedly, the Bank of England’s job is to keep inflation in line with the official target, not to support the government’s programme to restore fiscal sustainability. Even so, there may be a tacit understanding of some sort between the Bank and the government, that the Bank will take a relatively permissive view of the inflation target while the deficit is being curbed. And in my opinion, quite right, too.
This comes close to admitting what many of us have suspected that the Bank and HMG, while paying lip service to inflation targeting, actually, post the credit crunch, are only concerned with promoting growth and ensuring there is not a double dip. Without debating the legitimacy of the formal Bank of England remit (this author believes that the remit is far too narrow) this policy risks disaster.
It is clear that the Bank of England has, to date, consistently underestimated the persistence of inflation. The charts below show RPI and CPI since early 2007. Despite the worst recession in 50 years CPI (which underestimates inflation) has remained well above the official target while RPI has now reached 5%. The Bank persists with the notion that the ‘output gap’ will mute inflation and so called one off factors, like the increase in VAT. Given the official remit of the Bank this complacency is staggering. Indeed despite recent strong GDP numbers, and persistent inflation, the MPC still whisper that they may even need to extend QE as well as maintain rates at near zero for the foreseeable future. Only Andrew Sentance sees sense.
However Tim Congdon’s article is important because he implies that the Bank is in cahoots with HMG in believing a little bit of inflation might be a tad useful ‘to help the government press ahead with the necessary fiscal consolidation.’
If true, this is a highly dangerous strategy indeed. Inflation, once embedded, can be very difficult to eradicate and I would argue that the current policy, started by the previous Government, and broadly continued by this administration risks a loss of monetary confidence. Certainly the Keynesian aspect of the last regime is in the process of being ditched, as, thankfully, public sector austerity seems to be taken seriously. This is important and will be a genuine achievement of the Coalition, if implemented, but the monetary policy remains highly dangerous. ‘Near free’ money coupled with £200bn of newly minted QE, with the threat of possibly yet more, has expanded the monetary base of the banks and arguably distorted, downwards, the yield curve. Propensity to lend today may be low, but it is from highly elevated aggregate levels, and monetary velocity, as Congdon accepts, is a notoriously difficult animal to predict. To assume it will remain subdued, with the greatly expanded monetary base, is dangerous.
The ‘helicopter monetarists’ like Congdon believe, like the central planners of the old Soviet Block, that they can omnipotently manage the money supply — print a bit here when it contracts, magically withdraw a bit there when it over heats, and take our economy to the high plateau of stability. The reality is that this arrogance could well spell disaster. It is in any case a million miles from a market solution.
Despite strong evidence of the embedded nature of inflation, the MPC persists in talking about the mythical output gap, which in a modern, global, service based economy, is in my view increasingly irrelevant. Lending growth may be subdued, but let’s not forget that consumers and HMG remain very heavily in hock. Sterling, despite its recent modest recovery, is still in the doldrums making imports somewhat more expensive. Asset prices are through the roof. Without the inappropriate monetary policy real estate values would be 25-40% lower than the highs now achieved. This may sound good for property owners, like this author, but it is a major distortion and leaves individuals impotent to make decisions as they try and second guess the machinations of the central monentary policy makers.
It creates moral hazard. It rewards the imprudent over the prudent, the elderly and those of fixed income. A poor example indeed.
Congdon’s article in Critical Reaction does us all a favour. It is honest and explains very clearly that the MPC and HMG are quite happy with a bit of inflation — it suits their purpose. For the rest of us, don’t be a bond holder, don’t hold cash, don’t be old and don’t be prudent.
By Andy Duncan, on 7 July 10
AEP is a deeply frustrating writer because although he seems capable of understanding what is happening in an almost Austrian-lite fashion — with the proviso that he needs to shift copies of The Daily Telegraph to pay his own wages — his proposed solutions are usually of the Keynesian-lite variety.
This is like being able to spot a fire at a petrol station and then to suggest that the pumping of more gasoline onto the conflagration may create such an explosion that it blows out the flames; at best, it’s wishful thinking and at worst, it is highly dangerous.
AEP is at it again in his latest think-piece article:
“Roughly a million Americans have dropped out of the jobs market altogether over the past two months. That is the only reason why the headline unemployment rate is not exploding to a post-war high.”
This is something that even Peter Schiff could have said on one of his radio programmes. But then AEP goes and spoils it with the following paragraph, which could almost have been sent back in time and translated from the original French by Marie Antoinette:
“It is obvious what that policy should be for Europe, America, and Japan. If budgets are to shrink in an orderly fashion over several years – as they must, to avoid sovereign debt spirals – then central banks will have to cushion the blow keeping monetary policy ultra-loose for as long it takes.”
So we cut back on government spending via the sovereign bond market and we cushion this by increasing government spending via the quantitative easing printing press? Yes, AEP really does want to have his cake and eat it.
But it gets worse:
“Perhaps naively, I still think central banks have the tools to head off disaster.”
Translation: Whatever the problem, print more money (or do the same by moving ones and zeroes around a computerised financial asset ledger) to solve it.
This one-shot solution approach to any financial problem reminds me of the old phrase about ‘The King is Dead, Long Live the King!’
The modern equivalent is ‘Quantitative Easing Has Failed, Roll On the Quantitative Easing!’
By James Tyler, on 8 June 10
In recognition of soaring inflation, and the looming threat that our new government will resort to monetisation of the national debt, we are bringing forward this classic article, originally published in December 2009.
Mr Smith works hard, plans carefully, and saves what he can, putting his money into a building society. He pays his credit card bills off each month, and tries to overpay his mortgage when he can.
Mr Smith got a 3% pay rise last year – inflation was only 2% – so he felt good about that. But… he doesn’t feel any wealthier.
Year after year, the government had said that the economy was growing strongly, but still, things seemed harder for his family and him. Train ticket prices up again. Heating bills rocketed when the price of oil went up, but never seemed to come down. He swears a loaf of bread and a pint of milk were much cheaper in years gone by.
When he changes his cash for Euros, he realises that his holiday in France is now unbearably expensive. His tax rates didn’t go up, but still, after all his bills were paid, he seemed to have less and less spare cash than he remembers a few years ago.
There are Mr Smiths everywhere. Careful folk, who plan, save for a rainy day and have a sense of personal responsibility.
Smith is the target.
It is Mr Smith who is going to pay for the banking crisis.
His saved wealth will pay the national debt.
His prudence will bail out Gordon Brown’s profligacy.
His forgone holiday will pay the banker’s bonuses.
His careful spending will pay for the vast number of quangos.
His financial planning will bail out the failed NHS computer project, over-budget military programs and ID cards.
His sense of responsibility will end up funding the destruction meted out in Iraq and Afghanistan.
It won’t be the politicians or the bankers who pay for global warming – he will.
He knows he pays tax… but what is hard for him to comprehend is that there is another pernicious process draining his wealth and subverting his hard work towards paying for the misjudgement of others. Whether he likes it or not, he naively pays for the decisions made by the political class.
He has no choice. No option. He was never asked to vote for it. And for the most part, the act of theft is so subtle he doesn’t even know it is happening.
Why does he feel poorer?
Why is it that Mr Smith seemed to miss the ‘boom’, yet is hurting more in the bust? Why doesn’t life get easier for him? What is going on?
Inflation.
As technology produces things more cheaply, Mr Smith should have been able to reap the rewards – except that things don’t get cheaper for him. Society cheats him when the government opens the spigot of new money, washing this value away as the torrent of new money chases prices higher beyond his reach.
The winners are always those close to the gusher – the banks, financiers and politicians. These are the ones who get to spend the new money first, thus chase prices up before Mr Smith gets any sniff of what is happening.
To save or to invest?
Think about your personal circumstances. Every time your payslip comes in, you have a choice of how much to spend and how much to save. Every rational person knows that there is a balance to be struck between current enjoyment (consumption) and future enjoyment (savings – or deferred consumption).
This choice is exactly the same for society as a whole. As a country, we must decide how much to consume, and how much to defer consumption in order to allow our children and us to enjoy things in the future.
The choice for us all is simple. Defer consumption and invest for the future, or consume and enjoy now.
What is the process by which we save for the future? There are two ways.
- Voluntary saving. If society needs to invest for the future, but people prefer to consume, then the savings rate – the profits paid on investments and/or the interest rate paid on deposits, rises until people choose to defer consumption and invest.
- Forced saving. Government policy forces a decrease of the purchasing power of money via inflation of the money supply. The net effect is a transference of wealth from savers and fixed income groups towards net borrowers (itself included). It also creates an artificial pool of liquidity into which the government can sell its IOUs.
The evil of Forced Saving
The natural state of affairs in a free market, with a more consistent supply of money, is that general prices fall as technology advances. The prudent are rewarded, and borrowers have to carefully evaluate and moderate their flights of fancy, only investing borrowed funds carefully in sound projects.
When the value of money declines, savers find that their money buys less, whilst borrowers are happy to find that they can repay their debts with money of a decreased value. It’s like borrowing five books from the library and finding that you are only required to give four back!
By setting a target for rising prices and then pulling levers to increase the supply of money in the economy to achieve it, the government prevents the natural response of general prices to competition, increased efficiency and innovation: they stop prices from falling.
Entrepreneurs, innovators, inventors and new businesses exist because they believe that they can satisfy society’s wants better than they have been served before. They have ideas, innovations and take risks in order to provide goods that are cheaper than they otherwise would be. Businesses operating in a competitive environment always seek to reduce costs, be that one step more efficient and produce a cheaper or better widget. As group of people, entrepreneurs bring efficiency and innovation, and they make stuff cheaper.
The benefit to Mr Smith should be that his income goes further. As time progresses, technological innovation should mean he can buy more with the same cash. But that’s not what happens, as any pensioner knows. Saved money buys far less now than it did at the time it was saved.
Governments achieve rising prices by encouraging the supply of new money. This new money comes from the central bank via its control of the banking system. The first users of this new money are invariably politicians, finance capitalism and big business. These guys get to use the newly minted money first, and thus spend it first. This process bids up prices, leaving everyone else chasing behind, and poor old Mr Smith last in the queue.
What an evil system it is then, when government can control money in such a way as to give it a first user advantage that penalises all those in the general population whose wealth is being rapidly diluted. A process that systematically violates and loots pensions, savings, fixed incomes and the actions of prudent, and rewards the profligate, the speculative borrowers and above all, rewards the biggest borrower of all: Government.
Let’s be clear. The current system is a process that diverts the benefits of innovation and technological advancement that should accrue to the general population, and thrusts it towards the desired spending of the well connected and the political class.
We need to stop this continual violation of the little man. Mr Smith has to start realising what is happening to him.
That’s why I’m proud to support the efforts of the Cobden Centre.
By Andy Duncan, on 1 June 10
Let us be generous to the Bank of England. Let us avoid quibbling about that original £198bn of ‘quantitative easing’ coming from out of thin air. Let us agree that the principal securities in their UK gilt fund are now worth £199bn and that they have received £8bn in coupon interest payments, presumably to buy more UK gilts with. Let us even forget that the whole ‘quantitative easing’ programme is simply one element of the British government printing up some currency and then ‘buying up’ IOUs with it from another element of the British government. We will even forget about the £1bn in interest they had to pay themselves on their reserves.
Overall, we must suspend disbelief for a few moments about the kind of person who plays the banker in Monopoly and who keeps winning because they can’t resist the urge to help themselves to ‘free’ money from the game’s money supply.
If we can bring ourselves to do all that then we are left with a £207bn pound output from an initial input of £198bn pounds. To make the mathematics easy on ourselves, we will assume that the quantitative easing programme has been in place for exactly one year, since June the 1st, 2009, which delivers a healthy sounding return of 4.5%.
However, that return is all in one sinking paper currency, the pound sterling, and has only ‘grown’ recently in relation to other paper currencies, specifically the euro, because these other currencies are sinking even faster and people are shuffling their euro-based bond securities into pound-based bond securities in a fearful bid to find a ’safe haven’. All of the world’s paper fiat currencies are sinking because central bankers everywhere possess just one weapon, the electronic printing press, and they are all firing this weapon like there is no tomorrow. And they will continue to do so because they have no other strategy.
If they do keep going like this, then there really will be no tomorrow, certainly for the paper pound, which could eventually reach its intrinsic value, which is that of poor quality firelighters.
The unmentionable elephant in the room, however, is that all of these paper currencies are sinking against gold, which is their joint mutual enemy, because they all shrink and seem far less valuable within the reflective cast of its lustrous yellow metallic sheen.
What was the price of gold on the 1st of June, 2009? It was £595 pounds. What was it on the 1st of June, 2010? It was £840 pounds. This is a return of 41%.
Now that’s what I call a real investment.
This means that against gold, the current £207bn fund the Bank of England is so proud of, is worth just £147bn of last year’s money. This is a 29% loss. Or to put it another way, if £198bn of last year’s money had been placed into gold, it would now be worth £279bn. Which means that the celebrated men and women of the Bank of England have just lost £72bn pounds.
Yes, this is even more than the £5bn the late unlamented Gordon Brown threw away when he sold off a large chunk of the British government’s gold reserves, to exchange it for euros and other paper IOUs.
Gold is money.
We should accept nothing less.
By Steven Baker MP, on 25 May 10
 In their working paper Assessing UK money supply measures in the light of the credit crunch, Toby Baxendale and Anthony J. Evans provide a better measure of the money supply. In this article, Steven Baker explores the background to the paper and indicates some key findings.
This article was originally published in October 2009.
Many people know the Bank of England is creating new money through quantitative easing but if the quantity of money is being increased, how is that quantity being measured? What is counted as money?
As the Bank of England explains:
When the Bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero.
So if they are almost at zero, and there is still a significant risk of very low inflation, the Bank can increase the quantity of money – in other words, inject money directly into the economy. That process is sometimes known as ‘quantitative easing’.
But when I consider quantitative easing, I am concerned with the following problems:
- It is not clear that the Bank of England has a useful definition of the money supply. The present measures do not correspond to economic activity — which is what the Bank is trying to increase with new money — and this crisis was famously not foreseen.
- As commentators have reported, “the Bank’s Governor, Mervyn King, seemed pretty confident that QE could work. But even he would admit he has no idea how long it will take – or how much money he will have to print to get there.” This uncertainty seems less than ideal given the risk of price inflation.
- As the end of the present round of QE approached, it appeared it was not working.
- According to Austrian-School economic scholars including Hayek and Huerta de Soto, injecting new money can create only a harmful illusion of prosperity.
As my colleagues point out in their working paper, the fact that the monetary authorities have turned to increasing the quantity of money will focus attention on how that quantity is measured. This article provides some background information and indicates Baxendale and Evans’ key findings.
Continue reading “What is money?”
By Andy Duncan, on 29 April 10
If What Has The Government Done To Our Money? is an hors d’oeuvre, then The Mystery of Banking is the main appetiser in our quest to understand how the current financial global crisis arose. Far meatier than its predecessor, The Mystery of Banking paints the Mona Lisa’s face, where the earlier book simply sketches out the smile.
There are some who say that Murray N. Rothbard’s greatest work is Man, Economy, and State, which some hail as the successor to Human Action. Others say that the mantle of his greatest work lies with The Ethics of Liberty, the pulsating heart of the American libertarian movement. Yet more people declare that it must be Conceived in Liberty, the stunning four-volume series describing the genesis of the American revolution.
Everyone, of course, is right. Because all choices are subjective. However, if I were to be forced to become a Robinson Crusoe and made to occupy a desert island, with hopefully an inexhaustible supply of Gin & Tonic, and only allowed by some great Dictator in the sky to take just one Rothbard masterpiece to the island, then it would have to be The Mystery of Banking, in the same sense that if given the choice of whether to take Beethoven or Mozart, I would have to take Mozart, because although Beethoven is much deeper than our Salzburgian hero, Mozart carries a good tune which I could whistle on the beach. (Though I might also be tempted by The History of Economic Thought, but that’s a different thread in a different story.)
The Mystery of Banking has become an underground classic, with dog-eared copies of the book recently fetching hundreds of dollars on Amazon before the Mises Institute re-published a new edition, also making available a lovingly-produced PDF of the book online. (There is also a stunning version available on Scribd.)
The book has gained a hard-core underground following because it is simply amazing in the sense that it maps out the incredibly dense maze of fractional reserve banking, the Aladdin’s nest of myth and fantasy which since the Florentine banking domination of the Medici clan, has taken the western world to the brink of absolute financial collapse more times than Madonna has re-engineered her underwear. Man, Economy, and State and Conceived in Liberty are perhaps the greater works, due to their sheer undiluted mass, but pound for pound, The Mystery of Banking packs a far more devastating power-to-weight ratio as a water-slashing racing boat skating between high-momentum supertankers.
From its opening, with its dedication to three hard money champions — Thomas Jefferson, Charles Holt Campbell, and Ludwig von Mises — The Mystery of Banking is a remorseless Austrian dissection of what lies at the heart of the western world’s financial system; which some might say is “absolutely nothing at all” and which others might say is “fractional reserve banking”. (Or do I repeat myself?)
Professor Rothbard spends the first hundred pages of his incisive book describing money, its origins out of barter, its purposes, its uses, and its evolution, eventually leading towards the creation of loan banking and free banking from the late medieval period onwards.
Rothbard then describes a more developed world in which twenty dollars became a fixed weight of gold just under one ounce, and how the mathematical genius Isaac Newton defined the pound as a fixed weight of gold just under a quarter of an ounce. (From these fixed weights and their stable exchange rate, the division of labour between the two currency areas can thus be easily integrated into a single wealth-creating whole.)
Although Man, Economy, and State remains the more powerful book, The Mystery of Banking is far more dangerous to the establishment, because it blows the gaffe on their monopoly of money management and reveals who always benefits first from their nefarious practices of printing money directly from thin air (i.e. the government and its friends) and who pays for this benefit (i.e. everyone else).
Although this is obvious to all when a private counterfeiter spends his ill-gotten “money” in local stores, government has wrapped so many emerald-coloured curtains around the alchemy of their nationalisation of the money supply, that this wealth transference effect is much harder to discern with government-regulated fractional reserve banking.
Rothbard shreds these curtains, making it clear how the government always benefits first and why they are motivated to do it — even given an ability to tax — and how they have escaped detection for so long, with otherwise intelligent economic commentators in recent times demanding that governments engage in quantitative easing, to “help” the rest of us, which is like a householder demanding that a burglar steal his possessions in order to help with his insurance claim.
Rothbard blows away the rulers of the emerald city through clear analogy and example, such as beaming down the Angel Gabriel from heaven to double the supply of money in everyone’s pockets overnight, before examining the results of such an action in the morning, thus revealing that any supply of money is equally optimal; this leads to some startling implications.
However, this is just one example. There are many others like it, in the book.
Having carefully used historical precedent to reveal the history of money, in the second half of the book, Rothbard then gradually un-weaves the most insidious double-blind deception in history, which is the rise of central banking and the creeping nationalisation of the banking industry, to follow the nationalisation of money. Starting in England, and then spreading like a virus to the rest of the world, Rothbard lifts stone after stone in his unrelenting mission to expose the light-shy creatures underlying central banking, allowing none of these segmented arthropods to escape back into the darkness and the slime before he scores them with his acidic pen.
The final section of the book examines a Rothbardian seven-part plan, in the Cobden and Bright tradition, to return us all to a hard money standard. The annotated highlights of this plan are:
- Redefining money to be a fixed weight of gold
- Government gold deposits to be returned to their rightful owners, i.e. the holders of government paper money
- Central banks to be abolished
- Fractional reserve banking to be replaced by 100% gold reserve banking for all demand deposits
- Banks to become free to issue their own gold-certificate cash notes
- The complete de-nationalisation of money and the removal of government guarantees on bank accounts, to re-introduce the ‘healthy gale’ of bank runs back into the banking industry — one of Rothbard’s alleged favourite movie scenes is the collapse of the bank of Danglars in The Count of Monte Cristo!
- The abolition of government-mints to be replaced once again by the private minting of gold money
For all true followers of hard money, The Mystery of Banking is thus an essential element on the pathway to understanding how and why we can achieve the goal of honest money, which even the former alchemist Isaac Newton knew was impossible to manipulate over the long term. Let us also hope that if the Rothbardian plan outlined above comes to pass, that the new international name for the fixed weight of gold will be “The Rothbard”, in memory of this hero of hard money, whether this is one gramme, 10 grammes, or a good old-fashioned one Troy-ounce of gold.
By Toby Baxendale, on 21 April 10
Jimmy Stewart plays George Bailey who is cast as the “honest” and trustworthy banker in the classic Hollywood film, “It’s a Wonderful Life.” Kotlikoff’s book laments that in the real world of modern banking, such characters no longer exist.
Kotlikoff himself is a Professor of Economics at Boston. Several Nobel Prize winners have endorsed the book: George Akerlof, Robert Lucas, Robert Fogel, Edward Prescott, and Edmund Phelps. I count 36 endorsements from the great and the good of the academic world on the back cover and front pages. I do not recall ever seeing this in a book.
The book is written for the layman. It is very light on economic theory, but does reference some otherworldly models. It is very good at explaining what on the face of it appear to be complex financial phenomena, but are in fact con tricks that in any other industry would earn you a prison sentence. Kotlikoff shows his readers how the financial system has failed in its fiduciary duty, and presents a very simple and elegant solution for its salvation called Limited Purpose Banking (LPB). He also proposes a reduction of the financial service sector regulators in the USA from its current 115 down to one: the Federal Financial Authority (FFA).
In his opening remarks he discusses the Modigliani-Miller Theorem, written in 1958, showing in elegant maths how in the absence of bankruptcy costs, leverage does not matter. If a company takes on more risk by borrowing more, its owners will offset that risk by borrowing less, leaving total debt in the economy unchanged. Kotlikoff makes no mention of the fact that leverage in itself is not a bad thing if it is made up of people forgoing their consumption today, i.e. saving and committing it to projects that will deliver up goods in the future. This glaring omission does not impede him from telling the story of our financial meltdown and making a solid policy recommendation for this crisis. It does, however, prevent him from seeing the elephant in the room: that the credit creation process itself is the source of the boom and the bust.
The nature of fractional reserve banking is such that if you deposit your cash in a bank, it will lend it out many times over. This means that multiple claims come to exist on the original real money that was deposited. If you deposit £100 in bank A, which lends it to an entrepreneur who deposits it in Bank B, both you and the entrepreneur now have £100! Like magic, we have £200 in the system, with £100 of it created ex novo by the banking system itself! In the UK, with no legal reserve requirement, we have a only £3 on average kept in deposit for every £100 of IOU’s promised by the banking system.
Kotlikoff provides a mainstream justification for fractional reserve banking, citing the Diamond-Dybvig Model, which holds that we value immediate liquidity for emergencies. We do not need that money all the time, so banks can use this and get us a higher return in the meantime. Therefore, governments must do everything to prevent a bank run if more people want their money back than actually exists in the bank vaults.
This is the theoretical understanding we have today and the model is used to justify all sorts of bank bailouts, as we have seen.
Kotlikoff points out that whilst the bailouts have prevented a collapse of the system of fractional reserve banking, the bailouts do not preserve the purchasing power of money. They just guarantee that the money unit will still exist. This is a very good point. All the bailouts are being funded by more claims on the future taxpayer. In the UK, we have a system of money debasement called Quantitative Easing, which will just debase and reduce our purchasing power.
In effect, the bailouts do not do what they say they do on the tin, and daily our purchasing power is getting weaker. It is hard enough to get politicians in the UK to acknowledge the scale of our official national debt, but we owe at least as much again “off balance sheet”, in unfunded pension liabilities and Private Finance Initiative obligations. Debasement will be the most popular way forward for all future governments as they will not want to overtly extract more wealth from us. Dishonesty will be the preferred policy.
Limited purpose banking would be a simple solution to all of this. Banks would be limited to their main purpose of matching savers to borrowers. All financial companies would act as pass though mutual fund companies. They would be middle men, never would they own the financial assets. They could thus never fail in the “run on the bank” sense — i.e. depositors wishing to withdraw money — but only if they were very bad at business. This is thus as near as you will get to risk-free banking. Never again would the economy be held liable to bail out the bankers.
Kotlikoff foresees at least two mutual funds being offered, with custodians holding the assets: one that holds cash and one that holds insurance funds. He does stress that innovation could still happen, with a multiplicity of funds being offered. The Federal Financial Authority (FFA) would regulate the custody element of the safe keeping of the various mutual fund assets. He assumes that regulators will be able to opine, like the current rating agencies, on the soundness of the assets that have been bought by the fund. He would trust the government over the rating agencies. I personally would trust neither! In my industry, selling meat and fish, we have a number of free market created quality assurance bodies such as the British Soil Association for organic certification, the Marine Stewardship Council for fish sustainability that require no government sanction. These have the confidence of both the consumer and producer. I would suggest that this and not a super regulator is the way forward.
Cash funds are nice and easy; they hold cash and are 100% reserved. They can never go up or down in value. These cash mutual funds represent the demand deposits of the new spec banking system. All services such as cheque writing and paying bills is done via this vehicle.
I have written about 100% reserve banking here and Steve Baker has specifically examined the 100% reserve banking proposal of Irving Fisher, to which Kotlikoff refers. He notes that the current economic profession considers these ideas to be “crackpot”; the Diamond-Dybvig model remains dominant. He goes go on to say, “I want to be clear that I am not an advocate of narrow banking in of itself. Narrow banking is a small feature of limited purpose banking and would hardly suffice to deal with today’s multifaceted financial problems.”
He notes that with the many cash mutual funds in place, the money measure in the USA, MI, would correspond exactly with what the government had printed. So to cover all obligations, a massive print up in US dollars would need to take place — many trillions of dollars to truly purge the system. What Kotlikoff misses is De Soto’s insight, based on the work of Fisher, that there will be a unique moment in history when instead of causing debasement, the printed money would cover all unfunded demand deposits, swapping them out for cash. Wipe out or retire these demand deposits and the banking system has no current creditors, only assets. Take out the equivalent amount of assets from the banking system, so the banking system has the same net worth as before, then put these assets into the mutuals and pay off the national debt. This is not inflationary, requires no debasement, and will help deliver up safe banking. This is summarised in our Day of Reckoning article.
Insurance mutuals would have all the other banking instruments such as CDO’s in them and could market these funds to whomever they wished. These are essentially what we would term a hedge fund today, though Kotlikoff proposes that these be closed end. This means you have to sell your shares in the fund to redeem your money. Consequently, long term lending can take place in these funds without the fear of a maturity mismatch. The only money this type of fund can lose is what is invested in it. It could never in itself pull down the banking system.
I sense that the author does not feel comfortable with the 100% reserve label, with its “crackpot” associations. In discussing the transfer of Citigroup he says,
“Here we’d need to swap all of CitiGroup’s debt for equity and prevent it from ever borrowing again to fund risky investments. We can now think of CitiGroup as a huge mutual fund with lots of different assets, one big commercial bank with 100 percent capital requirement, or one LPB with a large number of different mutual funds corresponding to the different Citigroup asset classes.”
He also points out that LPB could not actually be that far away if you take into account all the reserves that have been created already. This is something George Reisman has also pointed out.
Kotlikoff defensively shows how LPB would not reduce liquidity. It would not reduce real credit, i.e. savers forwarding money to borrowers. It would stop credit created out of thin air via the banking system, the prime cause of the crisis, but this is not mentioned in his book. It would lead to an optimal size financial sector. Our cash assets would be safe as you can get. Government could still monetise debt as it could still create cash from nothing. The currency and thus the purchasing power of money could not collapse by the actions of the banking system, but only by the actions of the government.
Kotlikoff concludes,
Limited purpose banking is the answer. This simple and easily-implemented pass-though mutual fund system, with its built in firewalls, would preclude financial crises of the type we’re now experiencing. The system will rely on independent rating by the government, but private rating as well. It would require full disclosure and provide maximum transparency. Most important, it would make clear that risk is ultimately born by people, not companies, and that most people need, and have a right, to know what risks, including fiscal risk, they are facing. Finally, it would make clear what risks are, and are not, diversifiable. It would not pretend to insure the uninsurable or guarantee returns that can’t be guaranteed. In short, the system would be honest, and because of that, it would be safe-safe for ourselves and safe for our children.
Although I think he has failed to identify the state sponsored banking system, with its fractional reserve credit creation point as the cause of booms and busts, his solution has many merits and many similarities with the solution proposed by Fisher, De Soto, and others. He missed what I call the golden opportunity, or unique moment in history, to actually enact a reform that delivers up 100% reserve of LPB and pays off the national debt and other unfunded obligations at the same time. My own solution is the De Soto 100% reserve free banking solution with banks working within the existing commercial law to which all non-bank companies must adhere. However, both systems have the same effects and would do the job needed: to sort out the banking system, provide stability, and let capitalism flourish. Yet another workable solution has been proposed by our very own Paul Birch. Kotlikoff’s contribution to the debate, with all the Nobel endorsements, is timely, and I hope policy makers give due attention to innovative solutions like these.
By Steven Baker MP, on 8 April 10
This post is taken from Mises, The Theory of Money and Credit (1934), chapter 13 Monetary Policy (PDF, HTML), covering the limits of monetary policy. Follow this link for the series.
Emphasis mine.
6 The Limits of Monetary Policy
The results of our investigation into the development and significance of monetary policy should not surprise us. That the state, after having for a period used the power which it nowadays has of influencing to some extent the determination of the objective exchange value of money in order to affect the distribution of income, should have to abandon its further exercise, will not appear strange to those who have a proper appreciation of the economic function of the state in that social order which rests upon private property in the means of production. The state does not govern the market; in the market in which products are exchanged it may quite possibly be a powerful party, but nevertheless it is only one party of many, nothing more than that. All its attempts to transform the exchange ratios between economic goods that are determined in the market can only be undertaken with the instruments of the market. It can never foresee exactly what the result of any particular intervention will be. It cannot bring about a desired result in the degree that it wishes, because the means that the influencing of demand and supply place at its disposal only affect the pricing process through the medium of the subjective valuations of individuals; but no judgment as to the intensity of the resulting transformation of these valuations can be made except when the intervention is a small one, limited to one or a few groups of commodities of lesser importance, and even in such a case only approximately. All monetary policies encounter the difficulty that the effects of any measures taken in order to influence the fluctuations of the objective exchange value of money can neither be foreseen in advance, nor their nature and magnitude be determined even after they have already occurred.
Now the renunciation of intervention on grounds of monetary policy that is involved in the retention of a metallic commodity currency is not complete. In the regulation of the issue of fiduciary media there is still another possibility of influencing the objective exchange value of money. The problem that this gives rise to must be investigated (in the following part) before we can discuss certain plans that have recently been announced for the establishment of a monetary system under which the value of money would be more stable than that of a gold currency.
Read on…
Further Reading
Please see our literature for a range of further reading and also The Crack Up Boom.
By Steven Baker MP, on 6 April 10
This post is taken from Mises, The Theory of Money and Credit (1934), chapter 13 Monetary Policy (PDF, HTML), covering inflationism. Follow this link for the series.
Emphasis mine.
3 Inflationism
Inflationism is that monetary policy that seeks to increase the quantity of money.
Naive inflationism demands an increase in the quantity of money without suspecting that this will diminish the purchasing power of the money. It wants more money because in its eyes the mere abundance of money is wealth. Fiat money! Let the state “create” money, and make the poor rich, and free them from the bonds of the capitalists! How foolish to forgo the opportunity of making everybody rich, and consequently happy, that the state’s right to create money gives it! How wrong to forgo it simply because this would run counter to the interests of the rich! How wicked of the economists to assert that it is not within the power of the state to create wealth by means of the printing press!—You statesmen want to build railways, and complain of the low state of the exchequer? Well, then, do not beg loans from the capitalists and anxiously calculate whether your railways will bring in enough to enable you to pay interest and amortization on your debt. Create money, and help yourselves.
Other inflationists realize very well that an increase in the quantity of money reduces the purchasing power of the monetary unit. But they endeavor to secure inflation nonetheless, because of its effect on the value of money; they want depreciation, because they want to favor debtors at the expense of creditors and because they want to encourage exportation and make importation difficult. Others, again, recommend depreciation for the sake of its supposed property of stimulating production and encouraging the spirit of enterprise.
Depreciation of money can benefit debtors only when it is unforeseen. If inflationary measures and a reduction of the value of money are expected, then those who lend money will demand higher interest in order to compensate their probable loss of capital, and those who seek loans will be prepared to pay the higher interest because they have a prospect of gaining on capital account. Since, as we have shown, it is never possible to foresee the extent of monetary depreciation, creditors in individual cases may suffer losses and debtors make profits, in spite of the higher interest exacted. Nevertheless, in general it will not be possible for any inflationary policy, unless it takes effect suddenly and unexpectedly, to alter the relations between creditor and debtor in favor of the latter by increasing the quantity of money. Those who lend money will feel obliged, in order to avoid losses, either to make their loans in a currency that is more stable in value than the currency of their own country, or to include in the rate of interest they ask, over and above the compensation that they reckon for the probable depreciation of money and the loss to be expected on that account, an additional premium for the risk of a less probable further depreciation. And if those who were seeking credit were inclined to refuse to pay this additional compensation, the diminution of supply in the loan market would force them to it. During the inflation after the war it was seen how savings deposits decreased because savings banks were not inclined to adjust interest rates to the altered conditions of the variations in the purchasing power of money.
It has already been shown in the preceding chapter that it is a mistake to think that the depreciation of money stimulates production. If the particular conditions of a given case of depreciation are such that wealth is transferred to the rich from the poor, then admittedly saving (and consequently capital accumulation) will be encouraged, production will consequently be stimulated, and so the welfare of posterity increased. In earlier epochs of economic history a moderate inflation may sometimes have had this effect. But the more the development of capitalism has made money loans (bank and savings-bank deposits and bonds, especially bearer bonds and mortgage bonds) the most important instruments of saving, the more has depreciation necessarily imperiled the accumulation of capital, by decreasing the motive for saving. How the depreciation of money leads to capital consumption through falsification of economic calculation, and how the appearance of a boom that it creates is an illusion, and how the depreciation of the money really reacts on foreign trade have similarly been explained already in the preceding chapter.
A third group of inflationists do not deny that inflation involves serious disadvantages. Nevertheless, they think that there are higher and more important aims of economic policy than a sound monetary system. They hold that although inflation may be a great evil, yet it is not the greatest evil, and that the state might under certain circumstances find itself in a position where it would do well to oppose greater evils with the lesser evil of inflation. When the defense of the fatherland against enemies, or the rescue of the hungry from starvation is at stake, then, it is said, let the currency go to ruin whatever the cost.
Sometimes this sort of conditional inflation is supported by the argument that inflation is a kind of taxation that is advisable in certain circumstances. Under some conditions, according to this argument, it is better to meet public expenditure by a fresh issue of notes than by increasing the burden of taxation or by borrowing. This was the argument put forward during the war when the expenditure on the army and navy had to be met; and this was the argument put forward in Germany and Austria after the war when a part of the population had to be provided with cheap food, the losses on the operation of the railways and other public undertakings met, and reparations payments made. The assistance of inflation is invoked whenever a government is unwilling to increase taxation or unable to raise a loan; that is the truth of the matter The next step is to inquire why the two usual methods of raising money for public purposes cannot or will not be employed.
It is only possible to levy high taxes when those who bear the burden of the taxes assent to the purpose for which the resources so raised are to be expended. It must be observed here that the greater the total burden of taxation becomes, the harder it is to deceive public opinion as to the impossibility of placing the whole burden of taxation upon the small richer class of the community. The taxation of the rich or of property affects the whole community, and its ultimate consequences for the poorer classes are often more severe than those of taxation levied throughout the community. These implications may perhaps be harder to grasp when taxation is low; but when it is high they can hardly fail to be recognized. There can, moreover, be no doubt that it is scarcely possible to carry the system of relying chiefly upon “taxation of ownership” any farther than it has been carried by the inflating countries, and that the incidence of further taxation could not have been concealed in the way necessary to guarantee continued popular support.
Who has any doubt that the belligerent peoples of Europe would have tired of war much more quickly if their governments had clearly and candidly laid before them at the time the account of their war expenditure? In no European country did the war party dare to impose taxation on the masses to any considerable extent for meeting the cost of the war. Even in England, the classical country of “sound money,” the printing presses were set in motion. Inflation had the great advantage of evoking an appearance of economic prosperity and of increase of wealth, of falsifying calculations made in terms of money, and so of concealing the consumption of capital. Inflation gave rise to the pseudo-profits of the entrepreneur and capitalist which could be treated as income and have specially heavy taxes imposed upon them without the public at large—or often even the actual taxpayers themselves—seeing that portions of capital were thus being taxed away. Inflation made it possible to divert the fury of the people to “speculators” and “profiteers.” Thus it proved itself an excellent psychological resource of the destructive and annihilist war policy.
What war began, revolution continued. The socialistic or semi-socialistic state needs money in order to carry on undertakings which do not pay, to support the unemployed, and to provide the people with cheap food. It also is unable to secure the necessary resources by means of taxation. It dare not tell the people the truth. The state-socialist principle of running the railways as a state institution would soon lose its popularity if it was proposed, say, to levy a special tax for covering their running losses. And the German and Austrian people would have been quicker in realizing where the resources came from that made bread cheaper if they themselves had to supply them in the form of a bread tax. In the same way, the German government that decided for the “policy of fulfillment” in opposition to the majority of the German people, was unable to provide itself with the necessary means except by printing notes. And when passive resistance in the Ruhr district gave rise to a need for enormous sums of money, these, again for political reasons, were only to be procured with the help of the printing press.
A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, i.e., of antidemocratic, policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. It explains why inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. When governments do not think it necessary to accommodate their expenditure to their revenue and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism.
The various aims pursued by inflationists demand that the inflationary measures shall be carried through in various special ways. If depreciation is wanted in order to favor the debtor at the expense of the creditor, then the problem is to strike unexpectedly at creditor interests. As we have shown, to the extent to which it could be foreseen, an expected depreciation would be incapable of altering the relations between creditors and debtors. A policy aiming at a progressive diminution of the value of money does not benefit debtors.
If, on the other hand, the depreciation is desired in order to “stimulate production” and to make exportation easier and importation more difficult in relation to other countries, then it must be borne in mind that the absolute level of the value of money—its purchasing power in terms of commodities and services and its exchange ratio against other kinds of money—is without significance for external (as for internal) trade; the variations in the objective exchange value of money have an influence on business only so long as they are in progress. The “beneficial effects” on trade of the depreciation of money only last so long as the depreciation has not affected all commodities and services. Once the adjustment is completed, then these “beneficial effects” disappear. If it is desired to retain them permanently, continual resort must be had to fresh diminutions of the purchasing power of money. It is not enough to reduce the purchasing power of money by one set of measures only, as is erroneously supposed by numerous inflationist writers; only the progressive diminution of the value of money could permanently achieve the aims which they have in view. [5] But a monetary system that corresponds to these requirements can never be actually realized.
Of course, the real difficulty does not lie in the fact that a progressive diminution of the value of money must soon reach amounts so small that they would no longer meet the requirements of commerce. Since the decimal system of calculation is customary in the majority of present-day monetary systems, even the more stupid sections of the public would find no difficulty in the new reckoning when a system of higher units was adopted. We could quite easily imagine a monetary system in which the value of money was constantly falling at the same proportionate rate. Let us assume that the purchasing power of this money, through variations in the determinants that lie on the side of money, sinks in the course of a year by one-hundredth of its amount at the beginning of the year The levels of the value of the money at each new year then constitute a diminishing geometrical series. If we put the value of the money at the beginning of the first year as equivalent to 100, then the ratio of diminution is equivalent to 0.99, and the value of money at the end of the nth year is equivalent to 100 × 0.99n-1. Such a convergent geometrical progression gives an infinite series, any member of which is always to the next following member in the ratio of 100 : 99. We could quite easily imagine a monetary system based on such a principle; perhaps even more easily still if we increased the ratio, say, to 0.995 or even 0.9975.
But however clearly we may be able to imagine such a monetary system, it certainly does not lie in our power actually to create one like it. We know the determinants of the value of money, or think we know them. But we are not in a position to bend them to our will. For we lack the most important prerequisite for this; we do not so much as know the quantitative significance of variations in the quantity of money. We cannot calculate the intensity with which definite quantitative variations in the ratio of the supply of money and the demand for it operate upon the subjective valuations of individuals and through these indirectly upon the market. This remains a matter of very great uncertainty. In employing any means to influence the value of money we run the risk of giving the wrong dose. This is all the more important since in fact it is not possible even to measure variations in the purchasing power of money. Thus even though we can roughly tell the direction in which we should work in order to obtain the desired variation, we still have nothing to tell us how far we should go, and we can never find out where we are already, what effects our intervention has had, or how these are proportioned to the effects we desire.
Now the danger involved in overdoing an arbitrary influence—a political influence; that is, one arising from the conscious intervention of human organizations—upon the value of money must by no means be underestimated, particularly in the case of a diminution of the value of money. Big variations in the value of money give rise to the danger that commerce will emancipate itself from the money which is subject to state influence and choose a special money of its own. But without matters going so far as this it is still possible for all the consequences of variations in the value of money to be eliminated if the individuals engaged in economic activity clearly recognize that the purchasing power of money is constantly sinking and act accordingly. If in all business transactions they allow for what the objective exchange value of money will probably be in the future, then all the effects on credit and commerce are finished with. In proportion as the Germans began to reckon in terms of gold, so was further depreciation rendered incapable of altering the relationship between creditor and debtor or even of influencing trade. By going over to reckoning in terms of gold, the community freed itself from the inflationary policy, and eventually even the government was obliged to acknowledge gold as a basis of reckoning.
A danger necessarily involved in all attempts to carry out an inflationary policy is that of excess. Once the principle is admitted that it is possible, permissible, and desirable, to take measures for “cheapening” money, then immediately the most violent and bitter controversy will break out as to how far this principle is to be carried. The interested parties will differ not merely about the steps still to be taken, but also about the results of the steps that have been taken already. It would be impossible for any inflationary measures to be taken without violent controversy. It would be practically impossible so much as to consider counsels of moderation. And these difficulties arise even in the case of an attempt to secure what the inflationists call the beneficial effects of a single and isolated depreciation. Even in the case, say, of assisting “production” or debtors after a serious crisis by a single depreciation of the value of money, the same problems remain to be solved. They are difficulties that have to be reckoned with by every policy aiming at a reduction of the value of money.
Consistently and uninterruptedly continued inflation must eventually lead to collapse. The purchasing power of money will fall lower and lower, until it eventually disappears altogether. It is true that an endless process of depreciation can be imagined. We can imagine the purchasing power of money getting continually lower without ever disappearing altogether, and prices getting continually higher without it ever becoming impossible to obtain commodities in exchange for notes. Eventually this would lead to a situation in which even retail transactions were in terms of millions and billions and even higher figures; but the monetary system itself would remain.
But such an imaginary state of affairs is hardly within the bounds of possibility. In the long run, a money which continually fell in value would have no commercial utility. It could not be used as a standard of deferred payments. For all transactions in which com modities or services were not exchanged for cash, another medium would have to be sought. In fact, a money that is continually depreciating becomes useless even for cash transactions. Everybody attempts to minimize his cash reserves, which are a source of continual loss. Incoming money is spent as quickly as possible, and in the purchases that are made in order to obtain goods with a stable value in place of the depreciating money even higher prices will be agreed to than would otherwise be in accordance with market conditions at the time. When commodities that are not needed at all or at least not at the moment are purchased in order to avoid the holding of notes, then the process of extrusion of the notes from use as a general medium of exchange has already begun. It is the beginning of the “demonetization” of the notes. The process is hastened by its paniclike character. It may be possible once, twice, perhaps even three or four times, to allay the fears of the public; but eventually the affair must run its course and then there is no longer any going back. Once the depreciation is proceeding so rapidly that sellers have to reckon with considerable losses even if they buy again as quickly as is possible, then the position of the currency is hopeless.
In all countries where inflation has been rapid, it has been observed that the decrease in the value of the money has occurred faster than the increase in its quantity. If m represents the nominal amount of money present in the country before the beginning of the inflation, P the value of the monetary unit then in terms of gold, M the nominal amount of money at a given point of time during the inflation, and p the value in gold of the monetary unit at this point of time; then, as has often been shown by simple statistical investigations, mP > Mp. It has been attempted to prove from this that the money has depreciated “too rapidly” and that the level of the rate of exchange is not “justified.” Many have drawn from it the conclusion that the quantity theory is obviously not true and that depreciation of money cannot be a result of an increase in its quantity. Others have conceded the truth of the quantity theory in its primitive form and argued the permissibility or even the necessity of continuing to increase the quantity of money in the country until its total gold value is restored to the level at which it stood before the beginning of the inflation, that is, until Mp = mP.
The error that is concealed in all of this is not difficult to discover. We may completely ignore the fact already referred to that the exchange rates (including the bullion rate) move in advance of the purchasing power of the money unit as expressed in the prices of commodities, so that the gold value must not be taken as a basis of operations, but purchasing power in terms of commodities, which as a rule will not have decreased to the same extent as the gold value. For this form of calculation too, in which P and p do not represent value in terms of gold but purchasing power in terms of commodities, would still as a rule give the result mP > Mp. But it must be observed that as the depreciation of money proceeds, the demand for money (that is, for the kind of money in question) gradually begins to fall. When loss of wealth is suffered in proportion to the length of time money is kept on hand, endeavors are made to reduce cash holdings as much as possible. Now if every individual, even if his circumstances are otherwise unchanged, no longer wishes to maintain his cash holding at the same level as before the beginning of the inflation, the demand for money in the whole community, which can only be the sum of the individuals’ demands, decreases too. There is also the additional fact that as commerce gradually begins to use foreign money and actual gold in place of notes, individuals begin to hold part of their reserves in foreign money and in gold and no longer in notes.
An expected fall in the value of money is anticipated by speculation so that the money has a lower value in the present than would correspond to the relationship between the immediate supply of it and demand for it. Prices are asked and given that are not related to the present amount of money in circulation nor to present demands for money, but to future circumstances. The panic prices paid when the shops are crowded with buyers anxious to pick up something or other while they can, and the panic rates reached on the exchange when foreign currencies and securities that do not represent a claim to fixed sums of money rise precipitously, anticipate the march of events. But there is not enough money available to pay the prices that correspond to the presumable future supply of money and demand for it. And so it comes about that commerce suffers from a shortage of notes, that there are not enough notes on hand for fulfilling commitments that have been entered into. The mechanism of the market that adjusts the total demand and the total supply to each other by altering the exchange ratio no longer functions as far as the exchange ratio between money and other economic goods is concerned. Business suffers sensibly from a shortage of notes. This bad state of affairs, once matters have gone as far as this, can in no way be helped. Still further to increase the note issue (as many recommend) would only make matters worse. For, since this would accelerate the growth of the panic, it would also accentuate the maladjustment between depredation and circulation. Shortage of notes for transacting business is a symptom of an advanced stage of inflation; it is the reverse aspect of panic purchases and panic prices, the reflection of the “bullishness” of the public that will finally lead to catastrophe.
The emancipation of commerce from a money which is proving more and more useless in this way begins with the expulsion of the money from hoards. People begin at first to hoard other money instead so as to have marketable goods at their disposal for unforeseen future needs—perhaps precious-metal money and foreign notes, and sometimes also domestic notes of other kinds which have a higher value because they cannot be increased by the state (for example, the Romanoff ruble in Russia or the “blue” money of communist Hungary); then ingots, precious stones, and pearls; even pictures, other objects of art, and postage stamps. A further step is the adoption of foreign currency or metallic money (that is, for all practical purposes, gold) in credit transactions. Finally, when the domestic currency ceases to be used in retail trade, wages as well have to be paid in some other way than in pieces of paper which are then no longer good for anything.
The collapse of an inflation policy carried to its extreme—as in the United States in 1781 and in France in 1796—does not destroy the monetary system, but only the credit money or fiat money of the state that has overestimated the effectiveness of its own policy. The collapse emancipates commerce from etatism and establishes metallic money again.
It is not the business of science to criticize the political aims of inflationism. Whether the favoring of the debtor at the expense of the creditor, whether the facilitation of exports and the hindrance of imports, whether the stimulation of production by transferring wealth and income to the entrepreneur, are to be recommended or not, are questions which economics cannot answer. With the instruments of monetary theory alone, these questions cannot even be elucidated as far as is possible with other parts of the apparatus of economics. But there are nevertheless three conclusions that seem to follow from our critical examination of the possibilities of inflationary policy.
In the first place, all the aims of inflationism can be secured by other sorts of intervention in economic affairs, and secured better, and without undesirable incidental effects. If it is desired to relieve debtors, moratoria may be declared or the obligation to repay loans may be removed altogether; if it is desired to encourage exportation, export premiums may be granted; if it is desired to render importation more difficult, simple prohibition may be resorted to, or import duties levied. All these measures permit discrimination between classes of people, branches of production, and districts, and this is impossible for an inflationary policy. Inflation benefits all debtors, including the rich, and injures all creditors, including the poor; adjustment of the burden of debts by special legislation allows of differentiation. Inflation encourages the exportation of all commodities and hinders all importation; premiums, duties, and prohibitions can be employed discriminatingly.
Second, there is no kind of inflationary policy the extent of whose effects can be foreseen. And finally, continued inflation must lead to a collapse.
Thus we see that, considered purely as a political instrument, inflationism is inadequate. It is, technically regarded, bad policy, because it is incapable of fully attaining its goal and because it leads to consequences that are not, or at least are not always, part of its aim. The favor it enjoys is due solely to the circumstance that it is a policy concerning whose aims and intentions public opinion can be longest deceived. Its popularity, in fact, is rooted in the difficulty of fully understanding its consequences.
Further Reading
Please see our literature for a range of further reading and also The Crack Up Boom.
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