Few people are aware of what the Federal Reserve System, acting on behalf of the U.S. Government, is doing to their money. Hans Sennholz writes that it is inflating and depreciating the dollar at various rates–at double-digit rates during the 1970s and early 80s and at single-digit rates ever since. The present dollar is worth no more than 10 cents of the 1970 dollar and 50 cents of the 1980 dollar. FULL ARTICLE
Source link: http://blog.mises.org/3742/the-many-evils-of-inflation/
The Many Evils of Inflation
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Government gets away with inflating the currency because most of the population don’t understand the implications of inflation. The few savers in the nation may be aware that they’re receiving very low interest on their savings (bank accounts, various investment certificates etc). What very few ordinary people realise is that the fed increases the money supply at a higher percentage than the interest rate they’re receiving on their accumulated savings. Under a market-driven gold standard banking system, the rate of interest on savings always exceeds the rate at which the supply if money is being increased. This latter system provides greater long term security for ordinary private citizens who only have a very rudimentary understanding of economics.
Dr Sennholz is correct. The inflation system is pernicious.
Harry Valentine
In other words, a mild inflation favors net borrowers over net lenders. I suspect that the majority of Libertarians are net borrowers. The vast majority of working people are net borrowers. Our owners are net lenders.
A steady state system is impossible so I prefer the bias to favor the working people over our owners. When we had a gold money standard half of all Americans lived in poverty i.e. didn’t own any gold. Why do Libertarians think that reverting to the old money system would not produce the old results?
Libertarians tend to think the “system” holds them down. This is bad thinking. A person with normal intelligence can do OK as long as the rules are consistant and understood. Every system has a top half and a bottom half. Some systems have more mobility than others. Mobility is a two edged sword – easy to rise, easy to fall. As long as one’s position in the economic ranking isn’t determined by caste or chains a small rate of inflation will encourage the climbing people over the owners. Why do Libertarians want to help the owners?
Second, the international value of a nation’s money is determined by the relative economic position of the nation, not the distribution of wealth within the nation. Breaks my heart if the Japanese lose money by holding dollars. The Fed can hurt or help the working people but can’t control the international price of the dollar.
The only way the Japanese can use dollars is to spend them in America. The Japanese lost big time 20 years ago buying American real estate. If they buy and operate American factories more efficiently than Americans do, good for them. They can’t gain political control because factories don’t vote.
Third, Libertarian thinking is a century behind real time activity. In this age wealth will be produced by manipulating people and ideas (information), not by building large factories. This diminishes the need for physical capital.
I liked the focus on morality and inflation, hardly anyone I know has really wrote an article that focused on the trickery aspect of inflation. the whole thing(fiat money and playing with interest rates to achieve to desired levels of ‘employment, investment, etc etc) is a kind of shell game that academics blind themselves to. No one really asks when managing the central bank, of course we COULD try to achieve goal A, B, or C but is it really appropriate for us to do it this way?
“In other words, a mild inflation favors net borrowers over net lenders.”
No. The system is designed to facilitate two things: 1) Banks can lend out–and make interest on–money they don’t actually have. 2) Governments can spend money without the politically-inconvenient need to extract it from taxpayers first.
All the rest, whether true or not, is a distraction from this fundamental point.
I completely disagree with Mr. Wald. To the extent that inflation favours borrowers over lenders, this is a bad thing.
1. It discourages the saving and investment of capital, raising the lender’s time preferences.
2. It encourages wasteful spending habits and credit binges for borrowers. Their time preferences also go up.
“Why do Libertarians want to help the owners?” Because in a free society, libertarians are owners of capital, just like everyone else who works hard and consumes less than he produces. I see no rational basis for Mr. Wald’s constant assertion that free markets produce an oppressive owner caste. I also see no rational reason that manipulating ideas will be a source of wealth in the future, except to the extent that it makes the production of material goods more efficient and thus adds value.
Inflation does not really favor debtors unless the first order lenders are complete idiots and charge an interest rate under the rate of inflation. Look around you- do you really see this happening? I certainly don’t.
Now, in the sense that people like me who save large fractions of their income are the source of the loanable funds, then yes, I am being screwed by the Fed and by the banks, but they are not being screwed by the inflation- they, in fact, feed off of it like parasites.
I do not completely agree with the idea that the rate of inflation has slowed… “at double-digit rates during the 1970s and early 80s and at single-digit rates ever since.”
I remember quite distinctly that the productivity rate was the big bugaboo in the 70s and early 80s. However, productivity has SKYROCKETED since then and we are still seeing inflation. I dare say that if productivity had remained anywhere near what it had been earlier, actual “price inflation” would be through the roof. As it is, we just work longer hours more intensely – for lower inflation.
“At the same time Japanese and Chinese companies are investing surplus dollars in the United States, assuming control over American corporations. If the United States government should ever disrupt this peaceful relationship with discriminatory trade restrictions and painful barriers, the Asian creditors may dump some dollar holdings. The dollar crash would be heard around the globe.”
If by “dump some dollar holdings”, what is meant is the selling of US assets redeemable in US dollars, rather than the selling of actual US dollars kept purely as cash holdings, then I have to argue against it. I think that unless, on net, foreign (or domestic, for that matter) actors decide to reduce their actual USD cash holdings, any shift in ownership of USD denominated assets from foreign to domestic owners will have no impact whatsoever on the value of USD. I believe Mises argues the same in Human Action. But I will argue it on my own here: For a foreign actor to sell a US commodity, someone must pay with USDs. How do they do this: they have to in the end remove USDs from the economy. There are precisely as much fewer USDs available in the economy immediately after the sale of US assets by the foreign actors as are now in the hands of the foreign actor. Up to this point, then, there has been a net reduction in US dollars in the economy. From that point on, no matter what the foreigner does with his USDs, he can do no worse than to trade them with someone who wants them to spend on US assets again. He can do this by trading his USDs for his own or another currency, but regardless, he has, on net, not added a single USD available to the world than there was before the sale. If the purchasing power of a dollar is based purely on its supply and demand, and an action changes neither the supply nor the demand for a dollar, how can Asian creditors selling off US assets influence the USD?
Inflation doesn’t help borrowers over lenders – it is a fallacy because it is only partially true and only the first time inflation occurs.
Lenders figure out what is happening and then raise the interest rates not only to the current inflation, they add an inflation risk premium (or go out of business). Either way, there is less money to borrow AFTER inflation than before, or it costs more as there is more uncertainty.
Under gold, the lender knows he will get repaid with the same purchasing power, so he just needs the basic interest and something for default risk. Interest rates also tend to fluctuate far more without a gold standard, so there is also an interest rate risk premium.
The first inflation does reduce the value of the loan, but it also reduces the purchasing power of any remaining currency spent on other things besides paying back the loan as well as any income. It would be like a 10% tax imposed on income with a simultaneous 10% reduction in the value of all loans. Most people cannot increase their wages unilaterally to keep up with inflation.
I don’t consider “not owning any gold” as any sign of poverty, but I don’t even think that is true. Assuming you count deposits in banks, I think a vast majority during the gold standard owned some gold – or other assets which were more valuable (like farmland). Back then a 1/2 oz gold piece was $10 – by definition. Right now it would take over $200. Moving a decimal point might make someone feel richer, but it creates no wealth.
And even on an ownership basis, we are far poorer now than at the earlier part. The majority might have the title to their home, but some financial institution owns more than 50% of that, and if it needed to be paid off today would wipe out all their assets. Someone with a negative $100,000 in net worth is not rich although they may have a lavish lifestyle.
Gold keeps things honest. That might be your problem in that you prefer the illusion of prosperity (which will eventually disappear) with actual numerical poverty instead of actual prosperity at a lower level, but one that is more permanent.
Let me also state I am for the working person and the common man.
That means fixing problems with the economy and not giving it an anaesthetic so it can keep going while rotting from within.
And the international position of our currency is important because it is not neutral. It will by definition affect the wealth within the nation. The rich have inflation protected hedge funds and other means to actually profit. The typical worker has nothing – he can only get almost nothing in interest as his purchasing power erodes. When you play games and create distortions you hurt the common man.
And it hurts the working man again because the Japanese investor isn’t likely to be able to hire a worker directly, but can buy our commodities or other low-value-added items. Why build factories when they can invest in outsourcing multinationals or stores that buy all their stock items from China?
And we can inflate and distort the international value of our currency apart from our economic position – which would remain constant in gold terms.
When the next recession hits, people will stop buying “ideas”, and worry about getting food and other basic commodities. So “wealth” created in the virtual world will disappear.
China could have easily chosen to bypass an industrial, manufacturing economy and doesn’t have enough resources to easily create one, but does have an educated population. They could have leapfrogged into the “21st century”, but didn’t. I don’t think it is because they are nostalgic or stupid.
Even the libertarians are finding ways of creating digital gold currency systems. They are going ahead – far ahead. The nation-state as an entity is dying – the USSR broke apart, and the EU is going that way, and even the USA and Canada aren’t safe from break-up.
Gold worked as a currency for millenia, still does, and will.
Any manipulation, fuzziness, corruption, or such always hurts the poor more than the rich. But often you see the 5000 jobs announced with a big show at the subsidized factory, not the 10000 lost jobs when the businesses can’t afford to employ them but instead must pay taxes to build the subsidized factory – they’re invisible. You see the immediate benefits of inflation but ignore what Mises showed – that the fatcats get first use of the newly printed dollars at par, but the poor get them only after they have devalued.
With enough zoloft or prozac you can feel really good even if you are a couch potato. But that won’t make you healthy as someone who get proper rest, exercise, and nutrition.
Most libertarians, and particularly those like me are for fixed and honest standards and for true wealth. Not feel good illusions.
Good posts, TZ.
No mention of a dematerialized private money, is this idea generally considered dead?
Melt_Core,
I would be more interested in a method of rematerializing my money.:~)
melt_core writes: “No mention of a dematerialized private money, is this idea generally considered dead?”
No, it’s not dead, it’s just awaiting the momentum boost it will get as the fraud of central banking plays itself out, and the flight to sound money is on in ernest. Which is to say that the era of private, gold-backed electronic currencies (e.g., http://www.xandara.com/egold.htm) is only a matter time and that this State-squelching revolution cannot happen too soon.
There is no longer a direct connection between raising capital for industrial expansion and putting money into the stock market. Only initial offerings raise capital. All the rest is gambling that some sucker will pay more for a stock then you did.
Bill Wald:
I see your comments from time to time and stifle an urge to respond. And, though I’ve singled you out, there are a few others to whom I’d address the very same remarks.
You are engaging in discourse intended primarily for those with some more than superficial knowledge of the writings of Von Mises and other of the Austrian economic (and political) thinkers. Unless you are someone with a deliberate and somewhat malicious intent to distract or interrupt, your querstions, objections, and opinions are all of a single sort: made in complete ignorance of anything Mises has said on whichever of the topics has aroused your interest. I am not scornful of your opinion; rather, I (following the lead of Mises himself) attribute no base or dishonest intent to such expression–I interpret them as intellectually motivated.
But then, the question becomes: since you obviously have significant interest in the subjects discussed and relatively well-
formed (though not well-informed) opinions on them, why is it that you seem not to have the slightest clue as to what Mises has had to say on the many subjects on which you comment? After all, this is a MISES site and the man has addressed specific and compelling argumentation to EVERY matter on which I’ve ever seen you comment. It’s almost like attending a football game and expressing wonderment that the players don’t use bats or mitts. I’m not ridiculing you but I am chiding. Many of the posters here are capable of dealing with most of your commentary. But the point is missed: if you, yourself, are genuinely interested in these matters, how is it that you are able to ignore the work that forms the common-knowledge basis for most of the community? I will stipulate that Mises is not an “easy read”; but on the other hand, I will state plainly that he has expressed himself clearly and definitively on every matter in which you’ve shown interest. That in itself should excite your interest. Who knows–a bit of Mises and you may find yourself thinking differently about one or many topics; it’s happened before. My guess is that you wouldn’t have many questions left and, if you did, they’d be better ones and of greater general interest.
Inflation hurts BOTH borrowers and lenders, they tend to rise and fall together — The collateral for lending is artificially inflated and more borrowing will then occur for the increased profit of lenders… For awhile it looks like both parties are doing well. But the borrower tends to put himself in a position where he is unable to pay attempting to “get ahead” of the inflation as his wages don’t keep pace. Unexpected consumer price inflation might tilt the action in favor of borrowers temporarily, but it doesn’t do so for long.
Jim Bradley,
That is a very good point, and one that is often missed in asset/debt bubble discussions (for example, I didn’t even think of it when I replied earlier)- the collateral is overvalued. However, I tend to believe the borrowers eventually end up in a far worse position- having nowhere to live.
I think Mises was writing for the historical zero sum economy. I think his conclusions are wrong for the present electronic book keeping economy in which “money” is only a means to keep score in the game of life.
This system could crash but I don’t think it will return to the pre-WW2 system but that we will be blasted back 600 years to the old city-states where firepower rules.
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