Purging the Inflation-Debt Monster

For years, the inflation of prices in a given country was said to be caused by a wide variety of factors such as historical cycles, weather-induced shortages, greedy businessmen, excessive labor union demands, and generally the nature of modern life. Inflation was inevitable in a free economy, our professors and pundits told us. We must learn to live with it.

By the beginning of the 1980s, however, this manner of thinking had been thoroughly refuted. Numerous free-market economists (Friedrich Hayek, Ludwig von Mises, Milton Friedman, Henry Hazlitt, etc.) demonstrated that the incessant rise in the general price level is far from inevitable. Price inflation has a distinct cause, and that cause is the monetary inflation of the federal government and its central bank.

Both the Austrian and Chicago Schools of economics have shown that central bank expansion of the money supply at a faster rate than the economy’s production of goods and services always results in price inflation, and if not checked, brings about the chaos of runaway inflation as “velocity of money” exacerbates the process. History is replete with such disasters, e.g., Germany of the 1920s, China of the 1940s, and nearly every South American country throughout the 20th century.

The reasoning goes like this: Prices in general always rise when there is an increase in aggregate consumer demand over available supply. But there can be no increase in aggregate consumer demand without an increase in the total money that consumers have to spend. Without increased purchasing power consumers may have the desire to buy more things, but they don’t possess the power to do so. Put more money in their pockets, however, and they then have the power. Their desire is transformed into demand, which then bids prices up if the new money is created at a faster rate than the economy’s growth of goods and services.

Since the federal government has a monopoly on the creation of money in modern society via the Federal Reserve, it is the culprit whenever prices in general begin escalating in the economy. Through its central bank, the government can inflate the money supply at will. When it inflates at too fast a pace, the general price level (CPI) begins rising rapidly.

For example, if we had a primitive island economy where there were 1,000 products and services manufactured every year, and the total money supply on the island amounted to $1,000, the average price of the products and services would be $1.00. But if the chief of the island printed up $200 one year to aid his brother-in-law’s failing bow and arrow business, then the average price of those products and services would rise to $1.20, for there would now be 200 more dollars added to the island’s economy (and thus 20% more demand) to bid for the same supply of goods and services. The island’s general price level, i.e., the average of all prices of goods and services, would register a 20% inflation rate.

But if at the same time that the chief is printing up the $200 in new money, the whole island increases its total output of products and services by 200 during that year, then the average price of each would remain the same, at $1.00, for there would now be 1200 total products and services, and 1200 total dollars to bid for them. No price inflation would occur.

It is the same principle, no matter how complex the economy, the credit system, and the technological structure involved. America’s general price level keeps rising every year because the Federal Reserve is creating new paper dollars, and pyramiding credit upon them, at a faster rate than Americans are creating products and services.

The neo-Keynesian economic establishment’s justification for this monetary inflation is that it is needed in order to maintain stability and growth for a capitalist economy, which according to Keynes reached its “maturity” in 1929 and no longer can work without massive injections of “liquidity” from the Federal Reserve. This is a fallacy, which we will get into shortly, but first we need to understand why monetary inflation is morally wrong.

The Crime of Inflation

The crime involved in this monetary policy is that the nation’s currency is debased annually. Our money buys less and less every year because of this debasement (a house that cost $20,000 in the 1950s costs $400,000 today). In other words, the government is stealing our money from us because inflation acts as a hidden tax on our wealth.

For example, if the government inflates the money supply by 5% during the year, it means that our money will be worth 5% less at year’s end. A frugal saver with $100,000 in the bank now has only $95,000 worth of buying power. The federal government in Washington, however, has $5,000 extra in buying power because it printed the new money out of thin air. Multiply this times millions of savers in America, and we are talking about hundreds of billions of dollars that are being stolen from the people every year. The politicians and federal bankers become richer and more powerful, and we the people become poorer because of this theft. The government is stealing our wealth just as surely as if it was to come into our banks every year and physically steal 5% of every personal account in America. Unfortunately very few citizens are able to perceive this hidden form of taxation, which allows governments to get away with their criminality.

It should be obvious that the federal government is going to continue its arbitrary credit and currency expansion in a large scale way, and thus continue to dangerously inflate the size of the money supply until we as a people put a stop to it.

Why? 1) Because large scale credit expansion allows our politicians to buy voter support with more subsidies and political spending, and thus to claim during election time that they have brought prosperity to the people. 2) Such a practice gives to all bankers extra profits via interest charges that they would not normally be able to gain. 3) Injecting large amounts of money and credit into an economy acts in the same way that heroin injected into a human body acts; it makes the voting public feel temporarily better off.

Politicians evade all this because their jobs are determined by the voting public. Bankers comply with it all because their monetary interests are enhanced. And statist intellectuals justify it all because their col­lectivist yearnings for larger government are realized. The losers are those Americans who believe in honest productivity and saving the proceeds of their work for their families and loved ones.

The Danger of Inflation

Monetary inflation is, thus, morally wrong, and it is also economically very dangerous. The reason is because government-induced inflation is the beginning of the interventionist chain of events that leads to economic recessions and depressions. As we saw above, “price” inflation is brought about by government “monetary” inflation in excess of the nation’s production of goods and services. When the price inflation reaches too high a level, the result is an extended recession or perhaps a depression.

An economic recession is a massive cutting back of production, employment, expansion and credit by businessmen, corporations, and banks. It is brought about when the Federal Reserve deflates (decreases) the quantity of money circulating throughout the banking system, for if suddenly there is less money floating around, then everyone has to tighten their belts, loans have to be called in, less efficient businesses go under, workers get laid off, etc.

Technically speaking the Federal Reserve doesn’t actually “deflate” the quantity of the nation’s money supply. If such a quantitative deflation was enacted, it would bring on a total collapse of the economy or a full-scale depression. What the Fed does is merely slow the rate of increase of the money supply, which is enough to cause a recession. M2 or M3 is expanded by a smaller amount this month than last. So the correct term to use here is not “deflation” (a lessening of the actual quantity of the nation’s money supply), but “disinflation” (a lessening of the rate of increase each month in the money supply throughout the banking system). This is enough to bring on a recessionary period.

What is important to grasp, however, is that the recessionary period becomes necessary only in order to cool the economy down after government monetary inflation has heated the economy up. A recession is not due to any “inherent failing of the free-market process.” It is the federal government’s prolonged and unwarranted inflationary policies over the previous years or decades that eventually force it to disinflate the money supply, so as to bring back some semblance of price stability. Because the federal government (via the ­Federal Reserve) has inflated the money supply inordinately over a prolonged period, a rapid price increase has resulted for all goods and services throughout the country, and it needs to be stifled or chaos ensues. Thus, a lessening of the rate of money and credit expansion is enacted. The main danger in such manipulation of the money supply is that if the “disinflation” enacted by the Fed gets out of hand then “deflation” takes over, and the country is plunged into not just a recession, but a full-scale depression, which is what happened in 1929.

Contrary to what we were taught in school, it was not the so called “forces of the marketplace” that brought on the Great Depression of the 1930s. It was government intervention into the forces of the marketplace, specifically into the money and banking system through the institution of the Federal Reserve in 1913, that caused the crash by first creating excessive credit expansion throughout the 1920s and then the inevitable necessity of rapid disinflation in 1929 as the only salvation from the dangers of an out of control price structure, which backfired into a severe deflation and its resultant economic depression.

If we would think of inflation and deflation of the economy’s money supply as the same thing that happens to a drug addict consuming heroin, then the mystery of an economic depression wouldn’t be so myster­ious. When an addict shoots a dose of heroin into his bloodstream, he is doing to his body what the Fed is doing to the economy by injecting excessive money and credit into the marketplace. A psychological high results from the heroin, and an economic boom results from the new money and credit.

In order for an addict to come off his drug-induced high, he has to stop injecting the drug into his system; but when he does so, his system collapses, and he goes through withdrawl symptoms. In other words, he exper­iences a severe depression (the degree of the severity depending upon the degree of the high and the degree with which he withdraws the heroin).

Increasing an economy’s money supply works the same way, only economic­ally instead of psychologically. Inflation’s false prosperity is the high. Excessive money and credit is the drug. The Federal Reserve is the needle. And poli­ticians and bankers are the pushers. In order to come off the high of the inflationary spiral, we have to stop injecting money and credit into the system. But when we do so, the economy collapses and goes through a recession or a depression, the severity of which depends upon the degree of the preceding inflation and the degree with which we withdraw the drug of excessive credit and the fiat currency it is pyramided upon.

The way for a heroin addict to avoid going through the hell of drug with­drawal is never to begin taking heroin in the first place. The same principle applies to an economy also. The way to avoid deflation and its potential for creating a depression is simply never to begin inflation in the first place. And the way to never begin inflation is to prohibit the federal government from increasing the money supply faster than our production of goods and services.

Thus severe economic recessions and depressions are not “capitalist spawned.” They are government created, and then government exacerbated. As Professor Gene Smiley of Marquette University tells us in his book, Rethinking the Great Depression:

“The Great Depression is often said to demonstrate the instability of market economies and the need for government oversight and direction. The evidence can no longer support such assumptions. Government efforts to control and direct the gold standard for national purposes brought on the depression. Once it began, government actions, particularly in the United States, caused it to be much longer and much more severe. When the contraction finally ended, government interference in U.S. markets made the recovery unbearably slow and in 1937-1938 brought on a ‘depression within a depression.’ The 1930s economic crisis is tragic testimony to government interference in market economics.”¹

The Origin of the Boom / Bust Cycle

All well and good. Inflation and deflation are governmentally induced and can be likened to the experiences of a drug addict, but how did America get onto the inflation-deflation roller coaster anyway? How did it all get started?

It all began with the numerous attempts to nationalize America’s banking system during the 19th century by powerful interest groups that favored inflationary monetary policy for America (i.e., fiat paper money over gold). This necessitated a means to implement such a nationwide infla­tion (i.e., a national bank). These attempts at nationalization ultimately culminated with the inception of the Federal Reserve in 1913. This gave federally appointed bankers, in collusion with the federal government, certain regulatory capacities that enabled them to greatly increase the nation’s money supply in excess of the growth of goods and services. And this the new federal bankers proceeded eagerly to do with full scale monetary inflation throughout the 1920s, created by excessively low reserve requirements for bank loans, along with government manipulations of interest rates in the marketplace, etc.

Substantial increases in the money supply were brought about from 1920 on. Benjamin M. Anderson, in Economics and the Public Welfare,2 clearly chron­icles the process and how it took place. It is this government induced infla­tion of the 1920s that brought on the inevitable need to disinflate, which tumbled into actual deflation, which caused the crash of 1929 and the Great Depression of the 1930s.

The government, through its maneuverings with the Federal Reserve, had made money and credit so plentiful during the 1920s, which then flowed into the stock market to excessively bid up stock prices beyond their true value. Everyone thought they were richer than they really were. Permanent prosperity was presumed to finally be here, via the benevolent wisdom of the new government money managers. The bubble had to burst eventually, though, because paper economic booms, like heroin highs, cannot be sustained forever. The Federal Reserve had to finally disinflate the money supply in order to bring back price stability. As a result, there was the inevitable recession, which morphed into a full-scale depression.

It should be pointed out here that the price inflation of the 1920s took place in the stock market because this is where the money and credit injections of the Fed flowed to bid up prices of equities. Consumer goods, measured by the CPI, were relatively tame during this time, which is why so many economists remain confused as to the real reason for the Depression. Since the CPI was not rising, they assume there was no “price inflation.” Thus the reason for the crash could not have been inflationary monetary policy by the Fed.

On the contrary, the Fed’s egregious credit expansion was indeed the primary cause of the Depression. Excessive government monetary inflation always results in price inflation somewhere. The new money will flow where the public wishes it to go. During the 1920s, it went into the Dow. During the 1970s, it went into consumer goods and real estate. During the 1990s, it went into the Nasdaq.

The Fed’s wild expansion of the money supply in the 1920s, of course, was not the only cause of the Depression and its damage. But it was, far and away, the main cause. As Professor Smiley points out in Rethinking the Great Depression, there were other contributing factors such as Hoover’s myopic employment of wage and price controls and Roosevelt’s moonshine economic programs, which all added up to stultify an economy that desperately needed to be free to purge the massive debt and malinvestment built up by the Fed’s prior inflation policies. It was not to be, however. Big government spread over America like mange on a dog’s skin. And it now threatens us with another economic crisis of gigantic proportions.

After the crash of 1929 there was a whole bevy of theoretical proposals put forth by scholars as to why it happened. None of these “experts,” though, were willing to observe that it was not free enterprise that had failed at all, but actually government-managed enterprise that had crashed. It was not the absence of controls, but the presence of them that had brought on the rapid inflation and then the necessity of disinflation which backfired into deflation. But to propose such an unpopular idea as this in contradiction to an intellectual establishment that was growing increasingly socialist minded, was something that few scholars were capable of doing. Those few independent ones who did were not power­ful enough to overcome the swelling herd of anti-capitalists who wanted to believe that free enterprise had “had its day” and that what was now needed was a new age of government-managed economics.

Ludwig von Mises’ great work in Austria on the nature of the business cycle, and the inevitable nationwide depression that must come from gov­ernment inflation of the money supply, had not yet been translated into English. Outside the German speaking world, it was relatively unknown. Had it been more widely circulated, the history of the past 80 years would be considerably different.

Naturally, the politicians in power bought the idea of a government managed economy immediately, for politicians are always putty in the hands of intellectuals who advocate giving them more control over the affairs of men. FDR actually had no set convictions one way or the other toward business and free enterprise. He was simply a political opportunist. He craved power, and the intellectuals of the day who were clamoring for more controls offered him the excuse to seize such power.

The Keynesian Paradigm

The most notable of all the prominent economists proposing the ideas of government planning was, of course, John Maynard Keynes. It was his theories (along with men such as Rexford Tugwell and Alvin Hansen) that most influenced Roosevelt and led us into the welfare state age of big government, deficit spending, inflation and regulation.

In essence, Keynes’ message to a bewildered 1936 world was this: What needs to be done is to create vast amounts of government investment so as to stimulate and perpetually maintain consumer demand at a high level. If this is done, the problems of poverty and business cycles will be alleviated. The weakness of capitalism is that, in its mature stage of development, it lacks the abil­ity to produce enough “purchasing power,” i.e., demand among the people. The government must intervene and create continual monetary inflation via the Federal Reserve so as to provide “necessary demand” and thus adequate economic growth.

“Why it all sounds absolutely marvelous,” one can imagine FDR replying to his Brain Trust when informed of the wonders to be worked with Keynes’ new economics. “If capitalism has reached its mature stage and can no longer produce enough purchasing power, then we in Washington must step in and get the system going again. If people don’t have enough money, then all we have to do is create more and our problems will be solved.

Stripped of all the eloquent conceptualizations and slick technical jargon, this was the great “innovation,” the great “revolutionary insight” of Keynes: If we want to become wealthier as a nation and avoid economic recessions, we need to create more money by injecting credit into the economy via the Federal Reserve on a continual basis.

Consequently every administration since FDR has been doing this – injecting massive credit into the banking system to make us all more “prosperous.” But credit is not wealth. If credit was wealth, the government could just loan everybody a million dollars and wipe poverty off the face of the earth. Credit is just a euphemism for debt. True wealth is the goods and services that we have produced minus the debt we have incurred.

As of 2018, the total public and private debt for Americans is approximately $34 trillion dollars, but when you add in the unfunded liabilities of the federal government for social security, medicare and pensions owed, there is another $87 trillion dollars to be added to the tab. This totals out to $121 trillion dollars, or $480,000 of debt for every American adult. This is what Keynesian economics leads to – massive debt, not genuine wealth and prosperity.

The major theoretical flaw in Keynesianism is that a capitalist economy does not have a “mature stage” in which it can no longer produce demand. It will go on forever if left alone by government interventionists and inflationists.

The so called “mature stage” that Keynes decried was the eventual bust stage coming in reaction to the superficial boom stage created by the Fed’s massive injections of new money / credit into Wall Street and Main Street. Thus the way to avoid a deflationary crash is to never begin the inflationary monetary policy that brings it on.

Bar the government from excessively inflating the money supply via the Federal Reserve, and capitalism works just fine. You’ll have a cyclical economy, but not a boom-bust economy that crashes. This, the statist authorities of the 1920s and 1930s did not understand. Or if they did grasp it, they blanked out on it so as to pursue more power for the state and themselves.

How we must handle the upcoming depressionary crisis is to take a page out of the Depression of 1920-1921. Warren Harding had just succeeded Woodrow Wilson, and Congress was not yet lathered up with FDR socialists. Thus they left the marketplace alone. They didn’t intervene with massive regulations, taxes and subsidies that sucked vital capital out of investment channels. They didn’t try and prop up prices and wages; they left them alone to seek their rightful market levels, which allowed them to clear at lower, more realistic numbers, which allowed everyone to go back to work within 18 months and earn viable livings.

The moral of the story is to let the natural forces of the marketplace restore themselves. They have this corrective power if only our compulsive interventionists will just stay out of the market and leave people and businesses alone.

Granted the upcoming meltdown is going to be huge. We have been pumping money into the economy at a horridly irresponsible pace for over 45 years now. But the solution is not to preserve Keynesianism and begin pumping fiat money / credit into the economy again as we come out of the crash. The solution is to restore a gold-backed currency and come out of this New Depression with it in place rather than corruptible fiat money.

Restore sound money, end confiscatory taxes and obtuse regulations, and unemployment will evanescence in a tolerable amount of time like in 1920-1921. If we leave the marketplace alone, our citizens will shortly have all the jobs they can handle. We will begin churning along at 4% GDP levels again.

The Keynesian Debt Monster

This then is why we got onto the inflation-deflation roller coaster. Ideologically misguided intellectuals and politicians have succeeded in convincing the American people that our economy needs arbitrary credit inflation by the Federal Reserve to produce adequate growth and prosperity.

This has created our monstrous debt, both public and private, in America today, much of which must be liquidated in order to restore healthy growth and genuinely solve the world economic crisis unfolding around us.

The key will be how we resolve to come out of the coming crisis. Do we continue the economic fallacies of Keynesianism, or do we restore a gold-backed currency allowing its stability to govern the monetary system and the marketplace to govern the flow of interest rates? The former will bring on a dictatorship; the latter will restore freedom and a stable economy to America.

Notes

1. Gene Smiley, Rethinking the Great Depression (Chicago: Ivan R. Dee, 2002), p. x.
2. Benjamin M. Anderson, Economics and the Public Welfare: Financial and Economic History of the United States, 1914-1946, Princeton, NJ: D. Van Nostrand Co., 1949.