Freeman

ARTICLE

Inflation and Stabilization: The Elusive Promise

AUGUST 01, 1977 by WILLIAM L. BAKER

Mr. Baker teaches in the school system in Lub­bock, Texas.

Most "free marketers" understand that inflation is the increase of the money supply. In other words, in­flation is wholly a government-sponsored blessing. A lot of people, who otherwise believe in a free market economy, feel that a "cer­tain amount" of inflation is necessary. Otherwise, they state, there would not be enough money to buy the goods generated by increas­ed production in a dynamic and ex­panding economy. Besides, they argue, the "price level" should be kept stable. Thus, some governmen­tal interference is warranted even in a free market.

But just how true are all such assertions?

 

The "not-enough-money" concept has been around for a long time. It was popularized on a grand scale by John Law, the Scottish-turned ­Frenchman central banker, when he propagated his inflationary schemes at public expense. The theory was that so much money would buy just so much goods. Beyond that, no further production was possible without an increased supply of money.

This monetarist approach simply ignores the demand side of money while stressing the supply side. In reality, as production increases in an economy with a static money supply, prices will simply tend to drop. Competition or demand for money becomes more fierce. The result is a monetary unit that con­tinually enhances in value. Supply and demand works for money just as it does for apples and pears. There is always a sufficient amount of money to buy the products cur­rently on the market without a recourse to the printing presses. In­flation is not needed to foster prog­ress and industrialization. In fact, the free market can do much better without recourse to any type of in­tervention whatever.

But the advocates of inflationism do not end there. The price level, they maintain, must be kept stable. We must not have a fluctuating dollar.

Stabilization, the Enemy

First, there is nothing sacred about "stabilization"—especially as intended by the inflationist. In fact, it is precisely because most central banks are dedicated to "stabilizing" their respective cur­rencies that tremendous fluctua­tions in the value of the monetary unit are made possible at all. "Stabilization" is the enemy of the sound dollar.

Life is change. Life and valua­tions are always in flux. It would be absurd to attempt to freeze values where they stood yesterday, last week, or last year. The same applies in money and pricing. It is absurd to attempt to "prop up" prices via inflation. In the dynamic economy of the free market where prices tend to fall, the dollar is constantly growing in value. In order to "stabilize," the monetary unit must be continually weakened, causing unwarranted distortions in the market.

The truth is that the dollar or monetary unit cannot be "stabil­ized." It is a false issue. Purchasing power is simply transferred from the citizenry to the government who is the holder of the new "funny money." Current dollar holders are "stabilized" to the tune of whatever the government buys in confiscated purchasing power. The "stabiliza­tion" issue is just another apology for Big Government and Big Spend­ing. It is a particularly heinous fallacy that has no business in literate economic discussion—especially among those who sup­posedly cling to the principles of the free market.

The Myth of Price Level

But there are other errors in the stabilization doctrine. One is the very concept of a "price level" at all. There simply "is no such animal." It is a myth that is taking an exceptionally long time to die. There can be no question of an "average" price or a "price level" in an economy of unlike goods and services. How does one compare, average, or add the price of an orange to the price of a swimming instructor and come out with a "level" that means anything what­ever? There simply are no correla­tion points. But assume, for the mo­ment, that a "price level" did exist.

Why should it be kept "stable"? What is to be gained, and who is superhuman enough to administer it? And even if we could determine what the "price level" is, we must then ask why this price level and not the price level of last year or year before last?

Assuming, however, that all these problems were answerable and surmountable, a host of other difficulties must immediately pre­sent themselves. For, the govern­ment must dispose of the money somehow in the market place. The question becomes: "Who shall get it first?" If inflation (or "stabiliza­tion") were neutral in its effects, it would be of no concern to any of us, as we would all be affected propor­tionately. Prices would increase in direct proportion to the new money which we would all magically re­ceive (magically) at the same in­stant of time. No one would benefit at the expense of another (except on outstanding contracts). The only way inflation would affect us in such circumstances would be to force us to become better mathema­ticians.

But reality is different. The evil of inflation is the disproportionate ef­fects it has upon the populace—not of any proportionate rise in the "price level" that affects each and all to the same extent. It isn’t any abstract, mystical "price level" that gets the money, but rather real flesh and blood people who will use it to bid up prices for existing goods and services at the expense of everybody else in the market place. So who gets it (and gets it first) will make a big difference. "Stabiliza­tion" will affect different people to a different extent depending on when (or if) they get their hands on the newly "stabilized" money. One man’s stabilization is another man’s poison.

As stated before, life is change. But the "stabilization" theory aims at keeping things the same. It seeks to defy change. What it usually does is just to create the wrong kinds of change—such as an eroding monetary unit and a weakening in­centive to save. As an economic theory, it is bankrupt. It can only disrupt the market and rob people of their wealth which they have ac­cumulated.

The Role of Interest

The most serious problem of infla­tion, however, escapes the mone­tarist completely. And that is the role of interest rates in the modern structure of production. Inflation, at first, lowers the money rate of in­terest, thus attracting more business investment. Real savings, however, have not increased.

Businessmen have been lulled in­to wasteful and unprofitable in­vestments by these false rates. Why "false" rates? Because interest is really the discount of future goods over present goods. This method of analysis is called the time-preference approach. The lower the rate, the more "future looking" the society is. In other words, people have a "low" time preference for present goods as op­posed to future goods. Businessmen can "lengthen the structure of pro­duction" because people are saving and supplying the capital needed to engage in these time-consuming ventures. When additional money enters via the loan market, all this is thrown out of kilter. The market is distorted. Interest rates must fall, for a while, to deal with the ex­tra loan money. In so doing, a false time preference is indicated. It seems as if more people are becom­ing "forward looking" by saving. But in reality they are not. After the new money has worked its way down through the economy and rates tend to return to "normal," this error will become manifest. The situation will be made worse if it is repeated.

Because interest rates indicate either a low or high time preference, they are thus effective signals to businessmen as to what the con­sumer wants produced, whether it be automobiles or snowcones. To tamper with these rates destroys that device and sets the stage for a "bust" which must surely come, be it great or small.

Inflation Always Distorts

Inflation, then, is more money, not a certain amount of money. In­flation always distorts the market; it never benefits the market.

Inflation has always been the recourse of governments in search of cheap money. It will always bring disaster. Society cannot have the supposed "benefits" of inflation without paying the price. Inflation is not a certain rate of money in­crease. It is money increase, period.

And it is always bad. It will always lead to distorted production at the expense of what would have been produced without the infla­tion. Even when inflation occurs in such a minor degree that it is un­noticeable (as in an era of expanded production and falling prices), it still will work its effects at the cost of what would have been.

Inflation is no elixir of life. It is not the philosopher’s stone. It will not create a fountain of perpetual youth. It cannot turn stones into bread. It cannot make gold out of paper. It cannot create wealth.

It can only destroy. And that is just about all that "stabilization" can hope to achieve.

ASSOCIATED ISSUE

August 1977

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