Freeman

ARTICLE

Inflation Fighters Bark Up The Wrong Tree

JUNE 01, 1979 by OSCAR W. COOLEY

Mr. Cooley is Associate Professor of Economics Emeritus, Ohio Northern University, Ada, Ohio.

The war against inflation, as waged by the United States government, is in reality a war against the forces of supply and demand. The identity of the enemy is missed by Washington. Hence, it is not surprising that no ground is being gained.

Inflation is the over-supply of money in relation to the demand for money; it is not the rise of prices. For this reason, the wage and price guidelines, which are directed at the rising prices of goods and services, are irrelevant. They call to mind a coon dog barking up the wrong tree. And mandatory price controls, which Alfred Kahn keeps telling us are undesirable, but may become "necessary," would also miss the mark, for the same reason.

Prices have not risen uniformly. The prices of farm products rose on the average by 40 percent in early 1979. In the same period, the price of coffee beans fell. If inflation is a rise of prices, why did not the price of soybeans and of coffee beans rise at the same rate?

The answer, manifestly, is that the forces of supply and demand impinged differently on soybeans and on coffee. This may have been due to weather, war, different degrees of government meddling with markets in the U.S. and in Brazil, or to a multitude of other causes, special to each commodity. The combination of market forces, in the case of soybeans, pushed the price upward, while in the case of coffee the opposite occurred. Every individual good and service faces its own forces of demand and supply and, these being the determinants of price, its own pattern of price changes. This is normal and healthy.

Inflation, on the other hand, is neither normal nor healthy. It is a disease, specifically a disease of money. It is not the effect on price of changes in demand and supply of this and that good. In truth, it is totally unrelated to these fluctuating market forces. Inflation affects all goods alike—all goods for which the inflated money is exchanged.

That inflation is tied to money, not to goods, is indicated by the fact that each nation has its own unit of money—dollar, franc, yen—and each nation likewise has its own rate of inflation. These differ widely. While the United States has inflation of maybe 9 percent per year, Britain has 18 percent, Brazil 30 percent.

But a staple commodity such as wheat or cotton, has a world market price, which is virtually the same—adjusted for varying costs such as transport—in all countries. This world market price is a resultant of the world market forces of supply and demand, not of the inflation force which prevails in any one country due to mismanagement of the money in that country.

Admittedly, inflation pushes prices up—this is why rising prices and inflation are so often equated—but it is a quite different "push" from that exerted by demand and supply. Drought may affect the demand and supply equation, but drought surely is not the cause of inflation.

A useful analogy is that of the tide and the waves. Throw a cork into the ocean. The cork will rise and fall as a result of two entirely distinct forces: the tide, which is a rise in the general level of the ocean over a vast dimension—a rise caused by the gravitational pull of the moon; and the waves, which are rises of varying degrees at various points on the ocean’s surface, caused by the winds as they impinge on those points.

Inflation may be likened to the tide, while the varying changes in prices of individual goods and services are the waves, kicked up by the winds, which are local in nature and fickle in force and direction. Our cork may run into a gale and be hoisted accordingly, or it may encounter a calm, its level changing little. In either case, the tide will be operating under it, causing it to rise gradually but inexorably as the tide comes in.

Although the tide and the waves both affect the cork, they are totally unrelated to one another. So also are inflation and the demand-supply force. They are as little related as deficit financing is to drought.

To continue the analogy: it is possible to calm the ocean’s waves at any one point by pouring oil on the water. Now the cork would not rise on a comber because there would be no comber. But the oil would not have the slightest effect on the tide. That would come rolling in as usual.

Price and wage guidelines are a typical oil-on-water exercise. Using enough oil—including a generous portion of bear oil—one might smooth out a few waves, temporarily, thus modifying the rise of this or that cork, but all the oil in Saudi Arabia would not smooth out the tide.

The same would be true of mandatory controls. Here and there they would modify a price or wage change, but they would have as little effect on inflation as oil on the ocean would have on the gravity of the moon.

Inflation is dilution of the nation’s money, as a result of overproduction of money units. Each unit, because of its excessive supply, loses value.

This dilution, in turn, is a result of the desire of government functionaries to spend more money than the taxpayers provide.

Congress has again raised the limit to which the national debt may legally climb. This is to accommodate the ever-present desire to spend more dollars than are in the Treasury. That more will be created, generating more inflation.

But Washington dislikes to have the American people realize that the government itself is causing the inflation, and so it assiduously spreads the notion that the rising prices constitute the inflation. People conclude that the Arabs are to blame because they have hiked the price of petroleum; the weather is at fault because it did not grow more fodder and consequently farm prices rose; the businessmen especially are responsible because in their greed they have jacked up the prices of manufactured goods.

Never is the relation of the money supply to inflation acknowledged by a Washington bureaucrat, seldom by a journalist, and only occasionally—sad to say—by an economist.

 

ASSOCIATED ISSUE

June 1979

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