Inflation and Price Control
[Ludwig von Mises immigrated to the United States in 1940, a period of wartime economic planning in which production was planned, prices and wages controlled, and rationing dominated the consumer goods market. His writings against intervention thus became critically important, especially during the public debate concerning whether and to what extent these controls should be reduced following the war. This article appeared in the Commercial and Financial Chronicle, December 20, 1945, and was later printed in Planning for Freedom]
1. The Futility of Price Control
Under socialism production is entirely directed by the orders of the central board of production management. The whole nation is an "industrial army" (a term used by Karl Marx in the Communist Manifesto) and each citizen is bound to obey his superior's orders. Everybody has to contribute his share to the execution of the overall plan adopted by the Government.
In the free economy no production czar tells a man what he should do. Everybody plans and acts for himself. The coordination of the various individuals' activities, and their integration into a harmonious system for supplying the consumers with the goods and services they demand, is brought about by the market process and the price structure it generates.
The market steers the capitalistic economy. It directs each individual's activities into those channels in which he best serves the wants of his fellow-men. The market alone puts the whole social system of private ownership of the means of production and free enterprise in order and provides it with sense and meaning.
There is nothing automatic or mysterious in the operation of the market. The only forces determining the continually fluctuating state of the market are the value judgments of the various individuals and their actions as directed by these value judgments. The ultimate factor in the market is the striving of each man to satisfy his needs and wants in the best possible way. Supremacy of the market is tantamount to the supremacy of the consumers. By their buying, and by their abstention from buying, the consumers determine not only the price structure, but no less what should be produced and in what quantity and quality and by whom. They determine each entrepreneur's profit or loss, and thereby who should own the capital and run the plants. They make poor men rich and rich men poor. The profit system is essentially production for use, as profits can be earned only by success in supplying consumers in the best and cheapest way with the commodities they want to use.
From this it becomes clear what government tampering with the price structure of the market means. It diverts production from those channels into which the consumers want to direct it into other lines. Under a market not manipulated by government interference there prevails a tendency to expand the production of each article to the point at which a further expansion would not pay because the price realized would not exceed costs. If the government fixes a maximum price for certain commodities below the level which the unhampered market would have determined for them and makes it illegal to sell at the potential market price, production involves a loss for the marginal producers. Those producing with the highest costs go out of the business and employ their production facilities for the production of other commodities, not affected by price ceilings. The government's interference with the price of a commodity restricts the supply available for consumption. This outcome is contrary to the intentions which motivated the price ceiling. The government wanted to make it easier for people to obtain the article concerned. But its intervention results in shrinking of the supply produced and offered for sale.
If this unpleasant experience does not teach the authorities that price control is futile and that the best policy would be to refrain from any endeavors to control prices, it becomes necessary to add to the first measure, restricting merely the price of one or of several consumers' goods, further measures. It becomes necessary to fix the prices of the factors of production required for the production of the consumers' goods concerned. Then the same story repeats itself on a remoter plane. The supply of those factors of production whose prices have been limited shrinks. Then again the government must expand the sphere of its price ceilings. It must fix the prices of the secondary factors of production required for the production of those primary factors. Thus the government must go farther and farther. It must fix the prices of all consumers' goods and of all factors of production, both material factors and labor, and it must force every entrepreneur and every worker to continue production at these prices and wage rates. No branch of production must be omitted from this all-around fixing of prices and wages and this general order to continue production. If some branches were to be left free, the result would be a shifting of capital and labor to them and a corresponding fall in the supply of the goods whose prices the government has fixed. However, it is precisely these goods which the government considers as especially important for the satisfaction of the needs of the masses.
But when such a state of all-around control of business is achieved, the market economy has been replaced by a system of centralized planning, by socialism. It is no longer the consumers, but the government who decides what should be produced and in what quantity and quality. The entrepreneurs are no longer entrepreneurs. They have been reduced to the status of shop managers — or Betriebsführer, as the Nazis said — and are bound to obey the orders issued by the government's central board of production management. The workers are bound to work in the plants to whom the authorities have assigned them; their wages are determined by authoritarian decrees. The government is supreme. It determines each citizen's income and standard of living. It is totalitarian.
Price control is contrary to purpose if it is limited to some commodities only. It cannot work satisfactorily within a market economy. The endeavors to make it work must enlarge the sphere of the commodities subject to price control until the prices of all commodities and services are regulated by authoritarian decree and the market ceases to work.
Either production can be directed by the prices fixed on the market by the buying or the abstention from buying on the part of the public; or it can be directed by the government's offices. There is no third solution available. Government control of a part of prices only results in a state of affairs which — without any exception — everybody considers as absurd and contrary to purpose. Its inevitable result is chaos and social unrest.
2. Price Control in Germany
It has been asserted again and again that German experience has proved that price control is feasible and can attain the ends sought by the government resorting to it. Nothing can be more erroneous.
When the first World War broke out, the German Reich immediately adopted a policy of inflation. To prevent the inevitable outcome of inflation, a general rise in prices, it resorted simultaneously to price control. The much-glorified efficiency of the German police succeeded rather well in enforcing these price ceilings. There were no black markets. But the supply of the commodities subject to price control quickly fell. Prices did not rise. But the public was no longer in a position to purchase food, clothes and shoes. Rationing was a failure. Although the government reduced more and more the rations allotted to each individual, only a few people were fortunate enough to get all that the ration card entitled them to. In their endeavors to make the price control system work, the authorities expanded step by step the sphere of the commodities subject to price control. One branch of business after the other was centralized and put under the management of a government commissary. The government obtained full control of all vital branches of production. But even this was not enough as long as other branches of industry were left free. Thus the government decided to go still farther. The Hindenburg Program aimed at all-around planning of all production. The idea was to entrust the direction of all business activities to the authorities. If the Hindenburg Program had been executed, it would have transformed Germany into a purely totalitarian commonwealth. It would have realized the ideal of Othmar Spann, the champion of "German" socialism, to make Germany a country in which private property exists only in a formal and legal sense, while in fact there is public ownership only.
However, the Hindenburg Program had not yet been completely put into effect when the Reich collapsed. The disintegration of the imperial bureaucracy brushed away the whole apparatus of price control and of war socialism. But the nationalist authors continued to extol the merits of the Zwangswirtschaft, the compulsory economy. It was, they said, the most perfect method for the realization of socialism in a predominantly industrial country like Germany. They triumphed when Chancellor Brüning in 1931 went back to the essential provisions of the Hindenburg Program and when later the Nazis enforced these decrees with the utmost brutality.
The Nazis did not, as their foreign admirers contend, enforce price control within a market economy. With them price control was only one device within the frame of an all-around system of central planning. In the Nazi economy there was no question of private initiative and free enterprise. All production activities were directed by the Reichswirtschaftsministerium. No enterprise was free to deviate in the conduct of its operations from the orders issued by the government. Price control was only a device in the complex of innumerable decrees and orders regulating the minutest details of every business activity and precisely fixing every individual's tasks on the one hand and his income and standard of living on the other.
What made it difficult for many people to grasp the very nature of the Nazi economic system was the fact that the Nazis did not expropriate the entrepreneurs and capitalists openly and that they did not adopt the principle of income equality which the Bolshevists espoused in the first years of Soviet rule and discarded only later. Yet the Nazis removed the bourgeois completely from control. Those entrepreneurs who were neither Jewish nor suspect of liberal and pacifist leanings retained their positions in the economic structure. But they were virtually merely salaried civil servants bound to comply unconditionally with the orders of their superiors, the bureaucrats of the Reich and the Nazi party. The capitalists got their (sharply reduced) dividends. But like other citizens they were not free to spend more of their incomes than the Party deemed as adequate to their status and rank in the hierarchy of graduated leadership. The surplus had to be invested in exact compliance with the orders of the Ministry of Economic Affairs.
The experience of Nazi Germany certainly did not disprove the statement that price control is doomed to failure within an economy not completely socialized. Those advocates of price control who pretend that they aim at preserving the system of private initiative and free enterprise are badly mistaken. What they really do is to paralyze the operation of the steering device of this system. One does not preserve a system by destroying its vital nerve; one kills it.
3. Popular Inflation Fallacies
Inflation is the process of a great increase in the quantity of money in circulation. Its foremost vehicle in continental Europe is the issue of non-redeemable legal tender banknotes. In this country inflation consists mainly in government borrowing from the commercial banks and also in an increase in the quantity of paper money of various types and of token coins. The government finances its deficit spending by inflation.
Inflation must result in a general tendency toward rising prices. Those into whose pockets the additional quantity of currency flows are in a position to expand their demand for vendable goods and services. An additional demand must, other things being equal, raise prices. No sophistry and no syllogisms can conjure away this inevitable consequence of inflation.
The semantic revolution which is one of the characteristic features of our day has obscured and confused this fact. The term inflation is used with a new connotation. What people today call inflation is not inflation, i.e., the increase in the quantity of money and money substitutes, but the general rise in commodity prices and wage rates which is the inevitable consequence of inflation. This semantic innovation is by no means harmless.
First of all, there is no longer any term available to signify what inflation used to signify. It is impossible to fight an evil which you cannot name. Statesmen and politicians no longer have the opportunity to resort to a terminology accepted and understood by the public when they want to describe the financial policy they are opposed to. They must enter into a detailed analysis and description of this policy with full particulars and minute accounts whenever they want to refer to it, and they must repeat this bothersome procedure in every sentence in which they deal with this subject. As you cannot name the policy increasing the quantity of the circulating medium, it goes on luxuriantly.
The second mischief is that those engaged in futile and hopeless attempts to fight the inevitable consequences of inflation — the rise in prices — are masquerading their endeavors as a fight against inflation. While fighting the symptoms, they pretend to fight the root causes of the evil. And because they do not comprehend the causal relation between the increase in money in circulation and credit expansion on the one hand and the rise in prices on the other, they practically make things worse.
The best example is provided by the subsidies. As has been pointed out, price ceilings reduce supply because production involves a loss for the marginal producers. To prevent this outcome governments often grant subsidies to the farmers operating with the highest costs. These subsidies are financed out of additional credit expansion. Thus they result in increasing the inflationary pressure. If the consumers were to pay higher prices for the products concerned, no further inflationary effect would emerge. The consumers would have to use for such surplus payments only money which had been already put into circulation. Thus the allegedly brilliant idea to fight inflation by subsidies in fact brings about more inflation.
4. Fallacies Must Not Be Imported
There is practically no need today to enter into a discussion of the comparatively slight and harmless inflation that under a gold standard can be brought about by a great increase in gold production. The problems the world must face today are those of runaway inflation. Such an inflation is always the outcome of a deliberate government policy. The government is on the one hand not prepared to restrict its expenditure. On the other hand it does not want to balance its budget by taxes levied or by loans from the public. It chooses inflation because it considers it as the minor evil. It goes on expanding credit and increasing the quantity of money in circulation because it does not see what the inevitable consequences of such a policy must be.
There is no cause to be too much alarmed about the extent to which inflation has gone already in this country. Although it has gone very far and has done much harm, it has certainly not created an irreparable disaster. There is no doubt that the United States is still free to change its methods of financing and to return to a sound money policy.
The real danger does not consist in what has happened already, but in the spurious doctrines from which these events have sprung. The superstition that it is possible for the government to eschew the inexorable consequences of inflation by price control is the main peril. For this doctrine diverts the public's attention from the core of the problem. While the authorities are engaged in a useless fight against the attendant phenomena, only few people are attacking the source of the evil, the Treasury's methods of providing for the enormous expenditures. While the bureaus make headlines with their activities, the statistical figures concerning the increase in the nation's currency are relegated to an inconspicuous place in the newspapers' financial pages.
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Here again the example of Germany may stand as a warning. The tremendous German inflation which reduced in 1923 the purchasing power of the mark to one billionth of its prewar value was not an act of God. It would have been possible to balance Germany's postwar budget without resorting to the Reichsbank's printing press. The proof is that the Reich's budget was easily balanced as soon as the breakdown of the old Reichsbank forced the government to abandon its inflationary policy. But before this happened, all German would-be experts stubbornly denied that the rise in commodity prices, wage rates and foreign exchange rates had anything to do with the government's method of reckless spending. In their eyes only profiteering was to blame. They advocated thoroughgoing enforcement of price control as the panacea and called those recommending a change in financial methods "deflationists."
The German nationalists were defeated in the two most terrific wars of history. But the economic fallacies which pushed Germany into its nefarious aggressions unfortunately survive. The monetary errors developed by German professors such as Lexis and Knapp and put into effect by Havenstein, the Reichsbank's President in the critical years of its great inflation, are today the official doctrine of France and of many other European countries. There is no need for the United States to import these absurdities.
Ludwig von Mises (1881–1973) wrote 25 books on economics, philosophy, and history. This essay is from Planning for Freedom, a collection that is available from the Mises Shop for $10 plus s&h. Comments on this essay can be posted on the blog.