Epilogue

Epilogue

Defense Against Depression^(*)

I. The Depression Dilemma

1. Obscure Origins

One of the chief curses of our time is economic ignorance. We have reached almost universal agreement as to what constitutes desirable human objectives. All people of good will desire and seek world peace and general prosperity. The cause of most strife, scraps and schisms lies largely in differences as to the best means to attain our common objectives. The answers must be found in the field of economics?the study of the most efficient human action to attain desired objectives.

Perhaps our greatest fundamental economic problem is the prevention of depressions and the human distress that follows in their wakes. Much thought and consideration has been given to this problem. The correct solution has been in print for decades. Nevertheless, panaceas, long since exploded, are still popular with many in high academic, business, political and religious circles.

In early days, the causes of depressions were frequently [p. 230] clear to everyone. Some were attributed to acts of God, such as droughts in agricultural areas. Many more were attributed to wars, such as England?s depression in the early 1860s, when thousands of textile workers lost their jobs because raw cotton was no longer obtainable from our Southern states. But as time went on, the underlying cause of more and more depressions remained hidden from the eyes and minds of most men.

These unexplained depressions followed the rise of the modern banking practice of expanding credit and bank deposits beyond the amount the supply of basic money, gold, could safely support at the ?official price? for gold. Such depressions have been periods of contraction and readjustment resulting from prior credit expansions which greatly distorted all prices, wages and business operations. Recent credit inflations have resulted, primarily, from political policies stemming from the popular fallacy that more money is needed to stimulate more production.

It cannot be denied that credit or monetary expansion immediately helps some?the first recipients, who get something without contributing anything to society. But at the same time it hurts others?those wealth producers who must compete with the new money recipients in buying the available goods and services. Such wealth producers receive less than the fair market value of their contribution. More money, inflation, tends to direct business activity more toward satisfying the wants of the recipients of the new money or credit, and less toward satisfying the wants of the actual wealth producers.

This condition leads inevitably to either (1) further inflationary injections of new credit or paper money until the fiat money becomes worthless, as in the cases of our Continental currency and the German marks of 1923, or (2) a complete halt in inflationary injections causing business activity to readjust itself. Business then stops producing for the former receivers of the politically created money or credit and produces only for those who contribute desired wealth to the market. The longer and larger the inflation, the greater the required readjustments, assuming the former recipients of the new money or credit fail to earn and buy what they formerly got for nothing. [p. 231]

Many politicians and businessmen seek to delay the readjustment periods, which too often result in depressions. They advocate still more credit expansion so that the seeming prosperity will last until after the next election or after their business deals are completed. This short-sighted philosophy has become very popular in recent years.

It is now accepted by many so-called economists as well as those in the top echelons of business. It is the accepted philosophy of the Committee for Economic Development, whose Research and Policy Committee recently released a statement entitled Defense Against Recession: Policy for Greater Economic Stability. This statement is primarily a plea for greater inflation. It confuses more money with more goods and ignores the problem of adjusting production to the demands of productive consumers.

The authors are also confused as to their objectives. They really want economic progress. However, as the subtitle indicates, they also want ?greater economic stability.? All life, all human action, all economic progress is motion?the very antithesis of stability. Stability is defined by Webster as the ?State or quality of being stable, or firm; strength to stand or endure without alteration of position or material change; steadiness; firmness; as, the stability of a structure, of a government, of customs or habits.? Stability is the very opposite of change and progress is a form of change. All measures that assure stability stop progress.

All progress comes from changes for the better. The automobile industry upset the stability of the horse and buggy industry. All changes are costly to those who have adjusted their lives and investments to the old ways.

This contradiction between stability and progress forces the CED to re-define stability. ?By stability we mean less fluctuation in total economic activity around a strongly rising trend.? At another point they state that ?Our goal is not ?mere? stability but steady growth of an efficient economy.? As a result they advocate conflicting policies, some of which seek stability while others would increase efficiency and result in economic progress. [p. 232]

2. Political Money Policy

They believe that ?Government action to promote economic stability does not require an expansion of government powers but only a better use of the influence that government traditionally and properly exercises in a free society, for example, through monetary policy.? They thus advocate political manipulation of the monetary and credit system, the very cause of the depressions they seek to eliminate.

They tell us that ?moderating economic declines and preventing depressions is one-half of the problem of making the American economy more stable. The other half, of course, is the restraint of inflation.? The desired goal should not be a ?more stable? economy but the removal of restraints on progress. The problem of preventing general depressions is mainly a problem of preventing inflation. To prevent general economic declines, we should prevent the unsound upward movements brought about by monetary or credit inflations. These inflations distort the supply and demand of goods and bring about a condition which can only lead to one of the two results mentioned above.

The CED believes that preventing depressions ?requires a high and rising level of total demand.? It uses such terms as ?adequate total demand, . . . . excessive demand? and ?a general deficiency of demand,? without ever defining them. They are terms without meaning. There is no way to know or measure ?total demand.? Human demands are insatiable and their total is inconceivable. The demand for something more or better is inherent in every human action. The total demand for all things can never be known or satisfied. The demand problem is one of finding out the priorities of consumer demands. Desirable goods and services should be supplied in the best order and quantities possible with the scarce materials and skills available.

3. Future Uncertain

Every businessman is concerned with the future demand for his wares. He cannot be certain of future demand. He must [p. 233] make decisions based on his understanding of what the future demand will be. If he decides rightly, he makes a profit. If he decides wrongly, he may lose everything he owns. Then the means of production, which were his, will be transferred to those who had a better understanding of consumer demand and the ability to satisfy that demand.

The CED states that demand is generated by three methods. First, ?technological advance.? Second, improved ?selling and advertising effort.? And third, ?a growing supply of money and other liquid assets.?

The CED neglects the necessary antecedent of all technological advance?increased savings and investment. Savings not only feed the inventor while he is inventing, but also supply the capital for new machines and factories to turn out the new products before one cent of revenue can be obtained from consumers. All research and technological improvements are designed to disturb economic stability. Nevertheless, they are necessary for economic progress. The seed of such progress is more savings.

4. More Money No Remedy

Improved selling and advertising methods will increase human satisfactions. Any increase in human efficiency will do that. But, increased efficiency and inventions have little or nothing to do with preventing depressions, which are largely periods of correcting prior maladjustments in economic activity. The true remedy for depressions is to remove the original disturbing factor, usually government intervention in the form of inflation, so that economic activity will be directed solely by and for those who contribute to the general welfare in the market place.

The idea that a growing quantity of money promotes ?total demand? is a spurious one. It can only shift effective demand from one group to another. So long as the quantity of money is divisible into the smallest needed units, it is sufficient for all monetary needs. All increases in the quantity of money are a disturbing factor. Such additions help those who receive the increased quantity at the expense of those who do not. They [p. 234] alter consumer demand without adding one whit to ?total demand.? They increase demand for some products while reducing the demand for others.

New quantities of money alter the buying pattern and thus disturb the relative values of all commodities and services. Any new quantity of money must be put into circulation by one group. It benefits that group immediately. It next benefits to a lesser extent those who sell to the first spenders of the new money. These sellers raise their prices to the detriment of all consumers who, with no new money, have to compete for goods with those who can spend the new money.

Most people must pay the higher prices resulting from inflation, long before they receive any compensatory increase in their own income. In this respect, ministers are probably the greatest sufferers from inflation. They are about the last to receive the upward income adjustments which are necessary if they are to maintain their same relative economic position.

Gradually, market prices readjust to the new quantity of money and it has no further effect. If the first group is to be kept artificially prosperous, they must get another and larger injection of new money. This subsidizing of one group at the expense of others can continue only so long as wealth producers continue to have faith in a currency whose value deteriorates with each issuance of new money.

Generally rising prices fool many businessmen, especially those whose operations cover a long period of time. If they sell their finished product a year after they buy their raw materials, the generally higher prices make the operation seem more profitable than if the quantity of money and prices had not risen. The extra bookkeeping profit is meaningless, because, other things being equal, it will not buy any more goods or labor than a smaller amount of money would have bought a year earlier.

Increasing the quantity of money solves no problems. It merely disorganizes the market by helping one group at the expense of others. The real problem is how to increase production so that all who share in the market can have a higher standard of living. Demand is an inherent characteristic [p. 235] of human nature. The only way to satisfy it is to produce more of what people want. This calls for more efficiency in the use of what we have, plus increased savings to provide more tools and factories with which men can increase their output.

The answer to depressions is to produce more of what market contributors demand most and less of what they want only after prior demands have been satisfied. Increases in the quantity of money tend to support industries producing goods other than those desired most by wealth producers. At the same time, additions to the quantity of motley make it more difficult to start and operate new businesses which would supply what market contributing producers want most. If we want to prevent depressions, we should prevent artificial additions to the quantity of money which distort production activities and thus make later readjustments inevitable.

5. Stop the Manipulations

Injections of new money may delay the inevitable but they are not the answer. They are the primary cause of all the distress and human misery that depressions bring. The real answer is a quantity of money that cannot be manipulated by either bankers or politicians.

The correction of a prior inflation need not be an offsetting deflation. The most desirable solution is always an immediate stabilization of the quantity of money free from further manipulation. This will reduce the painful readjustment period to what is technically called ?a stabilization crisis.? This is the time needed to eliminate from all prices that element which they contained due to the prior expectation of continued inflation. Once this has been done, the economy can move forward to new and higher satisfactions of what consumers want most.

A wider understanding of economics is the only way to prevent depressions. [p. 236]

II. The Deficit Dementia

1. Economics and Morality

Economics might be defined as the science of getting the most for the least. In this sense, we are all economists. Each of us seeks to get the maximum satisfaction with the minimum expenditure of our scarce time, effort and material possessions. Logic, experience and, above all, Christian morality teach us that in the long run human happiness and satisfactions cannot be attained or maintained by resort to force or fraud in our dealings with our fellow men. Therefore, good economics is always in accord with good morality.

In the market place, as in the physical world, good intentions are not enough. Good deeds are necessary. If we are to satisfy our desires and those of others with the least waste, we must have a good knowledge and understanding of human action. Errors in economic action, due to ignorance, bring painful results for society as certainly as touching a hot stove will burn an innocent and unknowing child. Good Christians should learn the rudiments of economics and practice them in the light of logic, experience and Christian morality.

No Christian will knowingly seek his own satisfaction through deceit or theft of that which belongs to another. This is a practical principle of economics as well as a moral principle of Christianity. All such attempts are costly to society, regardless of the actor?s good intentions. The best solution of every economic problem is always in the long run both moral and practical. The highest human satisfactions are obtained by the most intelligent actions in conformity with the Christian code.

2. ?Stability? or Progress

A group of businessmen, known as the Committee for Economic Development, has recently proposed that our Federal government should plan to increase its deficits as a means of preventing or moderating depressions. Their proposal is entitled Defense Against Recession. As Christians and as economists we must ask: is this proposal a practical and moral [p. 237] solution to this great economic and ethical problem of our times?

The CED states ?A decline in production, payrolls and profits would automatically cause a sharp drop in Federal tax liabilities. At the same time, expenditure for unemployment compensation, farm price supports and certain other purposes would automatically rise. Thus the budget tends to sustain private incomes in a recession by subtracting less from private incomes and adding more to them . . . . The automatic tendency of government budgets to respond to an economic decline in a stabilizing manner is one of our main present defenses against recession.?

The CED concludes that ?The Federal government should adopt a stabilizing budget policy, under which it would not try to eliminate or reduce the large deficit that will automatically emerge in a recession as a result of a decline in tax receipts and an increase in certain expenditures. This deficit will be a force tending to limit the recession. A stabilizing budget policy should also produce surpluses to reduce the debt when employment is above a standard high level.?

The first section dealt with the primary cause of and remedy for modern depressions brought about by credit or monetary inflation policies such as the CED advocates. This section will be devoted to the deficit aspects of their proposal.

The underlying thought behind this proposal is that depressions will be prevented or moderated if the people are given enough money to buy, at profitable prices, what producers choose to offer. This plan places the cart before the horse. In general, it seeks to maintain or ?stabilize? the production pattern of the immediate past and thus prevent a prompt adjustment of production to the constantly changing wishes of consumers, whose spending money represents their contributions to society. The plan proposes to reduce or eliminate the losses of those who continue to offer at high prices what buyers do not want badly enough to buy with their own limited earned incomes. This is done by supplying politically selected groups with newly printed money (or credit) with which to buy such products at prices profitable to the seller. [p. 238] This serves to prolong the original maladjustment of production, which a free market would correct promptly with the least waste and distress.

The function of a free market is to adjust supply to demand and vice versa. If the market is truly free, all prices will quickly fluctuate to meet the ever-changing whims of consumers. Inflationists fear the flexibility which puts an end to no longer needed businesses. They believe that demand should be artificially adjusted to supply so as to keep these firms from failing. The CED proposes to do this by providing prospective consumers with more than their earned money. This additional money would permit them to pay higher prices for goods which would otherwise be sold only at a loss because the producers have wasted scarce labor and materials making goods which consumers do not want as much as they do want other goods.

The deficit advocates thus hope to keep supply and demand in balance by keeping malproducers in business. They would maintain the buggy producers when consumers want autos, or the butter producers when the people prefer oleomargarine. They neglect the real problem, which is producing goods in the order and quantity for which consumers show their preferences by offering to pay the highest prices over and above the costs of production.

3. Financing Deficits

The Federal government creates a deficit by paying out more money than it takes in. How does it get this additional money? There are only two ways. The government either borrows it from those who have it to lend, or it prints new money which is declared by law to be equal in value, dollar for dollar, with all prior paper money in circulation.

If the deficit is financed by money borrowed from private individuals, it cannot increase total spending or business activity. It merely shifts spending power, the real director of production, from the private lenders to the public borrowers, government. The only possible way that this could improve the production pattern would be for the government to satisfy [p. 239] human desires more efficiently than the private lenders would have done. Leaving aside problems of war and defense, this can only be true if socialism, the public ownership or control of the means of production, is more efficient than capitalism. The teachings of economics deny this.

Modern deficits, such as the CED advocates, have been primarily financed by printing bonds and then printing paper money which is issued with the bonds as security. The historical evolution has been that bonds now replace gold as the nominal security for paper currency. There is, however, a great difference between gold and government bonds as security for paper money. The claims of paper money holders can always be completely satisfied by redeeming their paper money with gold. Such claims cannot be fully satisfied by offering them another paper promise to pay, in the form of bonds payable in paper dollars at some future date. The value of a government bond and that of gold are too often two different values. Governments can only maintain their paper promise at the same value that people place on gold by making the two, gold and paper promises, freely interchangeable.

4. Unearned vs. Earned Dollars

When the government finances its deficit with additions to the quantity of money, as the CED advises, it declares each of the new paper dollars to have a value equal to that of each prior existing dollar. This places the buying power of the new dollars on a par with that of the old dollars earned by workers and investors in the service of their fellow men. The first users of this new money, the government or its political favorites, get something for nothing.

This something that is taken for nothing is a part of the value of every earned dollar in every private pocket and business till. Those privately earned dollars cannot buy the goods the new money takes from the market. They can only compete for what is left after the new dollars have been spent and become part of the total quantity of money competing for the total goods and services offered in the market place. The new dollars also lower the value of one side of every contract and [p. 240] future obligation expressed in terms of money, whether it be rent, bonds, life insurance, savings deposits or old age retirement incomes.

This proposal would have the government use part of these stolen values to pay people to remain unemployed or to produce that which consumers do not want at prices that cover their cost of production. Such governmental uses, of additions to the quantity of money, serve to ?stabilize? production at the expense of economic progress, by maintaining a maladjustment which the market would quickly correct with the least pain to all concerned. These governmental expenditures serve to keep men idle or producing what is not wanted. They do not solve any economic problem. They only make it worse. This course can only result in reducing total human satisfactions.

The real problem is how to keep those who want scarce goods busy producing what others will willingly accept in exchange for their own production or possessions. The free market is merely a voluntary cooperative process motivated by and operated for the mutual benefit of all participants. It uses a profit and loss system of accounting to direct the available labor and capital toward producing the most desirable goods in the order and quantities best suited to consumers? wishes.

The CED deficit program would reduce production by paying men to remain idle while at the same time maintaining the production of goods people want less than they want other things. It would compound the original maladjustment that led to the recession. If not halted, it would result in a runaway inflation, with a complete demoralization of all contracts and trading dependent on the use of American dollars. The longer the maladjustment is sustained by deficit financing, the greater the eventual readjustment and the accompanying distress.

As the CED sees it, the problem is to consume more of what is produced, so we can continue to produce more of the same things. The real problem is how to produce more of what workers want most and less of what they want only after their first demands are satisfied.

Few people enjoy working. Most people work solely for the [p. 241] fruit of their labor. The aim of an economy is not to create and maintain jobs. It is to produce what the contributing cooperators want. All proposals to improve economic conditions should aim at more efficient production of what consumers want most. Increased efficiency plus increased savings will free more and more capital and labor to produce that wealth which will satisfy the next realizable unsatisfied wish on the priority list of consumer wants.

From the above it would seem that the CED proposal of deficit financing, as a means of solving the depression problem, is both impractical and immoral. It can only make matters worse. It leads some people into thinking that they are entitled to something for nothing. It leads others to feel that they are entitled to set their own prices and wages irrespective of what consumers are willing to pay. It thus leads to immorality and civil strife.

5. Deficit a Defective Cure

People begin to think that the world owes them a living, whether or not they apply their God-given talents toward satisfying the needs and wants of their fellow men as expressed in the free market where each earned dollar repre sents the combined judgment of all who participate in that market.

The CED philosophy of deficit financing and inflation has been often tried, and has always been found wanting. Lacking in logic, experience and, above all, in Christian morality, it offers the informed Christian no solution to the depression problem. The best answer is to strive harder to find out what our fellow men want most and produce it for them. Honest money, every dollar of which represents a worthwhile contribution to society, is the keystone to a successful market economy in which every contributor will tend to receive his just reward. The printing and issuance of new paper money is a fraudulent practice which has never increased the total human satisfactions of any society. [p. 242] [p. 243]

Economic Depressions: Their Cause And Cure^(*)

1. Market Supplies Remedies

Producing a depression is not easy. It takes a long period of time, and requires a rare combination of skill and subtlety on the part of politicians and a colossal economic ignorance on the part of bankers, businessmen and the general public.

The market system possesses a tremendous resilience and a greater resistance to extinction than all the cats in the animal kingdom with all their reputed nine lives apiece. The human body can survive a lot of abuse and punishment, but a human life is frail and fragile when compared to the toughness and adaptability of a market economy. The urge of peaceful people to trade one with another for mutual advantage, like Christianity itself, can never be completely suppressed. However, the dark days of depressed trade are possible when politicians in power are long permitted to manipulate the nation?s quantity of money and credit.

Some people like to compare the market economy with a delicate machine with myriads of complicated parts. They [p. 244] refer to the market economy as automatic, like a machine. They look upon politicians as the engineers who must control its operations. When one part gets out of kilter, they advocate a political repair job to keep the entire economic machine from breaking down and coming to a halt.

Such comparisons of the market economy with a machine are ridiculous. No machine has a mind of its own. Once any man sets a machine in motion, its operations are truly automatic. One set of actions must always produce the same reactions, as every cause has its effect. If one piece of the mechanism is broken or out of order, the entire chain of operations may cease. We see this in our automobiles every day. A dead battery, a broken fuel line or even a loose wire may keep a car from running. The other parts cannot and do not shift their actions to keep the machine in operation.

The market system is quite different. Just as a human being can carry on after loss of an eye, an arm, a leg, or even all three; so the market system can quickly adjust to any loss or waste of wealth. It can suffer all sorts of punishment and derangement; but if the participants are left free, they will immediately take steps to surmount or get around the difficulty. They will keep the market in continuous operation by their attempts to satisfy consumers in the best manner possible under the prevailing modified situation. No blows can be struck at the market economy which are not met instantly by the minds and actions of millions striving to overcome or reduce the penalty of any impediment placed in the way of greater satisfactions for all.

This does not mean that optimum market operations cannot be hampered by accident or design. They can and have been.

2. Politics Produce Depressions

Most socialists and advocates of political intervention accept the dictum of Marx that the market economy contains the seeds of its own destruction. They believe that depressions are inherent in the operations of a free market economy. Political interventionists believe that political interference is necessary to prevent the complete collapse of capitalism that communists and socialists so eagerly seek. They fail to realize that [p. 245] it is this very political tinkering that produces the depressions that all right-minded men abhor.

Every political interference must reduce the satisfactions of all unfavored citizens. It prevents them from enjoying something they could enjoy in a completely free society. However, the market system can and does survive a tremendous amount of political interference. This is so because people can and do survive with lower living standards than they could and would enjoy in a completely free society.

The most dangerous political interference is tinkering with the quantity of money, that is the total quantity of cash and bank deposits available for immediate spending or investment. Since a market economy is built upon the advantages of indirect exchange, the exchange of goods and services for money and vice versa, any interference with the quantity of money affects the value of one side of every market transaction. The effect of any such political manipulation, plus the suspicion of unknowable future manipulations, can so confuse the market calculations of businessmen that they will delay any new or forward operations until they can be more certain of the new rules and conditions that will limit and guide their future transactions. This pause, popularly called a depression, permits businessmen to readjust their thinking and actions to the new set of conditions created by the unforeseen results of political tinkering with the quantity of money.

The first rule for ending a depression is to assure businessmen that there will be no more tinkering with the quantity of money or laws governing moral market actions. The best way to minimize the human suffering present during such adjustment periods is to stop all further political increases in the quantity of money and repeal all laws which hinder a rapid readjustment of all wages, prices and interest rates to the prevailing conditions of available supplies and consumer demand, as indicated in a completely free market.

3. Competition the Cure

When political policies protect high prices or wage rates from the open competition of a free market, the most desirable [p. 246] readjustments are retarded or prevented. Employment and production in the politically protected high wage and price areas are held below the levels that would prevail in a free economy. Some workers and savings are thus left un employed, or forced to compete in other areas where wages and investment returns are driven lower, because consumers do not desire more of such products as much as they want more of the goods and services that free competition would produce. If politically protected union wages were opened up to competition, there would immediately be a tremendous surge in employment, production, investment and consumption, as prices dropped and real wages rose, particularly for those millions of workers who do not enjoy the political privileges now granted to unions.

When political policies hold interest rates below those that would prevail in a free market, businessmen may be induced to start more enterprises on borrowed money than available materials will permit them to complete. This becomes evident when the politically expanded credit bids the prices of avail able materials up above the figures that borrowers used in making their calculations. Eventually, some businessmen must fail, with a loss of savings and return of unemployment. While the false hopes created in this matter may bring some temporary relief, the end result must always be more hardships than if interest rates were permitted to indicate the amount of real savings available at the prevailing prices that businessmen use in making their calculations.

All political policies which hold prices or wage rates too high, or interest rates too low, prevent the readjustments that would permit all workers and available savings to be employed in the most productive manner. It is only in a completely free economy that workers and savings gravitate into those employments where they combine to create the highest values, as indicated in the market place by the prices consumers voluntarily pay for the goods and services offered. The best antidote for any depression is wages, prices and interest rates that are freely and fully responsive to every change in market supplies and consumer demand. [p. 247]

4. Deceptive Causes

The creation of a severe depression is very difficult. If it is to be brought about by inflation, its slow development must be kept hidden from all who might spread the alarm, or else the minds of the great majority must be so misled that they will not believe the truth when they are exposed to it. The direct printing of new dollars would be too obvious. Millions would immediately realize the consequences and public opinion would stop it before much damage was done.

Ways have to be devised so that most people do not even suspect the artificial increase in the quantity of money. If they realized what was happening, they would rush to spend all their dollars and convert their bonds, saving accounts and insurance policies into stocks, real estate or other tangible property.

The expansion of the amount of money has to be gradual at first. Any rapid increase might be quickly detected. Experience has shown that the best way to keep the operation from public notice is to place the politically created new dollars in circulation through expanded bank loans. Borrowers cannot tell the difference between dollars saved by others and those created by political bookkeeping. Both kinds will buy the same things, even though the subtle addition of new dollars must eventually raise prices over what they would have been.

5. Bank Created Dollars

So the politicians reduce interest rates below free market rates?the rates that indicate the saved sums available for lending that will buy available materials at prevailing prices. Then, the Federal Government can borrow from the banks, at lower than free market interest rates, all the dollars that those in power desire to spend. Actually, the government borrows dollars with its right hand that it has created with its left hand. As a result, politicians can continue deficit spending without the necessity of borrowing from private sources at free market interest rates. [p. 248]

At the same time, businessmen eager to cut costs may also be tempted, by the lower interest rates, to expand their operations with borrowed money. The longer and larger their loans, the greater the savings they will expect to realize from the artificially lower interest rate. If they spend the borrowed funds quickly, the brunt of the inevitably higher prices will be borne by others.

The newly borrowed funds permit businessmen to embark confidently on long term expansion plans. The more time their plans need for completion, the longer it will take for any errors to be detected and the greater the quantity of money can be expanded without detection.

6. Public Fooled

In order to create a depression, the people must be led to believe that every dollar, new or old, represents a real value that has been produced and can be bought with that dollar. There must be no hint that any dollars have been obtained by any process other than the creation of an equivalent value in real wealth. If a significant number of persons should realize and expose the fact that paper or bookkeeping dollars, which did not represent the production of real wealth, were being pumped into circulation along with those that represented produced wealth, the jig would be up.

Once people realized that the number of dollars was constantly being increased by political bookkeeping, they would refuse to sell their goods and services for dollars. The market value of dollars would then disintegrate and market traders would resort to barter until a new commodity became generally acceptable as the money of the market place.

Most people realize the evils that flow from an inflationary spiral. Once there is general recognition that one has been started, public opinion will demand that it be stopped immediately. It can be continued only as long as public leaders fail to explain the significance of the existing situation, either because of their own ignorance or their desire to keep the truth a secret. [p. 249]

7. Understanding Needed

Some may know the facts of the case, but as long as they do not understand the significance of the semi-hidden increase in the quantity of money it can be continued. As long as it continues, it will misdirect business activities, inducing borrowers to overexpand in some industries while forcing others to curtail their more desirable activities. Eventually, this malproduction pattern must become evident, but the day of reckoning can often be put off as long as bankers, businessmen and the general public do not realize or understand what is happening. Larger and larger increases in the quantity of money may still be able to stimulate a spurt in some business activities and employment that will waste available savings and create ?surpluses? for which there is relatively little consumer demand. All this can go on for decades before the waste of savings and human effort becomes evident with the dawn of a depression.

Even after a depression makes its appearance, the illusion may be renewed and continued for another spell by a greater than ever increase in the quantity of money. This can be continued as long as the holders of dollars and dollar obligations do not realize that the process is a stealthy switch of a part of their wealth to those who receive a claim to it in the form of political subsidies or newly created bank loans.

If a depression is to be developed, these semi-secretive increases in the quantity of money must continue to fool most of the people for a long, long time. The tempo of the money and credit expansion can only be set at a pace that is not generally recognized. Those aware of what is happening can protect themselves by escalator clauses, whereby their dollar income goes up as the value of the dollar declines. But only a few can enjoy this protection, because it increases the burden that falls on all others, who will then be more likely to realize what is happening.

8. Almost All Misled

All this is a necessary part of creating a depression by the [p. 250] process of expanding the quantity of money. It must be done by public measures and yet their significance must be kept from the public. It is an extremely difficult task. And yet, over a long period of years, our political authorities have managed to accomplish it. Over these years, they have fooled almost everyone, including themselves.

Actually, most of this has been done legally by well-meaning men who had no idea of the results their actions would produce. They were acting under the delusion that the creation of money by political manipulation was helpful and not harmful.

Unfortunately, their good intentions cannot prevent or alleviate the consequences of actions which were both immoral and uneconomic. Fortunately, we can always adopt and pursue the moral and economic policies of a free market economy. The sooner we do this, the sooner we shall reduce, to the very minimum, the inescapable human suffering that is the penalty for the sins already committed. [p. 251]

How Much Money?^(*)

1. More Money for All

Most people want more money. So do I. But I wouldn?t keep it long. I would soon spend it for the things I need or want. So would most people. In other words, for most of us, more money is merely a means for buying what we really want. Only misers want more money for the sake of holding onto it permanently.

However, if more money is to be given out, most of us would like to get some of it. If we can?t get any for ourselves, the next best thing, from our viewpoint, would be for it to be given to those who might buy our goods or services. For then it is likely their increased spending would make us richer.

From such reasoning, many have come to believe that spreading more money around is a good thing?not only for their personal needs, but also for solving most all of the nation?s problems. For them, more money becomes the source of prosperity. So they approve all sorts of government programs for pumping more money into the economy.

If such programs are helpful, why not have more money for everyone? Why not have the government create and give everyone $100 or $200 or, better yet, $1,000? Why not have the [p. 252] government do it every year or every month or, better yet, every week?

Of course, such a system would not work. But why not? When we understand why not, we will know why every attempt to create prosperity by creating more money will not work. When we have learned the answer, we shall have taken a long step toward eliminating the greatest cause of both human misery and the decay of great civilizations.

One way to find the answer is to analyze the logic which seemingly supports the idea that more money in a nation?s economy means more prosperity for all. If we can spot an error in the chain of reasoning, we should be able to make it clear to others. Once such an error is generally recognized, the popularity of government money-creation programs will soon disappear. Neither moral leaders nor voting majorities will long endorse ideas they know to be false.

2. Stable Price Argument

Perhaps the basic thought that supports an ever-increasing quantity of money is the popular idea that more business requires more money: if we produce more goods and services, customers must have more money with which to buy the additional goods and services. From this, it is assumed that the need for prosperity and ?economic growth? makes it the government?s duty to pump out more purchasing power to the politically worthy in the form of more money or subsidies paid for by the creation of more money.

Support for such reasoning is found in an idea that goes back at least to medieval days. In the thirteenth and fourteenth centuries some of the world?s best minds believed there was a ?just price? for everything. The ??just price? was then thought to be determined by a fixed cost of production. Actual prices might fluctuate slightly from day to day or season to season, but they were always expected to return to the basic ?just price,? reflecting the supposedly never-changing number of man-hours required for production.

From such thinking, it naturally follows that increased production can only be sold when consumers have more [p. 253] money. More goods might be needed for any of several reasons, let us say for an increased population. However, no matter how much they were needed, they would remain unsold and unused unless buyers were supplied additional funds with which to buy them at, or near, the ?just price.?

What is the situation in real life? What do businessmen do when they have more goods to sell than customers will buy at their asking price?

They reduce prices. They advertise sales at mark-down prices. If that doesn?t work, they reduce their prices again and again until all their surplus goods are sold. Any economic good can always be sold, if the price is right.

The way to move increased production into consumption is to adjust prices downward. Businessmen, who have made mistakes in judging consumer wants, will suffer losses. Those who provide what consumers prefer will earn profits. Lower prices will benefit all consumers and mean lower costs for future business operations. Under such a flexible price system, there is no need for more money. Businessmen soon learn to convert available supplies of labor and raw materials into those goods for which consumers will willingly pay the highest prices.

3. What Are Prices?

Prices are quantities of money. They reflect a complex of interrelated market conditions and individual value judgments at any one time and place. Each price reflects not only the available supply of that good in relation to the supply of all other available goods and services, but also the demand of individuals for that good in relation to their demand for all other available goods and services.

But even this is only one side of price-determining factors. The money side must also be taken into consideration. Every price also reflects not only the quantity of money held by each market participant, but also?since very few people ever spend their last cent?how much money each participant decides to keep for his future needs and unknown contingencies. [p. 254]

Prices thus depend on many things besides the cost of production. They depend primarily on the relative values that consumers place on the satisfactions they expect to get from owning the particular mixture of goods and services that they select. However, prices also depend on the amount of money available both to each individual and to all individuals. In a free market economy, unhampered prices easily adjust to reflect consumer demand no matter what the total quantity of money or who owns how much of it.

4. What is This Thing Called Money?

Money is a commodity that is used for facilitating indirect exchange. Money first appeared when individuals recognized the advantages of the division of labor and saw that indirect exchange was easier and more efficient than the clumsy, time-consuming direct exchange of barter.

In the earliest days of specialized production, those who made shoes or caught fish soon found that if they wanted to buy a house, it was easier to buy it with a quantity of a universally desired commodity than with quantities of shoes or fresh fish.

So, they first exchanged their shoes or fish for a quantity of that commodity which they knew was most in demand. Such a commodity would keep and not spoil. It could be divided without loss. And most important, all people would value it no matter what the size of their feet or their desire for fish. The commodity which best meets these qualifications soon becomes a community?s medium of exchange, or money.

Many things have been used as money. In this country we once used the wampum beads of Indians and the shells found on our shores. As time passed, reason and experience indicated that the commodities best suited for use as money were the precious metals, silver and gold. By the beginning of this century, the prime money of the world had become gold. And so it is today. Gold is the commodity most in demand in world markets.

Money is always that commodity which all sellers are most happy to accept for their goods or services, if the quantity or [p. 255] price offered is considered sufficient. Money is thus the most marketable commodity of a market society. It is also the most important single commodity of a market society. This is so because it forms a part of every market transaction and whatever affects its value affects every transaction and every contemplated transaction.

5. Kinds of Goods

There are three types of economic goods:

1.       Consumers? goods.

2.       Producers? goods.

3.       Money.

Consumers? goods are those goods which are valued because they supply satisfaction to those who use or consume them. Producers? goods are goods which are valued because they can be used to make or produce consumers? goods. They include raw materials, tools, machines, factories, railroads, and the like. Money is that good which is valued because it can be used as a medium of exchange. It is the only type of economic good that is not consumed by its normal usage.

In the case of consumers? goods and producers? goods, every additional unit that is produced and offered for sale increases the wealth not only of the owner but of everyone else. Every additional automobile that is produced not only makes the manufacturer richer but it also makes every member of the market society richer.

How?

The more useful things there are in this world, the larger the numbers of human needs or wants that can be satisfied. The market system is a process for distributing a part of every increase in production to every participant in that market economy. When there is no increase in the quantity of money, the more goods that are offered for sale, the lower prices will be?and, consequently, the more each person can buy with the limited amount of money he has to spend. So every increase in production for a market economy normally means more for every member of that economy. [p. 256]

On the other hand, when any consumers? goods or producers? goods are lost or destroyed, not only the owner but all members of the market community suffer losses. With fewer goods available in the market place, and assuming no increase in the quantity of money, prices must tend to rise. Everybody?s limited quantity of money will thus buy less.

Recently, a Montreal apartment house was destroyed by an explosion. The loss to the occupants and the owners or insurance companies is obvious. The loss to all of us may be less obvious, but nevertheless it is a fact.

The market society has lost forever the services and contributions of all those who were killed. It has also lost for a time the contributions of all those whose injuries temporarily incapacitated them. There is also a loss for all of us in the fact that human services and producers? goods must be used to clear away the wreckage and rebuild what was destroyed. This diversion of labor and producers? goods means the market will never be able to offer the things that such labor and producers? goods could otherwise have been used to produce. With fewer things available in the market, prices will tend to be higher. Such higher prices will force each one of us to get along with a little less than would have been the case if there had been no explosion.

Thus, we are all sufferers from every catastrophe. Be it an airplane crash, a tornado, or a fire in some distant community, we all lose a little bit. And all these little bits often add up to a significant sum.

This is particularly true of war losses. Every American killed in Vietnam hurts every one of us not only in the heart but also in the pocketbook. Our government must supply some monetary compensation to his family and an income, however little, to his dependents. In such cases, the loss may continue for years. The killed man?s services are lost for his normal life span and his dependents become a long-term burden on the nation?s taxpayers and consumers. Such losses can never be measured or calculated, but they are real nonetheless.

So, in a market society every increase in consumers? goods or producers? goods permits us to buy more with whatever [p. 257] money we have, and every decrease in consumers? goods or producers? goods means ultimately higher prices and less for our money. Increased supplies of such economic goods help both the producers and everyone else who owns one or more units of money.

6. Limited Goods Available

With money, the situation is quite different. Any increase in the quantity of money helps those who receive some of the new quantity, but it hurts all those who do not. Those who receive some of the new quantity can rush out and buy a larger share of the goods and services in the market place. Those who receive none of the new quantity of money will then find less available for them to buy. Prices will rise and they will get less for their money.

Pumping more money into a nation?s economy merely helps some people at the expense of others. It must, by its very nature, send .prices up higher than they would have been, if the quantity of money had not been increased. Those with no part of the new quantity of money must be satisfied with less. It does not and cannot increase the quantity of goods and services available.

There are some who claim that increasing the quantity of money puts more men to work. This can only be so when there is unemployment resulting from pushing wage rates above those of a free market by such political measures as minimum wage laws and legally sanctioned labor union pressures. Under such conditions, increasing the quantity of money reduces the value of each monetary unit and thus reduces the real value of all wages. By doing this, it brings the higher-than-free-market wage rates nearer to what they would be in a free market. This in turn brings employment nearer to what it would be in a free market, where there is a job for all who want to work.⁽¹⁾

Those who create and slip new quantities of money into [p. 258] the economy are silently transferring wealth which rightfully belongs to savers and producers to those who, without contributing to society, are the first to spend the new money in the market place. When this is done by private persons, they are called counterfeiters. Their attempts to help themselves at the expense of others are easily recognized. When caught, they are soon placed where they can add no more to the quantity of money.

7. Governments Inflate

In recent generations our major problem has not been private counterfeiters. It has been governments. Over the years, governments have found ways to increase the quantity of money that not more than one or two persons in a million can detect. This is particularly true when production is increasing and when more and more of the monetary units are held off the market. Nonetheless, whether prices go up or not, every time a government increases the quantity of money, it is taking wealth from some and giving it to others.

This semi-hidden increase in the quantity of money occurs in two ways:

One, by the creation and issuance of money against government securities. This is a favorite way to finance government deficits. Government securities that private investors will not buy, because they pay lower-than-free-market interest rates, are sold to commercial banks. The banks pay for such securities by merely adding the price of the securities to government bank accounts. The government can then draw checks to pay suppliers, employees and subsidy recipients. (This process is encouraged and increased by technical actions and direct purchases of the nation?s central bank. In the United States, these powers reside in the Federal Reserve Board, which has not been hesitant about using them.)

The government thus receives purchasing power without contributing anything to the goods and services offered in the market place. It thus gets something for nothing. As a result, there is less available for those spending and investing dollars they have received for their contributions to society. The [p. 259] consequence of such government spending is that prices are higher than they would otherwise have been.

Two, the other major semi-hidden means of increasing the quantity of money is for banks to lend money to private individuals or organizations by merely creating or adding a credit to the borrowers? checking accounts. In such cases, they are not lending the savings of depositors. They are merely creating dollars, in the form of bank accounts, by simple bookkeeping entries. The borrowers are thereby enabled to draw checks or ask for newly created money with which to buy a part of the goods and services available in the market place. This means that those responsible for the production of these goods and services must be satisfied with less than the share they would have received if the quantity of money had not been so increased.

By such systems of money creation, our government and our government-controlled banking system have, from the end of 1945, increased the nation?s quantity of money from $132.5 billion to an estimated $289.9 billion by the end of 1964. This is an increase of $157.4 billion. During the same period, the gold stock, held as a reserve against this money and valued at $35 an ounce, fell from $20.1 billion to $15.4 billion. The increase in the quantity of money for 1964 amounted to $21.0 billion.⁽²⁾

All these new dollars provided the first recipients with wealth which, had there been no artificial additions to the quantity of money, would have gone to those spenders and investors who received their dollars in return for contributions to society. Last year alone, political favorites were helped to the tune of $21 billion, at the expense of all the nation?s producers and savers of real wealth.

These money-increasing policies remain hidden from most people, particularly when prices do not rise rapidly. It is now popular to say there is no inflation unless official price indexes [p. 260] rise appreciably. This popular corruption of the term inflation, originally defined as an increase in the quantity of money, makes it seem safe for the government to increase the quantity of money so long as the government?s own price indexes do not rise noticeably. So, if these price indexes can somehow be kept down, the government can continue buying or allocating wealth which has been created by private individuals who must be satisfied with less than the free market value of their contributions.

8. Price Rise Kept Down

Since World War II, there have been two continuing situations which have helped to keep official price indexes from reflecting the full effect of this huge increase in the quantity of money. The first such situation is that throughout this period American production of wealth has continued to increase. The second is that during these years foreigners and their banks and governments have taken and held off the market increasing quantities of dollars.

If there had been no upward manipulation of the quantity of money, the increased production of wealth would have re-suited in lower prices. This would have provided more for everyone who earned or saved a dollar. It would also have reduced costs and increased the amount of goods and services that would have been sold at home and abroad.

As it was, with prices rising slowly over the 1945-64 period, the Federal government and our government-controlled banking system have been able to allocate the benefits of increased production, and a little bit more, to favored bank borrowers who pay lower than free market interest rates and those who received Federal funds over and above the sums collected in taxes or borrowed from private individuals or corporations.

Untold billions of dollars have also gone into the hands or bank accounts of international organizations, foreigners, their banks, and governments. Many of these dollar holders consider $35 to be worth more than an ounce of gold. Such dollar holders have felt they could always get the gold and, meanwhile, they can get interest by leaving their dollars on deposit [p. 261] with American banks. Foreign governments could even count such deposits as part of their reserves against their own currencies. For example, the more dollars held by the Bank of France, the more it can expand the quantity of French francs. So the inflations of many European governments are built on top of the great increase in their holdings of dollars.

Short term liabilities of American banks to foreigners at the end of 1945 were only $6.9 billion.⁽³⁾ By the end of last year, they had risen to an estimated $28.8 billion, an increase of $21.9 billion.⁽⁴⁾ How many more dollars rest in foreign billfolds or under foreign mattresses cannot even be guessed. Should such foreign dollar holders lose confidence in the ability of their central banks to get an ounce of gold for every $35 presented to our government, more and more of these dollars will return to our shores where their presence will bid up American prices.

9. Adjustment Inevitable

This whole process of increasing the quantity of money by semi-hidden manipulations is not only highly questionable from the viewpoint of morality and economic incentives, but it also has a highly disorganizing effect on the production pattern of our economy. Over the years, as these newly created dollars have found their way into the market, they have forced profit-seeking enterprises to allocate a growing part of production to the spenders of the newly created dollars, leaving less production available for the spenders of dollars which represent contributions to society. Once this artificial creation of dollars comes to an end, as it must eventually, those businesses whose sales have become dependent upon the spending of the newly created dollars will lose their customers.

This will call for a reorganization of the nation?s production facilities. Such reorganizations of business have become known as depressions. The depression can be short, with a [p. 262] minimum of human misery, if prices, wage rates and interest rates are left free to reflect a true picture of the ever-changing demands of consumers and supplies of labor, raw materials, and savings. Private business will then move promptly and efficiently to employ what is available to produce the highest valued mixture of goods and services. Any interference with the free market indicators will not only slow down recovery but also misdirect some efforts and reduce the ability of business to satisfy as much human need as a completely free economy would.

The day of reckoning can only be put off so long. Once the nation?s workers and savers realize that such semi-hidden increases in the quantity of money are appropriating a part of their purchasing power, they may take their dollars out of government bonds, savings banks, life insurance policies, and the like in order to buy goods or invest in real estate or common stocks, and even borrow at the banks to do so. If this trend should develop, the government would soon be forced to adopt sound fiscal and monetary policies.

The same effect might be produced by a rush of foreign dollar holders to spend the dollars they now consider as good as one thirty-fifth of an ounce of gold. In any case, an ever-increasing quantity of dollars and ever-increasing prices will eventually bring on a ?run-away inflation,? unless the government stops its present practices before the situation gets completely out of hand.

10. Remove Temptation

The important thing to remember is that increases in the nation?s quantity of money can never benefit the nation?s economy. Such increases in the quantity of money do not and cannot increase the supply of goods and services that a free economy would produce. Such inflations of the quantity of money can only help some at the expense of others. Even such help for the politically favored is at best only temporary. As prices rise, it takes ever bigger doses of new money to have the same effect and this in turn means still higher prices.

The fact is that no matter what the volume of business may [p. 263] be, any given quantity of money is sufficient to perform all the services money can perform for an economy. All that is needed for continued prosperity is for the government to let prices, wage rates and interest rates fluctuate so that they reveal rather than hide the true state of market conditions.

Under the paper money standard, politicians are easily tempted to keep voting for just a little more spending than last year and just a little less taxing than last year. The gap can be covered by a semi-hidden increase in the quantity of money?just a little more than last year. Then, too, the illusions of prosperity are often helped along by an easy money policy?holding interest rates below those of a free market. This tends to increase the demand for loans above the amount of real savings available for lending. The banks then meet the demand for more credit by the bookkeeping device of increasing the bank accounts of borrowers.

Clever financial officials must then find ways to put off the day of reckoning. If gold continues to flow out, private travel, imports, and investments can be blamed and controls instituted. When the first controls do not succeed, more and more controls can be added. When these fail, public attention can always be diverted by a war. War is now generally considered a sufficient excuse for more inflation and a completely controlled economy of the type Hitler established in Germany.

No man or government should ever be trusted with the legal power to increase a nation?s quantity of money at will.

The great advantage of the gold standard is that gold cannot be created by printing presses or by bookkeeping entries. When a country is on the gold standard, politicians who want to vote for spending measures must also vote for increased taxes or sanction the issuance of government securities paying free market interest rates that will attract the funds of private savers and investors. Under a true gold standard, men remain free, the quantity of money is determined by market forces, and both the manipulated inflations and the resulting depressions are eliminated, along with all the poverty and human misery that they cause.

1.       See the author?s ?Jobs for All,? in Essays on Liberty VI (1959), pp. 367-370, and in Free Market Economics: A Basic Reader, compiled by Bettina Bien Greaves (1975), pp. 114-115, both published by the Foundation for Economic Education, Inc. (Irvington-on-Hudson, New York 10533).

2.       Figures from the Federal Reserve Bulletin, February 1965. Figures for the quantity of money include those for currency outside of banks, demand deposits, and time deposits of commercial banks which in practice may be withdrawn on demand.

3.       Federal Reserve Board ?Supplement? to Banking and Monetary Statistics, Sec. 15, International Finance.

4.       Federal Reserve Bulletin, February 1965. [p. 264] [p. 265]

Lower Interest Rates By Law^(*)

1. Laws Have Inevitable Effects

Why would it be a mistake for Federal Reserve officials to lower interest rates?

Wouldn?t it help the building industry? It would seem that a reduction in interest rates would lead to a renewal of building activity. This would put a lot of people to work and provide a lot more homes for those who want them. In fact, wouldn?t lower interest rates be a spur to other industries and be good for the country as a whole?

The answer is easy. If lower interest rates were free market interest rates, business would boom and bid up wage rates. However, if lower interest rates were the result of a government fiat, the effects would be disastrous. As the late Professor Ludwig von Mises frequently stated, every political interference with free market processes makes matters worse, not better, even from the viewpoint of those who propose such political interferences.

The reason for this is often difficult to understand. Unfortunately, those who attempt to push down interest rates by legal [p. 266] edict do not foresee the inevitable undesirable consequences. In recent years many people have learned the hard way about the consequences of political price and wage controls. Learning from experience the consequences of political interest rate controls could be even more painful.

When the government attempts to maintain prices above those of the free and unhampered market, as it has with some farm products, this inevitably leads to surpluses. Too much land, labor and scarce materials are devoted to producing such subsidized goods. This has two results. First, there are surpluses which must be stored, destroyed or given away. Second, the land, labor and scarce materials are not available to produce those goods and services which consumers desire in larger quantities. We know this because there are people willing to pay more than the free market production costs of such goods and yet they cannot find them on the market.

When the government attempts to maintain prices below those that would prevail in a free and unhampered market, as it recently did with price controls, this inevitably leads to shortages such as we experienced in a matter of months. In addition to the shortages, we soon had more unemployed workers, factories and transportation facilities, not to mention the increased welfare expenses this made necessary.⁽¹⁾ Businessmen, being human, will not continue to produce what they cannot sell at prices that cover their costs. Their available capital will not long permit it.

When the government attempts to raise wage rates above those that would prevail in a free and unhampered market, as it has for some forty years, it inevitably produces unemployment or underemployment with an accompanying demand for welfare payments. Such welfare payments are a burden on all who buy goods and services in the market place. The un employment and underemployment mean higher prices because fewer goods and services are produced to compete for the consumers? limited number of dollars. [p. 267]

When the government grants privileges to labor unions to raise wage rates above those of a free and competitive market, it raises the costs of producing union-made goods and services. The resulting higher prices inevitably reduce sales. This in turn reduces employment in such industries, or in other industries whose sales fall off because consumers, paying higher prices for union-made goods and services, have less for other things. This means that those who could have worked in the curtailed industries must look elsewhere for jobs and accept lower wages or remain unemployed and eventually increase the need for welfare payments. Those who take jobs at lower wage rates than they could have had in a free market will be underemployed. That is, they will be producing goods or services less desired by consumers than those that have been priced out of the market by the legal privileges which permit labor unions to extort higher than free market wages from society.

Such ill-fated attempts to raise wage rates above those earned in a free market inevitably force more and more unfortunate workers to take lower-paying jobs. Eventually, with the growth of labor union power, the competition for such lower-paying jobs drives some wages so low that many workers find it difficult to maintain their previous standard of living. Those who believe that political power can raise all wage rates then advocate minimum wage laws. Such laws compel employers to pay all their employees at least the minimum wage. Employers, being human and having limited resources, soon refuse to employ those for whom the minimum wage rate raises production costs above what customers will pay. Such unfortunate persons, including many youngsters, members of minority races and others with limited skills, then become legally unemployable. Their bleak choice is between a life of crime or subsistence on welfare payments until the value of the dollar is reduced by inflation to the point where they become employable at the legal minimum wage rate.

There was no long term mass unemployment in this country when everyone was free to take the highest wage rate that any employer could and would offer for his or her services. Market [p. 268] competition forced employers to pay their workers the full market value of their contribution. If they failed to do so, other employers would bid away such underpaid workers. Political interferences in the labor market, with the intentions of raising all wage rates, have created our present mass unemployment, underemployment and the growing need for welfare pay ments. Only a return to a free and unhampered labor market will bring to an end such unemployment and underemployment. In a free market there are jobs for all⁽²⁾ and no need to subsidize in idleness those who are able to work.

2. The Market Produces Interest Rates

Interest rates, like prices and wage rates, are market phenomena. Political interferences with interest rates, like price and wage controls, create economic chaos. Such chaos leads to a general loss of freedom and inevitably reduces the living standards of every member of society. It is thus vital that we all understand why the government should not interfere with free market interest rates.

Market interest rates are a sum of three contributing market factors:

(a) The first is true or pure interest, what Mises called ?originary interest.? This is payment for time preference. A person currently short of cash may wish to spend $1,000 for something now, and pay for it later when he expects to have more cash. If he wants that object so badly now that he is willing to promise to pay $1,100 a year from now, he may be able to obtain an immediate loan of $1,000. That would mean he values spending the $1,000 now so much more than waiting a year to do so that he is willing to pay 10 per cent, or $100, more to have the object now.

In order to borrow this $1,000, the borrower must find someone who has saved $1,000 and is willing to lend it to him for one year for an interest rate of 10 per cent or less. Few people will lend their savings, except for charitable purposes, without receiving some benefit in return. The prospective [p. 269] lender may want to buy a car or take a trip at the end of a year. He will make the loan only on condition that he be repaid an extra sum for making the sacrifice of not spending his money now. That extra payment, called interest, must be high enough for his prospective lender to value the future repayment, with interest, higher than he values spending the $1,000 now. So the loan depends on each party?s placing a higher value on what he receives than on what he furnishes the other party. The difference between the sum loaned and the sum to be repaid is true or pure interest?a payment that will compensate a saver for postponing his own spending for the time of the loan.

(b) The second factor in market interest rates is the certainty or uncertainty that the loan will be repaid as specified. If there is valuable collateral or if the lender thinks the chances of repayment are good, this factor will be minimal. However, if the borrower has few resources and there is reason to believe that the loan might not be repaid if he died or lost his job, this would be a factor the lender would consider in arriving at the total interest rate he would request before making a loan to that specific person. This factor would differ from person to person and from loan to loan, but it is present to some extent in the interest rate on every loan.

(c) The third and currently most important factor in market interest rates is what is expected to happen to the purchasing power of the dollar during the term of the loan. If the lender expects prices to rise 10 per cent in the next year and he only gets 10 per cent more dollars back from the borrower at the end of the year, he does not receive one cent of pure interest. Pure interest is only the amount the lender gets back over and above the purchasing power he has lent. So in times of inflation, when the value of the dollar is going down, this third factor must rise. As it rises, so does the market interest rate, which is the total of the three factors just discussed?(a) pure interest based on time preference, (b) uncertainty of repayment and (c) change in the dollar?s purchasing power.

Current market interest rates are considered high because this third factor, reflecting an anticipated drop in the dollar?s [p. 270] purchasing power, is high. The way to reduce this factor is to reduce the expectation that the purchasing power of the dollar will drop in the next year. So the only satisfactory way to reduce current high interest rates is to eliminate the expectation that future prices will be ever higher. This means we must stop the inflation.

3. More Savings Are Needed

Lower interest rates that represent free market interest rates are always helpful to society in general. Lower interest rates in a free market society mean there are comparatively more savers with funds they want to lend than there are borrowers who will pay high interest rates. These savers seek to lend their funds so as to earn as much money as possible. Rather than spend their savings now, they seek more funds at a later date when their current income may be lower, as when they retire, or when their expenses may be higher, as when they may want to buy a car or a house or send a child to college. It is the higher amounts of such savings, bidding in the market place for borrowers, that produce lower interest rates in a free society. To bring about such lower interest rates, government should protect and encourage voluntary loans made with the expectation they will be repaid in dollars with the same or an increasing purchasing power.

But the question in many minds today is, why not have the Federal Reserve System lower market interest rates by fiat? The answer is simply this: If the Federal Reserve lowers interest rates when there are no increased savings available for lending, there will be a bigger demand for loans at the lower interest rate than can be made with available savings. Under present laws and conditions, the banks meet this increased demand for loans at the lower interest rates by creating more loan money out of thin air (or should we say paper?). The borrowers get their loans in the form of an addition to their bank accounts on which they can draw checks. No one else has chosen to reduce his spending so as to make his savings available to the borrower, as is always the case with free market credit transactions. [p. 271]

4. Why Interest Rate Controls Hurt

When the Federal Reserve System reduces interest rates by fiat, it must create more spendable money than was previously earned or saved. It puts into the market dollars which do not represent any contribution to society. You have more dollars in the hands of borrowers and no reduction in the numbers of dollars which savers may spend currently. This has several undesirable effects, some obvious and others largely unseen.

The most obvious effect is that with more money bidding for the same quantity of goods and services in the market place, prices must be higher than they would otherwise be. Largely unseen are the ways in which this increased quantity of money enters the market place and how it affects the structure of production and the welfare of different individuals.

Those who borrow the savings of people who must reduce their current expenditures and those who borrow artificially created bank money cannot be distinguished in the market place. In fact, most borrowers from banks do not know whether they are borrowing the funds of the bank?s stockholders and depositors or newly created funds. The borrowers of the newly created funds are in a position to bid away available goods from the earners and savers who would have bought them if the quantity of dollars had not been increased. What such borrowers buy drives prices up and leaves less for all who earned or saved the money they take to market. In the short run, these artificially lower interest rates help borrowers and those who sell to them?the construction industry if the borrowers buy houses?at the expense of all workers, savers and those who would have profited from supplying what the workers and savers can no longer buy.

5. Outstanding Contracts Affected

Although some may be helped by such artificial lowering of interest rates, all who have earned or saved money are hurt. Such creation of more dollars not only hurts all workers and savers, by reducing the value of their dollars, but it also affects the value of every outstanding contract. It means every pre-existing [p. 272] dollar is worth less and every contract promising to pay dollars in the future has been altered in favor of the payer and to the disadvantage of the recipient. This means a reduction in the real value of all bank accounts, insurance policies, wage rates, salaries and pensions as well as all rental contracts, time payments and other purchase agreements. When savers foresee such effects, they refuse to make any more loans unless the interest rates will more than compensate them for the expected drop in the value of the dollars they lend.

6. Misdirection of Economy

The most important, generally unrealized, effect of such artificial increases in the quantity of spendable dollars is that they redirect the whole economy. They do so in a manner that cannot be continued without an ever-increasing quantity of newly created dollars to compensate for the resulting higher prices. As the political increase in the quantity of dollars accelerates, more and more of the nation?s production facilities are devoted to supplying the spenders of the newly created dollars. This means a smaller and smaller part of the production facilities are devoted to supplying the nation?s workers and savers. Eventually, i.f the process is not stopped in time, the system breaks down and the dollars become worthless.

7. Stopping Dollar Creation Has a Price

Of course, the process can be stopped at any time, but not without consequences. Once the government stops increasing the quantity of dollars artificially or even slows down the rate of artificial increase in the quantity of dollars, producers supplying goods and services to the spenders of newly created unearned dollars lose a large number of their customers. They must then lay off men and there is a recession or de-pression?until production is adjusted to supplying only those with earned or saved dollars to spend.

Under present policies, the government is continually faced with deciding whether to inflate artificially the quantity of spendable dollars or permit market forces to readjust the economy. If free and unhampered market forces are permitted [p. 273] to emerge, free market prices, wage rates and interest rates will quickly redirect the economy toward a more efficient satisfaction of all those who contribute toward production. Those who had spent newly created dollars will have to curb their spending or earn the dollars they spend. The available supplies of workers and capital goods will be quickly redirected toward producing solely for those spending dollars they have earned or saved in the service of their fellow men.

In short, when Federal Reserve officials lower interest rates artificially, they send a part of the economy off on a spree at the expense of the nation?s workers and savers. The spree can only be continued by an ever-increasing inflation of the quantity of spendable dollars. If we want to end that inflation and all its undesirable consequences, we must permit the free market to determine interest rates as borrowers compete for the real savings made available by those willing to reduce their potential spending temporarily for a price, commonly called interest. Only freely determined interest rates, without any artificial manipulation or control of the quantity of dollars, will eliminate the inflation problem from our economy.

8. The Optimum Solution

The best way to reduce market interest rates is to remove the expectancy of further inflation. Once this is done, more people will be encouraged to save more dollars and their competition for borrowers will bring lower market interest rates. Then there can be a profitable expansion of those industries that will direct available supplies of labor and capital into producing more of the things that workers and savers want most.

The only way Federal Reserve officials can help workers, investors and consumers is to stop increasing the quantity of dollars?stop inflating?and permit free market forces to set interest rates that reflect the actual supply of, and demand for, such savings as are available for lending. Any interference with free market interest rates must upset the economy and produce results that all honest and intelligent people consider undesirable.

1.       People who sanction laws which deprive some workers from earning a living for themselves and their families are honor bound to provide the necessities of life for such second class citizens.

2.       See above p. 257n. [p. 274] [p. 275]

On Private Paper Money^(*)

August 23, 1977

Editor
The Wall Street Journal
New York, New York

Dear Sir:

Professor Hayek?s declaration for a Free Market Money (Wall Street Journal, August 19, 1977) is to be welcomed as travelers on a long, dry trek across a desert would welcome their first oasis.

He offers his proposal as ?a radical cure?i.e, taking from government the monopoly of issuing money, and handing the task to private industry.? This now appears to him as ?an effective remedy to our monetary problems.? This is a position which all informed students of sound money and a free society will heartily endorse.

However, when Professor Hayek claims that this ?opens a new and unexplored chapter of monetary theory,? we must demur. Carl Menger, on whom Professor Hayek is the most eminent authority, wrote as early as 1871 in his Principles of Economics: ?Money is not an invention of the state. It is not the product of a legislative act.?⁽¹⁾ As Menger demonstrated, money is a phenomenon of the market.

In 1912, Ludwig von Mises, with whom Professor Hayek was closely associated in the 1920's, wrote in his The Theory of Money and Credit:

The concept of money as a creature of Law and the State is clearly untenable. It is not justified by a single phenomenon of the market. To ascribe to the State the power of dictating the laws of exchange, is to ignore the fundamental problems of money-using society . . . . State declarations of legal tender affect only those monetary obligations that have already been contracted. But commerce is free to choose between retaining its old medium of exchange or creating a new one for itself.⁽²⁾ [p. 276]

In 1912, Mises did not foresee that governments would outlaw the use of gold as money, but he certainly did analyze and present the theory of a free market money.

Forty years later in his ?Monetary Reconstruction,? which appeared in the 1953 edition and later printings of his The Theory of Money and Credit, Professor Mises wrote:

The sound-money principle has two aspects. It is affirmative in approving the market?s choice of a commonly-used medium of exchange. It is negative in obstructing the government?s propensity to meddle with the currency system . . . .

      Sound money still means today what it meant in the nineteenth century: the gold standard.

      The eminence of the gold standard consists in the fact that it makes the determination of the monetary unit?s purchasing power independent of the measures of governments . . . . It makes it impossible for them to inflate.⁽³⁾

Professor Hayek, the most publicized living member of the Austrian School of Economics, believes he is on the path to a ?stable currency.? Shades of Ponce de Leon and his search for the ?Fountain of Youth.? From Menger to Mises, the basic foundation on which the Austrian School has been built has been the subjective theory of value?the idea that the values of economic goods are in the minds of individual men and, therefore, neither constant nor inherent in the goods themselves. Economic values, being the judgments of individuals, vary from person to person and even from time to time for the same person. As Mises said in his 1912 book, ?Money is an economic good with its own fluctuations in value.?⁽⁴⁾

In this same volume, Mises demonstrated the shortcoming of subjectively selected and weighted index numbers ?for solving practical problems of economic policy.?⁽⁵⁾ You cannot measure the variable value of money with any combination, weighted or un-weighted, of the variable values of other commodities. For measurement, you need an invariable standard.

In a 1928 German-language volume, Mises dealt with this problem in considerable detail. This has not been available in English. Before he died, Mises authorized the undersigned respectively to translate and to edit this valuable work. It is now in the hands of the printers [p. 277] and is expected to appear shortly in a collection entitled On the Manipulation of Money and Credit. In this work, Mises states:

The concept of ?stable value? is vague and indistinct. Strictly speaking, only an economy in the final state of rest, where all prices remain unchanged, could have a money with a fixed purchasing power . . . . There is not and never can be any such thing as stability of value . . . . This will come as no surprise to anyone who is acquainted with the fundamental problems of modern subjectivistic catallactics.⁽⁶⁾

In his Human Action, Mises tells us:

As far as there is human action, there is no stability, but ceaseless alteration . . . . There are in this world no such things as stability and security and no human endeavors are powerful enough to bring them about . . . . There are no such things as eternal, absolute, and unchanging values. The search for a standard of such values is vain.⁽⁷⁾

Even Professor Hayek has written in his recent Denationalisation of Money, ?Strictly speaking, in a scientific sense, there is no such thing as a perfectly stable value of money?or of anything else. Value is a relationship.?⁽⁸⁾

Despite this, the ultimate goal of Professor Hayek?s ?stable currency? proposal is a society with a stable commodity price index. With increased production, prices would not be permitted to fall. For if they did, the purchasing power of money would rise and the index would fall. This would no longer be a ?stable currency.? It would then be considered necessary to increase the quantity of money. This Professor Hayek or his bank would apparently do by increasing bank loans, i.e., by credit expansion. Yet the Austrian theory of the trade cycle, on which Professor Hayek has frequently written, maintains that it is just such credit expansions that create booms which must inevitably lead to busts. Is Professor Hayek ready to renounce this theory?

Two other important things must be considered in connection with such an increase in the quantity of money:

(1)       As Mises wrote in his 1928 book, ?No fixed quantitative relationship can be established between the changes in the quantity of money and those of the unit?s purchasing power.?⁽⁹⁾ After years of experience, our Federal Reserve officials can corroborate this. A private bank would find it no easier to adjust the quantity of [p. 278] money to what will produce the ?guide number? of ?an appropriately weighted average of the monetary prices.?

(2)       As Mises wrote in 1912, ?The increase in the stock of money . . . always increases the stock of money at the disposal of certain individual economic agents.?⁽¹⁰⁾ This means those receiving the newly created money are helped at the expense of those who do not receive it. Would a free society long permit a private bank to give its favored clients newly created unearned money that meant higher prices for everyone else?

These are problems raised by credit expansion which Professor Hayek should think through to their logical conclusion.

In a truly free society, we would have free banking. Professor Hayek and his bank would be allowed to issue paper certificates. So would we and our neighbors down the street. The real question is: Who would accept such certificates for their goods or services? Remember, they are not legal tender. Their value could not be insured. ?For purposes of instant liquidity,? the issuer would ?hold a certain limited reserve in other currencies??official currencies which ?continue to depreciate.? It is difficult to believe that sophisticated businessmen would long accept such paper certificates when, in a free society, they could ask for and receive gold or certificates redeemable in gold, now illegal.

As Menger and Mises have taught those exposed to the Austrian School of Economics, money is a market phenomenon. In a free society, it is chosen by market participants.

As Mises wrote in his great 1912 book:

An object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange-value based on some other use . . . . This link with a pre-existing exchange-value is necessary not only for commodity money, but equally for credit money and fiat money. No fiat money could ever come into existence if it did not satisfy this condition . . . . Before an economic good begins to function as money it must already possess exchange-value based on some other cause than its monetary function.⁽¹¹⁾

In short, money cannot spring full-grown, so to speak, from the head of a Zeus, a Hayek or a bank.

American dollars were originally defined legally as a quantity of gold or silver. For years our paper dollars were exchangeable for gold [p. 279] or silver. Their use followed the path that Mises described. The privately issued paper certificates that Professor Hayek would issue could only meet this condition by being made redeemable in the very currencies he seeks to replace.

Given the fact that few people now alive have ever known sound money and given the general ignorance of sound monetary theory, it is possible that some established banks might find some who would accept their privately issued paper certificates. But, as Hans Christian Andersen tells the story of the illusion of ?The Emperor?s Clothes,? sooner or later some innocent bystander would point out that such paper certificates are not the most marketable commodity in a free society and hence not ?money.?

Let us, by all means, end the government?s monopoly issue of money and move toward a free market money. Let us adopt free banking. But let us not fool ourselves that a paper certificate that the issuer is not constantly prepared to redeem in a commonly acceptable medium of exchange is free market money.

Over the centuries, many commodities have competed for popular acceptance as the commonly used medium of exchange. Gradually, the precious metals won out. After a period of competition between gold and silver, including governmental attempts at bimetallism, gold became the universally accepted money. As Mises wrote a quarter of a century ago: ?Sound money still means today what it meant in the nineteenth century: the gold standard.?⁽¹²⁾

A free market money is a market-chosen medium of exchange. Given the chance and the choice, there can be little doubt but what the free market would choose gold for its money. Have you ever heard of any person, company or country refusing to accept gold?

BETTINA BIEN GREAVES
PERCY L. GREAVES, Jr.

1.       English ed., Glencoe (Illinois), 1950. p. 261.

2.       1912 German ed., pp. 57 & 60; 1934 and later English eds., pp. 69 & 71.

3.       1953 and later English eds., pp. 414 & 438.

4.       1912 German ed., p. 316; 1934 and later English eds., p. 276.

5.       1924 German ed., p. 177; 1934 and later English eds., p. 194.

6.       Pp. 81, 90 & 88 above.

7.       2nd and 3rd eds., pp. 223, 226 &228.

8.       London, 1976. p. 58.

9.       P. 91 above.

10.       1912 German ed., p. 150; 1934 and later English eds., p. 138.

11.       1912 German ed., pp. 109-111; 1934 and later English eds., pp. 110-111.

12.       1953 and later English eds., p. 438.

NOTE: On Oct. 28, 1977, President Carter signed the Helms Act^(*) which legalizes gold clause contracts. This opens the door for a retreat from paper money. However, a sound gold standard cannot be maintained without a reasonably free market in energy, prices, wage rates and interest rates along with a balanced budget and the repeal of laws and taxes which inhibit private investment in productive enterprise.

P.L.G., Jr. [p. 279] [p. 280] [p. 281]