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1. Stabilization of the Monetary Unit — From the Viewpoint of Theory (1923)

VI. The Inflationist Argument

1. Substitute for Taxes

Nowadays, the thesis is maintained that sound monetary relationships may certainly be worth striving for, but public policy is said to have other higher and more important goals. As serious an evil as inflation is, it is not considered the most serious. If it is a choice of protecting the homeland from enemies, feeding the starving and keeping the country from destruction, then let the currency go to rack and ruin. And if the German people must pay off a tremendous war debt, then the only way they can help themselves is through inflation.

This line of reasoning in favor of inflationism must be sharply distinguished from the old inflationist argument which actually approved of the economic consequences of continual monetary depreciation and considered inflationism a worthwhile political goal. According to the later doctrine, inflationism is still considered an evil although, under certain circumstances, a lesser evil. In its eyes, monetary depreciation is not considered the inevitable outcome of a certain pattern of economic conditions, as it is by adherents of the “balance of payments” doctrine discussed in the preceding section. Advocates of limited inflationism tacitly, if not openly, admit in their argumentation that paper money inflation, as well as the resulting monetary depreciation, is always a product of inflationist policy. However, they believe that a government may get into a situation in which it would be more advantageous to counter a greater evil with the lesser evil of inflationism.

The argument for limited inflationism is often stated so as to represent inflationism as a kind of a tax which is called for under certain conditions. In some situations it is considered more advantageous to cover government expenditures by issuing new notes, than by increasing the burden of taxes or borrowing money. This was the argument during the war, when it was a question of defraying the expenses of the army and navy. The same argument is now advanced when it comes to supplying some of the population with cheap foodstuffs, covering the operating deficits of public enterprises (the railroads, etc.) and arranging for reparations payments. The truth is that inflationism is resorted to when raising taxes is considered disagreeable and when borrowing is considered impossible. The question now is to explore the reasons why it is considered disagreeable or impossible to employ these two normally routine ways of obtaining money for government expenditures.

2. Financing Unpopular Expenditures

High taxes can be imposed only if the general public is in agreement with the purposes for which the funds collected will be used. In this connection, it is worth noting that the higher the general burden of taxes, the more difficult it becomes to deceive public opinion as to the fact that the taxes cannot be borne by the more affluent minority of the population alone. Even taxes levied on property owners and the more affluent affect the entire economy. Their indirect effects on the less well-to-do are often felt more intensely than would be those from direct proportional taxation. It may not be easy to detect these relationships when tax rates are relatively low, but they can hardly be overlooked when taxes are higher. However, there is no doubt that the present system of taxing “property” can hardly be carried any farther than it already has been in the countries where inflationism now prevails. Thus the decision will have to be made to rely more directly on the masses for providing funds. For policy makers who enjoy the confidence of the masses only if they impose no obvious sacrifice, this is something they dare not risk.

Can anyone doubt that the warring peoples of Europe would have tired of the conflict much sooner, if their governments had clearly, candidly, and promptly, presented them with the bill for military expenses? No war party in any European country would have dared to levy any considerable taxes on the masses to pay the costs of the war. Even in England, the printing presses were set in motion. Inflation had the great advantage of creating an appearance of economic well-being, of an increase of wealth. It also concealed capital consumption by falsifying monetary calculations. The inflation led to illusory entrepreneurial and capitalistic profits, which could be taxed as income at especially high rates. This could be done without the masses, and frequently even without the taxpayers themselves, noticing that a portion of capital itself was being taxed away. Inflation made it possible to turn the anger of the people against “war profiteers, speculators and smugglers.” Thus, inflation proved itself an excellent psychological aid to the pro-war policy, leading to destruction and annihilation.

What the war began, the revolution continues. A socialistic or semi-socialistic government needs money to operate unprofitable enterprises, to subsidize the unemployed and to provide the people with cheap food supplies. Yet, it cannot raise the funds through taxes. It dares not tell the people the truth. The pro-statist, pro-socialist doctrine calling for government operation of the railroads would lose its popularity very quickly if a special tax were levied to cover the operating losses of the government railroads. If the Austrian masses themselves had been asked to pay a special bread tax, they would very soon have realized from whence came the funds to make the bread cheaper.

3. War Reparations

The decisive factor for the German economy is obviously the payment of the reparations burden imposed by the Treaty of Versailles and its supplementary agreements. According to Karl Helfferich,21 these payments imposed on the German people an annual obligation estimated at two-thirds of their national income. This figure is undoubtedly much too high. No doubt, other estimates, especially those pronounced by French observers, considerably underestimate the actual ratio. In any event, the fact remains that a very sizeable portion of Germany's current income is consumed by the levy imposed on the nation, and that, if the specified sum is to be withdrawn every year from income, the living standard of the German people must be substantially reduced.

Even though somewhat hampered by the remnants of feudalism, an authoritarian constitution and the rise of statism and socialism, capitalism was able to develop to a considerable extent on German soil. In recent generations, the capitalistic economic system has multiplied German wealth many times over. In 1914, the German economy could support three times as many people as a hundred years earlier and still offer them incomparably more. The war and its immediate consequences have drastically reduced the living standards of the German people. Socialistic destruction has continued this process of impoverishment. Even if the German people did not have to fulfill any reparations payments, they would still be much, much poorer than they were before the war. The burden of these obligations must inevitably reduce their living standard still further—to that of the thirties and forties of the last century. It may be hoped that this impoverishment will lead to a reexamination of the socialist ideology which dominates the German spirit today, that this will succeed in removing the obstacles now preventing an increase in productivity, and that the unlimited opening up of possibilities for development, which exist under capitalism and only under capitalism, will increase many times over the output of German labor. Still the fact remains that if the obligation assumed is to be paid for out of income, the only way is to produce more and consume less.

A part of the burden, or even all of it, could of course be paid off by the export of capital goods. Shares of stock, bonds,22 business assets, land, buildings, would have to be transferred from German to foreign ownership. This would also reduce the total income of the people in the future, if not right away.

4. The Alternatives

These various means, however, are the only ways by which the reparations obligations can be met. Goods or capital, which would otherwise have been consumed within the country, can be exported. To discuss which is more practical is not the task of this essay. The only question which concerns us is how the government can proceed in order to shift to the individual citizens the burden of payments, which devolves first of all on the German treasury. Three ways are possible: raising taxes; borrowing within the country; and issuing paper money. Whichever one of the three methods may be chosen, the nature of its effect abroad remains unaltered. These three ways differ only in their distribution of the burden among citizens.

If the funds are collected by raising a domestic loan, then subscribers to the loan must either reduce their consumption or dispose of a part of their capital. If taxes are imposed, then the taxpayers must do the same. The funds which flow from taxes or loans into the government treasury and which it uses to buy gold, foreign bills of exchange and foreign currencies to fulfill its foreign liabilities, are supplied by the lenders and the taxpayers through the sale abroad of commodities and capital goods. The government can only purchase available foreign exchange which comes into the country from these sales. So long as the government has the power to distribute only those funds which it receives from tax payments and the floating of loans, its purchases of foreign exchange cannot push up the price of gold and foreign currencies. At any one time, the government can buy only so much gold and foreign exchange as the citizens have acquired through export sales. In fact, the world prices of goods and services cannot rise on this account. Rather their prices will decline as a consequence of the larger quantities offered for sale.

However, if and as the government follows the third route, issuing new notes in order to buy gold and foreign exchange instead of raising taxes and floating loans, then its demand for gold and foreign exchange, which is obviously not counterbalanced by a proportionate supply, drives up the prices of various kinds of foreign money. It then becomes advantageous for foreigners to acquire more marks so as to buy capital goods and commodities within Germany at prices which do not yet reflect the new ratios. These purchases drive prices up in Germany right away and bring them once again into adjustment with the world market. This is the actual situation. The foreign exchange, with which reparations obligations are paid, comes from sales abroad of German capital and commodities. The only difference consists in how the government obtains the foreign exchange. In this case, the government first buys the foreign exchange abroad with marks, which the foreigners then use to make purchases in Germany, rather than the German government's acquiring the foreign exchange from those within Germany who have received payment for previous sales abroad.

From this one learns that the continuing depreciation of the German mark cannot be the consequence of reparations payments. The depreciation of the mark is simply a result of the fact that the government supplies the funds needed for the payments through new issues of notes. Even those who wish to attribute the decline in the rate of exchange on the market to the payment of reparations, rather than to inflation, point out that the quotation for marks is inevitably disturbed by the government's offering of marks for the purchase of foreign exchange.23 Still, if the government had available for these foreign exchange purchases only the number of marks which it received from taxes or loans, then its demand would not exceed the supply. It is only because it is offering newly created notes, that it drives the foreign exchange rates up.

5. The Government's Dilemma

Nevertheless, this is the only method available for the German government to defray the reparations debt. Should it try to raise the sums demanded through loans or taxes, it would fail. As conditions with the German people are now, if the economic consequences of compliance were clearly understood and there was no deception as to the costs of that policy, the government could not count on majority support for it. Public opinion would turn with tremendous force against any government that tried to carry out in full the obligations to the Allied Powers. It is not our task to explore whether or not that might be a wise policy.

However, saying that the decline of the value of the German mark is not the direct consequence of making reparations payments but is due rather to the methods the German government uses to collect the funds for the payments, by no means has the significance attached to it by the French and other foreign politicians. They maintain that it is justifiable, from the point of view of world policy, to burden the German people with this heavy load. This explanation of the German monetary depreciation has absolutely nothing to do with whether, in view of the terms of the Armistice, the Allied demand, in general, and its height, in particular, are founded on justice.

The only significant thing for us, however, since it explains the political role of the inflationist procedure, is yet another insight. We have seen that if a government is not in a position to negotiate loans and does not dare levy additional taxation for fear that the financial and general economic effects will be revealed too clearly too soon, so that it will lose support for its program, it always considers it necessary to undertake inflationary measures. Thus inflation becomes one of the most important psychological aids to an economic policy which tries to camouflage its effects. In this sense, it may be described as a tool of antidemocratic policy. By deceiving public opinion, it permits a system of government to continue which would have no hope of receiving the approval of the people if conditions were frankly explained to them.

Inflationist policy is never the necessary consequence of a specific economic situation. It is always the product of human action—of man-made policy. For whatever the reason, the quantity of money in circulation is increased. It may be that the people are influenced by incorrect theoretical doctrines as to the way the value of money develops and are not aware of the consequences of this action. It may be that, in full knowledge of the effects of inflation, they are purposely aiming, for some reason, at a reduction in the value of the monetary unit. So no apology can ever be given for inflationist policy. If it rests on theoretically incorrect monetary doctrines, then it is inexcusable, for there should never, never be any forgiveness for wrong theories. If it rests on a definite judgment as to the effects of monetary depreciation, then to want to “excuse it” is inconsistent. If monetary depreciation has been knowingly engineered, its advocates would not want to excuse it but rather to try to demonstrate that it was a good policy. They would want to show that, under the circumstances, it was even better to depreciate the money than to raise taxes further or to permit the deficit-ridden, nationalized railroads to be transferred from government control to private hands.

Even governments must learn once more to adjust their outgo to income. Once the end results to which inflation must lead are recognized, the thesis, that a government is justified in issuing notes to make up for its lack of funds, will disappear from the handbooks of political strategy.

  • 21. Karl Helfferich, Die Politik der Erfüllung (Munich, 1922), p. 22. [NOTE: Helfferich (1872–1924), as Minister of the German Imperial Treasury, 1915–1916, and later in various official and unofficial capacities, was instrumental in promoting inflation and opposing reparations payments.—Ed.]
  • 22. Thus, raising a foreign loan falls within this category too.
  • 23. See Walter Rathenau's addresses—January 12, 1922, before the Senate of the Allied Powers at Cannes, and March 29, 1922, to the Reichstag (Cannes und Genua, Vier Reden zum Reparationsproblem [Berlin 1922], pp. 11ff. and 34ff.). [NOTE: Rathenau (1867–1922), a German industrialist, became an official in the post-World War I German government—Minister of Reconstruction (1921) and Foreign Minister (1922).—Ed.]