From Bretton Woods to World Inflation

1983

This concludes our 40-year history of inflation, from the fateful conference at Bretton Woods to the present. What lessons does it teach us? What must we do about it now?

The short answer to these questions is obvious. We must stop inflating. But the details of this answer can be complicated, and the political obstacles to getting it done are all but insurmountable.

Let us begin by making a few points clear. Inflation is not some great natural disaster, that falls upon us from without like an earthquake, a volcanic eruption, or a flood. Neither is it some economic accident that is nobody’s fault. It is something we bring about by our own actions. If we wish to narrow the blame, we may say that it is something brought about by the actions of our politicians, our government officeholders. But our politicians act as they do because they want to be elected or re-elected. They are responding to the demands, or the presumed demands, of the majority of voters.

It is always very easy to start an inflation, but the longer it has lasted, and the further it has been allowed to progress, the more difficult it becomes to stop.

The cycle begins, say, when the politicians in power decide to confer special benefits on favored groups. The government sets up, for example, an elaborate Social Security system, to guarantee everybody enough to retire on after the age of 65. It initiates a system of unemployment insurance which begins making payments automatically, for 15 weeks, say, to anybody who has quit or been thrown out of work. It offers relief payments, or issues food stamps, to people assumed to be in need “through no fault of their own.” It offers subsidies to farmers for growing less. When surplus milk production reduces farm income, the politicians set a minimum price for milk and order the government to buy whatever amount is necessary to maintain that price. The government puts this in storage, in the form of butter or cheese, and when the amount in storage becomes appallingly high, starts giving it away. The politicians provide a score of other handouts or subsidies. And all these programs are justified as the minimum duty of a “compassionate” government.

At first the politicians pay for all these benefits by raising taxes, but this becomes increasingly unpopular. The politicians begin to run out of ideas for additional types of subsidies, so they increase the subsidies they have already established. Social Security benefit payments are increased. Unemployment insurance entitlements are raised, extended to 26 weeks, and sometimes to 39. Relief payments, food stamps, and other subsidies also mount.

Much of this growth is generated by the programs themselves. Social Security causes more and more people to retire early. Unemployment insurance prolongs unemployment. Minimum prices for milk increase the output of milk. And so on.

It becomes increasingly difficult, politically and economically, to impose still heavier taxes. The recipients of subsidies and other handouts come to regard them as a right. Any proposal for the slightest reduction is treated as outrageous. No politician dares suggest reducing any subsidy, much less halting it. “Entitlements” grow. Budgets become unbalanced and stay unbalanced. The government pays for the deficits by going further into debt or prints more and more inconvertible paper money.

To be specific, the United States government has not balanced its budget since the fiscal year 1969. Though the tax burden has steadily mounted, there have been 45 deficits in the 53 years since 1930. These deficits have been growing at an accelerative rate. President Reagan—even on the assumption that the cutbacks and freezes in spending proposed in his budget message of Jan. 31, 1983, will be adopted—projected a deficit of $188.8 billion in the fiscal year 1984, $194 billion in fiscal 1985, $148 billion in 1986, $142 billion in 1987, and $117 billion in 1988. When one considers that future budget deficits have been chronically underestimated in the past, the outlook at the moment of writing this is frightening.

The candid recognition of this outlook clearly tells us what must now be done. Congress and the Administration must stop the deficit spending. They must begin not in some indefinite future, but at the earliest possible moment.

Is this asking for the “politically impossible”? We can’t say. But what we can say is that if it is not done very soon the consequences will be economically disastrous.

The public, the bulk of the press, and the politicians are unduly complacent at the moment because they have been looking backward instead of forward. What they see is that “the rate of inflation”, as they call it (by which they mean the rise in “the price level”), has slowed down in the last few years (from the 13.3 percent in 1979 to 3.9 percent in 1982.) But this has been brought about by causes that can change at any moment. Bad as inflationary conditions have been in the United States, for example, they have been much worse in many other countries. The result is that the dollar, even since we have been off the gold standard, has remained the world’s principal “reserve currency.” The greater distrust of other currencies has increased the world demand for the dollar. But a sudden tack of confidence in the dollar itself could change this situation overnight.

The value of a currency, like the value of stocks and bonds and commodities on the exchanges, is determined by people’s beliefs and expectations rather than directly by the objective facts. If a flight from the dollar suddenly developed, we could quickly be thrown into a hyper-inflation. Let us hope that our politicians and monetary authorities will begin to act responsibly before that happens. It is far easier to forestall an inflationary panic—a “crack-up boom”—than to stop it once it has started.

I have put first the halting of domestic deficits (by reduction of spending and not by a further increase in the tax burden), and the consequent strict control of further increases in the money supply, as the most urgent of all measures. But close behind it is the need to abolish the inflationary practices and international lending institutions set up by the Bretton Woods Agreements of 1944. While this step may seem less urgent than bringing domestic government spending under control and restricting the issuance of more paper money, it is nonetheless an inseparable part of what must now be done. For as I have emphasized in the preceding pages, the International Monetary Fund, and the pure paper-money basis on which it now rests, not only superimpose a world inflation upon all the individual national inflations, but systematically give these inflations, and the socialistic policies that bring them about, acquiescence and encouragement.

A word must be said at this point about a question that still seems to be little understood, even by most economists. I have put more emphasis on budget deficits, and less on changes in the money supply, than is customary. I recognize, of course, that increases in the money supply are usually the most direct objective cause for the consequent fall in the purchasing power of the monetary unit. But budget deficits are nearly always the chief reason why the quantity of money is increased; and their chronic persistence is the chief cause of the fear of future inflation. But when, as has happened in this country In the last few years, the Federal Reserve refrains from monetizing the deficits as they appear, it obliges the government to sell its bonds in the open market to raise the money to meet the deficits. This in turn forces up interest rates to oppressive levels for private business, and brings recession and unemployment. But because of the present dominance of a strict mechanical quantity theory of money among many economists, the urgency of halting the deficits has been ignored. The result is a dangerous complacency.

One more step is an essential part of the anti-inflation program I have just outlined. The world must return to a gold standard. That standard, as its detractors insist, may have its imperfections, but all these are more than offset by one decisive negative virtue: it takes our money out of the hands of the politicians. As Ludwig von Mises once put it: “The excellence of the gold standard is to be seen in the fact that it renders the determination of the monetary unit’s purchasing power independent of the policies of governments and political parties.” (The Theory of Money and Credit, 1953.) And to quote once more the words of David Ricardo in 1817:

“Experience...shows that neither a state nor a bank ever has had the unrestricted power of issuing paper money without abusing that power; in all states, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose as that of subjecting the issuers of paper money to the obligation of paying their notes either in gold coin or bullion.”

In 1983, alas, there are only a comparative handful of economists who recognize this, and almost none of them are in positions of political power. Moreover, as even few of the present supporters of a gold standard recognize, if we assume that we should try to return to the traditional government-managed type of gold standard, the technical problem of returning to it without precipitating a serious deflation or inflation, has never been so difficult as it is today.

When the value of the paper currency unit has totally disappeared, as with the American Continentals in 1780, the French assignats in 1797, and the German mark in 1923, the problem of fixing a new legal ratio between the outstanding paper currency and gold does nor arise. The country simply goes back to gold money. But at times in the past—in the United States in 1875 and 1879, and in England in 1925—when a currency that had gone off the gold standard and depreciated was restored to it at its former rate, the restoration was achieved only at the cost of a long and painful deflation. In England, in fact, the restored former level could not be maintained, and England went off gold again in September, 1931, intensifying the world depression already under way.

The problem that we face today in the United States is that of fixing a workable rate of conversion. If we set the “price” of gold in paper dollars too high, we will bring on a further inflation; if we set it too low, we may bring on a serious deflation. We cannot be guided simply by the current world market gold price. This has fluctuated wildly, even from day to day, in the last few years, influenced mainly by changes in speculative expectations about interest rates, and about how long the present inflation will continue and to what heights it will drive paper-dollar prices.

But, given a return of political responsiblity and courage, the problem is not insoluble. If Congress and the Administration announce a determination to return to a gold standard, if they can balance the budget and keep it balanced for a couple of years, if they can stop or very strictly limit the growth of the paper-money issuance for a similar period, the market price of gold will quickly show a tendency to stabilize. The government can set a date for restoring a gold standard and make a reasonably good estimate of a workable and sustainable rate of conversion.

We could of course return to a merely private gold Standard, but this is likely to happen only by default, when the paper dollar has become worthless, and millions of Americans have been ruined. I shall abstain from discussing such a possibility.

We have been drawn into considering the whole problem of what we must do to halt the present American and world inflation. Our discussion has carried us much beyond the narrower subject with which this book has concerned itself—the fatal stimulus to world inflation provided by the International Monetary Fund and the whole ideology embodied in the Bretton Woods Agreements of 40 years ago.

Fortunately, this part of the present world inflationary problem is more easily solved than most of the rest. We cannot, of course, abolish the IMF overnight. For one thing, we will meet determined resistance from most of the other members of the United Nations. But we can at least put a termination to our own contributions. We can urge that the Fund be prevented from making any further increase in its enormous net volume of outstanding loans, and start devoting itself to getting repaid. The business of foreign lending can once more be left to private investors, genuinely concerned about the soundness of their loans.

What we are asking of our politicians is not unreasonable: Let them at least stop subsidizing the socialistic programs and inflations of other countries.