Common Sense Economics

As the English version1 of this book goes to press the economy of the United States, as well as that of many European countries, has reached a state which can be described only as that of a highly inflationary boom. All pertinent data—total investment, demand deposits, consumer credits and production—show clearly a steep upward trend. And many characteristic signs of an overstressed economy, such as bottlenecks in employment and raw materials, backlogs for deliveries, exaggerated stockmarket booms, have made their appearance.

The inflationary character of the American boom is now recognized by an increasing number of economists but is still denied by some. The main argument in support of the latter’s opinion, and therefore of a laissez-faire, laissez-aller attitude, is based on the relative stability of the general price level in the United States.

The consumer price averages have indeed remained entirely, and the wholesale price averages almost, unchanged since 1953. However, the picture is very different when one examines the prices of the single groups of commodities upon which the price averages are based. One sees immediately that the prices of industrial finished goods have risen substantially since 1953, and those of industrial goods, especially building materials, since 1954. These increases are offset in the price averages by the decline in agricultural prices. But this decline is merely the result of the liquidation of over-production during the World and Korean wars. Viewed from a quantity theoretical standpoint these lower prices appear to be due to a temporary over-supply from the side of goods; this, however, does not change but only conceals the over-demand from the money side. The price movements in the industrial sector alone show all the features of inflation. And this is decisive. For crises are nowadays—this should not be forgotten—industrial and not agricultural crises.

But apart from this it seems very doubtful that much importance can be attributed to the stability of the price level in times of marked increases in productivity. Higher productivity without inflation leads to lower prices. If prices remain stable in spite of rapidly increasing productivity, this can be only the result of an inflationary credit expansion. Such a monetary inflation without, or with only little, price inflation is in principle not less dangerous than an inflation with strong price inflation. Whether inflation profits are the result of prices going up while costs lag, or of prices remaining stable while costs decline through an increase in productivity, a dynamic process is stimulated which is bound to end in crisis and depression—if for no other reason than because every stimulus must finally exhaust itself.2

Was the present inflation unavoidable, or avoidable only at the cost of permanent unemployment? I do not believe so. When, in 1953, the Republicans took over the administration they endeavored—successfully—to interrupt the inflationary post-war boom3 by the classical means of tightening money and credit. As a result unemployment had risen substantially by the end of the year. The Republican administration found itself faced with the dilemma of correcting this unemployment—which was essentially a stabilization and not a deflation phenomenon4—through renewed inflation or through enforced adjustments of costs to the no longer permanently inflating price level. The administration chose—to the regret of conservative and to the satisfaction of Keynesian economists—the first method. As was easily predictable,5 unemployment disappeared, but at the price of continued inflation.

Recognizing the danger of inflation the authorities have, since the beginning of 1955, allowed the interest rates to go up somewhat. But the boom has not decreased and has even increased in vigor—see, for instance, the movement of prices for steel scrap and certain metals in 1955.

This is not surprising. For the measures adopted are adequate only for dampening but not for stopping inflation. What the authorities are doing, in order to keep the economy running at a high level of production and employment, is to tighten the reins when inflation seems to be getting out of hand, and to loosen them—thus resorting again to inflation—as soon as the boom appears to be weakening. One must concede that this policy of “leaning against the wind” is carried out with ability and—considering the strong political pressure in favor of inflation—with remarkable courage. But will this policy which is nevertheless one of inflation, even though that inflation is a slow and regulated one, succeed in the long run? I doubt it. It is the tragedy of every boom created and carried forward by inflationary credit expansion that it never leads to stabilization but always to reaction.

Thus there is only the choice: either one tolerates further inflation, then the boom continues until a saturation point of demand is reached—at that point a depression will inevitably set in, the more severe the longer the boom has lasted; or one stops inflation, then the reaction sets in immediately—a very unwelcome occurrence especially in an election year.

This whole paradoxical situation of the economies of the United States and of most Western countries is, I think, in the last analysis the logical consequence of an economic policy which in theory overstresses the importance of effective demand for the attainment of full employment, and in practice recommends the correction of any sign of unemployment by more and more credit expansion, using for its justification the old purchasing power theory and all the other semi-scientific arguments advocated for centuries by inflationists.

The present book is, from the first to the last word, nothing but an endeavor—perhaps inadequate—to demonstrate the theoretical shortcomings and the practical danger of this philosophy by stressing the importance of the supply of production factors for the maintenance of a high and stable level of economic activity.

My grateful acknowledgments are due to Mrs. Elizabeth Henderson of London and Rome, whose editing improved the English manuscript and purged it of a number of inconsistencies.

Paris, June 1956.          A. H.