The Inflation Crisis, and How to Resolve It

3

The Fallacy of “Cost-Push”

In chapter 1, I declared that inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit.

There is nothing peculiar or particularly original about this statement. It corresponds closely, in fact, with “orthodox” doctrine. It is supported overwhelmingly by theory, experience, and statistics.

But this simple explanation meets with considerable resistance. Politicians deny or ignore it, because it places responsibility for inflation squarely on their own policies. Few of the academic economists are helpful. Most of them attribute present inflation to a complicated and disparate assortment of factors and “pressures.” Labor leaders vaguely attribute inflation to the “greed” or “exorbitant profits” of manufacturers. And most businessmen have been similarly eager to pass the buck. The retailer throws the blame for higher prices on the exactions of the wholesaler, the wholesaler on the manufacturer, and the manufacturer on the raw-material supplier and on labor costs.

This last view is still widespread. Few manufacturers are students of money and banking; the total supply of currency and bank deposits is something that seems highly abstract to most of them and remote from their immediate experience. As one of them once wrote to me: “The thing that increases prices is costs.”

What he did not seem to realize is that cost is simply another name for a price. One of the consequences of the division of labor is that everybody’s price is somebody else’s monetary cost, and vice versa. The price of pig iron is the steelmaker’s cost. The steelmaker’s price is the automobile manufacturer’s cost. The automobile manufacturer’s price is the doctor’s or the taxicab-operating company’s cost. And so on. Nearly all costs, it is true, ultimately resolve themselves into salaries or wages. But weekly salaries or hourly wages are the “price” that most of us get for our services.

Now inflation, which is an increase in the supply of money, lowers the value of the monetary unit. This is another way of saying that it raises both prices and costs. And costs do not necessarily go up sooner than prices do. Ham may go up before hogs, and hogs before corn. It is a mistake to conclude, with the old Ricardian economists, that prices are determined by costs of production. It would be just as true to say that costs of production are determined by prices. What hog raisers can afford to bid for corn, for example, depends on the price they are getting for hogs.

In the short run, both prices and costs are determined by the relationships of supply and demand—including, of course, the supply of money as well as goods. It is true that in the long run there is a constant tendency for prices to equal marginal costs of production. This is because, though what a thing has cost cannot determine its price, what it now costs or is expected to cost will determine how much of it will be made.

If these relationships were better understood, fewer editorial writers would attribute inflation to the so-called wage-price spiral. In itself, a wage boost (above the “equilibrium” level) does not lead to inflation but to unemployment. The wage boost can, of course (and under present political pressures usually does), lead to more inflation indirectly by leading the government monetary authorities to increase the money supply to make the wage boost payable. But it is the increase in the money supply that causes the inflation. Not until we clearly recognize this will we know how to bring inflation to a halt.

For years we have been talking about the inflationary wage-price spiral. But Washington (by which is meant both the majority in Congress and officials in the executive branch) talks about it for the most part as if it were some dreadful visitation from without, some uncontrollable act of nature, rather than something brought about by its own policies.

Let us see just how those policies, over the last forty-six years, have produced the wage-price spiral. First of all, under a series of laws beginning most notably with the Norris-La Guardia Act of 1932, followed by the Wagner Act and by its later modification, the Taft-Hartley Act, it was decided that labor troubles developed chiefly because there was not enough unionization and because unions were not strong enough.

The federal government was in effect put into the union-organizing business. It compelled employers to deal exclusively with the unions thus quasi-officially set up, regardless of how unreasonable the demands of these unions might turn out to be. Though illegalizing all efforts to deny employment to workers who joined unions, the government explicitly legalized arrangements to deny employment to workers who did not join unions. (In Section 14[b], however, the Taft-Hartley Act did allow any individual state to nullify such a compulsory arrangement within its own borders by enacting special legislation.)

But worst of all, the unions and union members were given a privilege not granted to any other associations or individuals—the power of private coercion and intimidation. The Norris—La Guardia Act in effect prevented either employers or nonunion employees from going to the federal courts for immediate relief from irreparable injury. The government refuses, contrary to legal practice in every other field, to hold a union liable for the acts of its agents. It tolerates mass picketing, which is intimidating and coercive, preventing employers from offering to other workers the jobs abandoned by strikers, and preventing other workers from applying for such jobs. And then officials are astonished and indignant when these special privileges, against which they provide no effective legal protection, are “abused.”

The inevitable result of these laws is that there are built up huge unions with the power to bring basic national industries to a halt overnight. And when they have done this, there seems to be no way of getting an industry started again except by giving in to the demands of the union leaders who have called the strike.

This accounts for the upward push on money wage-rates. But it does not account for the inflationary spiral. The effect of pushing wage rates above the level of marginal labor productivity, taken by itself, would simply be to create unemployment. But as F. A. Hayek has put it: “Since it has become the generally accepted doctrine that it is the duty of the monetary authorities to provide enough credit to secure full employment, whatever the wage level, and this duty has in fact been imposed upon the monetary authorities by statute, the power of the unions to push up money wages cannot but lead to continuous, progressive inflation.”

Soon or late our federal lawmakers and administrators must face up to the labor-union-boss dictatorship and the wage-price spiral that their own laws and actions have created. But they refuse to do this when each new crisis arises. When, for example, a nationwide steel strike is prolonged, they become panicky. They seek to settle it by the only means that seem possible to them—by giving in once more to union demands, by granting still another wage increase and setting off a new upward wage-price spiral.

Politicians demand that the president appoint a “fact-finding” board to “recommend,” i.e., to impose, in effect, compulsory arbitration that would compel the employers to grant another increase to employees. Thus one government intervention begets a further government intervention. Because government has failed in its primary task—that of preventing private coercion—politicians ask, in effect, for price and wage fixing; and we are driven toward totalitarian controls.