What You Should Know About Inflation

The late Sumner H. Slichter, professor of economics at Harvard, was a clear, vigorous, able, and highly influential writer. He made many instructive contributions, but in the field of money and inflation, to which he mainly devoted himself in the last years of his life, I cannot believe that his influence was for the good. I take as one example an article by him in Harper’s Magazine of August, 1952, under the title “How Bad Is Inflation?” This article, in fact, seemed to epitomize all the shopworn fallacies that have been put forward as apologies for inflation in the last two centuries.

Professor Slichter began by dismissing the conclusions on inflation by the American Assembly, a group of distinguished economists, as “uncritical and almost hysterical.” The assembly concluded that “inflation is a continuous and serious threat to the stability of the American economy and to the security of the entire Western world.” This judgment was not hysterical, but restrained.

It was Slichter who was appallingly uncritical. He not only thought that it is easy for a government to plan and control “a slow rise in prices”; he actually believed that an “extreme” inflation “is not easily started.” It would be interesting to learn what his definition was of an “extreme” inflation, and what his concept was of difficulty. Germany inflated until its mark fell to one-trillionth of its previous value. Nationalist China inflated until the yuan reached 425 million to the dollar. In Great Britain prices at the time this Harper’s article appeared were three times as high as they were before World War II; in the Argentine (with no “war” excuse) prices were already five to eight times as high; in France, more than 25 times as high; in Italy, more than 50 times as high. None of these countries found it at all difficult to get its inflation going, but most of them were finding it politically almost impossible to stop.

Slichter’s argument throughout was based on assumptions that are neither proved nor warranted. One of these is that a rising price level is necessary for prosperity. This is refuted by a wealth of historical experience. The great American boom from 1925 to 1929, for example, occurred in spite of a falling price level. And Slichter did not seem to remember that depressions are caused chiefly by the collapse of previous inflations.

Nor did Slichter seem to understand how inflation temporarily works its magic. It does so only as long as prices run ahead of costs (mainly wages). Then the prospective restoration or increase of profit margins may lead to an increase in production and employment. But the jig is up once labor gets on to the game, and wages and other costs begin to rise faster than prices. The apostles of permanent inflation (“continuous slow” inflation) are those who believe that labor can be permanently fooled.

Slichter did not explain in his article by exactly what process a “slow” permanent rise in prices—say 2 or 3 per cent a year—could be produced. He did not understand why no nation has yet succeeded in keeping an inflation, once started, under control. He forgot that you can’t afford to tell people in advance that you are planning to cheat them. A government can’t plan a “gradual” increase in prices, because if people know that prices will be 3 per cent higher, say, next year, they will bid prices up nearly that much right away. If creditors know that the purchasing power of the money they are asked to lend today is going to depreciate 3 per cent within a year, they will add 3 per cent to whatever interest rate they would otherwise demand; so that instead of lending at 5 per cent, say, they will ask 8.

Most astonishing of all, Slichter advocated a continuous inflation to combat Communism. One might have referred him to the late Lord Keynes, who wrote a generation ago: “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. Lenin was certainly right. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Slichter, alas, was not that one man.