What You Should Know About Inflation

From time to time I get letters from readers asking how they can protect themselves from the eroding effects of inflation on their savings. Many pamphlets from investment advisers attempt to tell people how this can be done. Schemes are constantly proposed for the issuance of government bonds and other securities with interest payments or redemption values that would increase in the same proportion as the cost of living. Many other schemes are put forward to counter the bad effects of inflation.

Both the advice and the schemes indirectly call attention to one of the worst results of inflation. It steadily wipes out the value of dollar savings, of savings-bank deposits, of bonds, of mortgages, of insurance benefits, of pensions, of fixed-income payments of every kind. It thereby penalizes and discourages thrift and saving, discourages the “safer” and more conservative investments, and forces everybody to be a speculator or gambler. For if, in the midst of an inflation, a man leaves his money in savings banks or mortgages or fixed-interest securities, he faces a certain loss in its real purchasing power.

Can any scheme be devised that would offset this effect? The escalator clauses in wage contracts are an attempt to do this for union labor. Proposals are frequently made that private companies, or the government itself, should issue bonds on which the interest payments, as well as the redemption value at maturity, would increase by the same percentage as the official index of consumer prices.

But the objections to such schemes are very serious. The borrower, whether a private company or the government, would assume an obligation of unknown extent. It would have no assurance, particularly if the subsequent inflation were severe, that its own income would rise proportionately to the cost of living (or, to put the matter another way, in inverse proportion to the drop in the value of the dollar). Such “escalator” bonds, like the escalator wage contracts, would simply increase the number of people with no interest in halting the ravages of inflation against the rest of the population.

What is not understood by those who propose these schemes is that inflation can benefit one group only at the expense of other groups. The price of what you have to sell can go up more or faster than the average price of what you have to buy only if the price of what other people have to sell to you goes up less or slower than the price of what they have to buy from you. The net amount of any real gain from inflation must be offset by an equivalent amount of real loss. Roughly speaking, one half of the population can gain from inflation only at the expense of the other half. The political appeal of inflation comes from fostering the illusion in the great majority of voters that they will some how get the better of the swindle, and profit at the expense of a few unidentified victims.

If we grant that it would be possible to devise any scheme by which the gains from inflation would exactly equal the losses, so that nobody would either gain or lose by it, then all the arguments which sustain inflation would collapse. For inflation does not come without cause. It is the result of policy. It is the result of something that is always within the control of government—the supply of money and bank credit. An inflation is initiated or continued in the belief that it will benefit debtors at the expense of creditors, or exporters at the expense of importers, or workers at the expense of employers, or farmers at the expense of city dwellers, or the old at the expense of the young, or this generation at the expense of the next. But what is certain is that everybody cannot get rich at the expense of everybody else. There is no magic in paper money.

It is true that an alert individual can do certain things to protect himself from the eroding effects of inflation on the value of his dollars—but only on the assumption that he acts both sooner and more wisely than the majority.

Even this used to be easier than it is today. In the German inflation which culminated in 1923, for example, a German could always buy American dollars, at whatever the current rate happened to be, as soon as his monthly, weekly, or daily income above current needs became available to him. But as German internal prices went up much slower than the dollar (or, more accurately, as the external value of the German mark fell much faster than its internal value), even this proved an inadequate “hedge” for the German people considered as a whole. As the rush to buy foreign currencies made the external value of the mark depreciate even faster (so that, at the end, it took hundreds of billions of them to buy a single dollar), there was no profit in the operation for the latecomers.

Today, Americans have no completely safe major foreign currency to turn to to protect them against further depreciation of their own dollar. They are prohibited by law from buying and holding gold at home. (This is a left-handed confession by our monetary authorities that the people do prefer gold to paper and would make the exchange if they could.) If they buy gold abroad, they face the risk that our government (following the domestic precedent of 1933), may force them to turn in their gold holdings at an arbitrary value in paper dollars.

They are left, then, in practice, with the choice of buying real estate, common stocks, mink coats and motor cars, television sets and oriental rugs, jewelry—any equity or luxury that is not dollars or a fixed obligation payable in dollars. They are forced, in short, into extravagance and speculation.

An inexpert speculator may, of course, turn to investment trusts or mutual funds which diversify his investment for him and protect him to some extent against his own lack of expert knowledge. But always, the individuals who buy first, or at lower prices, can profit or protect themselves only at the expense of those who buy later or at the top.

It is impossible, in short, for everybody to protect himself against inflation. The early minority can do so only at the expense of the majority, or the early buyers at the expense of the later. And the scramble to get out of money and into things only intensifies the inflation, only increases and accelerates the rise of prices or the fall of the dollar.

This last result must follow whether individuals try to protect themselves against inflation by individual action, or whether they try to do so through such group devices as escalator wage clauses or escalator bond clauses. Even the arithmetic of such schemes is against them. Neither prices nor wages go up uniformly. Suppose some wages and prices do not go up at all, and others go up 100 per cent. The average increase, say, is 50 per cent. Suppose cost-of-living escalator clauses are prevalent, and that wages or prices that have gone up less than 50 per cent are raised to that average. This raises the average increase itself. It may now be 75 per cent. If the prices or wages that have advanced less than this are now raised 75 per cent above the old level, the average advance has again been pushed up to, say, 85 per cent. And so on. The process could be stopped only if the monetary authorities refused to supply the added money and credit necessary to sustain successive increases.

There is only one solution—only one sure hedge against inflation that can protect everybody: Don’t have the inflation. If you have it, halt it as soon as possible.