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Inflationomics, in
popular terminology, indicates the sway of inflation thought in education and
the affairs of government. It permeates political life and behavior, especially when economic policies are discussed
and decided. It usually speaks well of an increase in the amount of money by
a central bank and of deliberate expansion of bank credit in order to finance
government deficits and stimulate economic activity. Inflationomics
is a basic ideology of our time.
Its intellectual roots are very old, growing in Europe during the 17th and 18th centuries and serving
as guiding principles of state policy. They produced strong central
governments with monetary powers as a means of economic well-being and with
central banks to control the money of the country. The Bank of England, which
was founded in 1694, set the example for all others. Most European countries
followed suit during the 19th century. The United States established the
Federal Resrve System in 1913. Today, nearly every
country has a central bank or is a member of a central bank system.
Paper money first appeared some 300 years ago, but
it usually was backed by gold or silver into which it was convertible on
demand. Even during its early history governments often made it inconvertible,
i.e. they made it "fiat". Gold and silver were used as standard
money and coined without any limit set by legislation. But the ratio between
gold and silver was fixed by law without close relation to the market value
of the metal. It always activated Gresham's
Law according to which "bad money drives out good money." Whenever
the ratio between two kinds of money, e.g. gold and silver, was fixed by law
without relation to the market value of the metal, people used the metal
whose market value was less than the other and hoarded the more valuable one.
The common failure of the bimetallic standard tended to give rise to a de
facto monometallic currency, usually silver coins. In England it led to a gold
standard.
The monetary system of the United States was based on
bimetallism during most of its history. A full gold standard was in effect
from 1900 to 1933. The Legal Tender Act of 1933 made all American coins and
paper money "legal tender" which must be accepted at face value by
creditors in payment of any debt, public or private. The Gold Reserve Act of
1934 stipulated that gold could no longer be used as medium of domestic
exchange, making paper money the only lawful medium of exchange. During the
early 1970s the U.S. dollar became fiat money also in international money
markets.
Inflationomics
sprang from the old roots of central banking and fiat money. The most
influential mastermind undoubtedly was John Maynard Keynes who made
"expansionism" the essence of his teaching. The "Keynesian
Revolution" made credit expansion a powerful method for stimulating
business and creating employment. Cloaking his reasoning in the sophisticated
language of mathematical economics, he swayed public opinion and most
politicians with the urgent need for currency devaluation, inflation and
credit expansion, unbalanced budgets, and deficit spending. In short, Lord
Keynes provided a new justification for old policies.
Keynes viewed most problems of the business cycle as
symptoms of "underconsumption", which has
been a popular explanation of depression ever since. If economic recessions
and depressions are caused by low demand for money and goods, an increase in
spending is bound to revive economic activity and increase employment. Keynes
therefore considered government control an economic necessity in order to
restore and maintain desirable levels of spending. In this respect he
resembled the Mercantilists of old. But in contrast to the economists of the
17th and 18th centuries he also injected popular notions of social conflict. Passages
from his General Theory of Employment, Interest, and Money (1935)
clearly make this point.
"The richer the community, the wider will tend
to be the gap between its actual and potential production; and therefore the
more obvious and outrageous the defects of the economic system. For a poor
community will be prone to consume by far the greater part of its output, so
that a very modest measure of investment will be sufficient to provide full
employment; whereas a wealthy community will have to discover much ampler
opportunities for investment if the saving propensities of its wealthier
members are to be compatible with the employment of its poorer members. If in
a potentially wealthy community the inducement to invest is weak, then, in
spite of its potential wealth, the working of the principle of effective
demand will compel it to reduce its actual output, until, in spite of its
potential wealth, it has become so poor that its surplus over its consumption
is sufficiently diminished to correspond to the weakness of the inducement to
invest." (p. 31.)
In Keynesian tradition most American professors and
media commentators favor credit expansion and
deficit spending whenever a recession comes in sight. And most elected representatives call and vote for more government spending
that promises more employment and higher incomes for their constituents. But
whatever government may do to increase spending and whatever the central bank
may devise in order to avert a recession, they inflate and depreciate the currency,
aggravate the maladjustment, and prolong the pains of readjustment.
Ours is an age of inflationomics.
It dawned with the sway of Keynesian economics in Europe as well as America and
commenced visibly in 1971 when President Nixon abolished the last vestiges of
the gold standard and repudiated all international obligations to make
payments in gold. The U.S. dollar has depreciated at various rates ever
since, at double-digit rates during the 1970s and early 1980s and at
single-digit rates ever since. The present dollar is worth some 10 cents of
the 1970 dollar and is bound to lose ever more in the future. Moreover,
inflation misleads businessmen in their investment decisions, which is the
root cause of the business cycle. Indeed, inflation breeds many evils and
haunts many Americans who are rather unenlightened about its causes.
A cursory look at presidential policies since 1971
corroborates the point. When wages and prices soared, President Nixon, with
Congressional approval, imposed a four-phase program of wage and price
controls which immediately led to shortages in many areas. A serious
"energy crisis" reduced home heating-oil supplies and led to
gasoline shortages. A recession gripped the United
States together with other Western industrialized countries
and Japan;
while the rates of inflation exceeded 10 percent a year, production declined
and the levels of unemployment rose sharply. This new combination of high
rates of inflation and high rates of unemployment, which was aptly called
stagflation, caught all Keynesian economists by surprise.
The Carter Administration's chief economic
affliction was rampant inflation and the decline of the dollar's value in
relation to that of other major currencies. No matter what it did to assist
the dollar, including "massive intervention" in international
currency markets, a quintupling of gold sales, and an increase in the
discount rate, inflation rose in each year of the Carter Administration.
The Reagan Administration (1981-1989) reversed
long-standing Keynesian trends by pursuing a supply-side economic program of
tax and non-defense budget cuts. The program built
on the thought that high tax rates and government regulation discourage
private investment in areas that fuel economic expansion, and that more
capital in the hands of private investors will benefit the rest of the
population. Facing the deepest recession since World War II with unemployment
reaching a rate of 10.8 percent in 1982, it soon suffered huge budget
deficits which more than doubled the size of the national debt. Although the
economy picked up between 1983 and 1986, the budget deficits consumed most of
the capital released by the tax reduction and thus thwarted possible
supply-side benefits. Economic expansion remained relatively modest although
the rate of inflation fell below 4 percent during President Reagan's tenure. It
allowed the dollar to expand internationally and strengthen its acceptability
as a world reserve currency.
President George Herbert Walker Bush resolutely
returned to Keynesian formulas of spending and happily continued the budget
deficits. During his first year in office (1989) his administration enjoyed a
$152 billion deficit, in its last year (1993)a $255
billion shortage. After a prolonged battle with the Democratic Congress he
agreed to a deficit reduction bill that raised business taxes. He thereby
broke his 1988 campaign pledge not to raise taxes, which irritated many
Republicans. His presidency was marked by a stagnant economy, rising levels
of unemployment, and a prolonged international recession. His inability to
institute a program of economic recovery other than deficit spending made him
vulnerable in the 1992 presidential election. Arkansas governor Bill Clinton won by a
comfortable margin.
As president, Bill Clinton managed to obtain
Congressional approval of a North American Free Trade Agreement which was
designed to make the United states,
Canada, and Mexico
more competitive in the world marketplace. But he failed to realize his
campaign promise to reform the nation's health-care system, which critics
likened to socialized medicine. In the 1994 midterm election his rash
proposals not only led to Republican majorities in both the Senate and the
House but also provided Republicans with an ambitious agenda for social,
economic, and institutional change which they dubbed "Contract with
America." It influenced and colored the Clinton presidency and
surprised the world as it gave rise to the "great expansion of the
1990s." Emerging from recession in 1991, the economy expanded throughout
the 1990s. Wages, which had been stagnant throughout the 1980s, rose again;
unemployment reached a 30-year low. The rise of individual and corporate tax
payments pushed the Federal budget into an extraordinary surplus for four
years, beginning in 1998. But the trade deficits with foreign countries
continued to grow as Americans continued to import far more than they
exported. Foreign central banks readily invested their surplus dollars in
U.S. Treasury securities and foreign corporations used their dollars to
expand their operations in the U.S. The Federal Reserve supplied
them at bargain rates.
By the end of 2000 many
maladjustments were clearly visible, causing the economy to sink into
recession for the first time in 10 years. Other industrial economies slumped
as well and were jolted by the September 11 terrorist attacks on the United States.
When economic productions fell to recession levels the Federal Reserve cut
interest rates eleven times. Prodded by President George Walker Bush,
Congress passed a large multiyear tax cut, and the U.S. Treasury sent out tax
rebates to boost consumer spending. Thereafter, the economy seemed to shake
off national disasters and soaring energy prices. Labor
productivity apparently rose and the nation's unemployment rate declined
again. All along, the Federal government embarked upon massive deficit
spending which increased its debt from $3.314 trillion at the beginning of
the new administration to more than $8 trillion today (May 15, 2006). U.S. trade
deficits, too, hit record highs of $618 billion in 2004 and topped $700
billion in 2005. As the deficits widened, the Federal Reserve began to nudge
short-term interest rates higher, 0.25% at a time from its base rate of just
one percent. The nudging prudently remained far below unhampered market rates
which would have called an instant halt to the pleasures of debts and
deficits.
All in all, this writer does not have much
confidence that inflation will remain moderate. Inflationomics
is still in vogue. The Fed is unlikely to raise its rates to a level that
would call a halt to the currency and credit expansion and thus reinforce the
world-wide trust in the U.S. dollar. Instead, the Fed is likely to limp after
the rising market rate and continue its expansion policies until an
international dollar crisis calls for drastic emergency measures. In crisis
and bedlam, Washington
politicos are likely to add their controls and regulations, conditions and
restrictions, prohibitions and penalties to the structure they created. In
the footsteps of President Herbert Hoover, President Bush may even call for
more trade barriers, which would turn the recession into a depression and
breed much international conflict.
Dr Hans F. Sennholz
www.sennholz.com
Dr. Sennholz is President of
The Foundation for Economic Education, Irvington-on-Hudson, New York and a
consultant, author and lecturer of Austrian Economics.
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