Inflation: What It Is, Why It’s Bad, and How to Fix It
by Steve Forbes, Nathan Lewis, and Elizabeth Ames (Encounter Books, 2022).
We have been through this many times before — prices start to increase at an accelerating pace and consumers grumble about inflation, while politicians try to pin the blame for it on parties other than themselves. Right now (May 2022), prices are rising at their fastest rate in many years, and people wonder just how bad it will get.
They won’t find that exact answer in the new book by Steve Forbes, Nathan Lewis, and Elizabeth Ames, Inflation: What It Is, Why It’s Bad, and How to Fix it, but they will learn everything else they need to know. It’s easy to read (plain English uncluttered by economic jargon and pointless mathematics), and the authors provide the antidote for all of the disinformation that statists peddle about inflation. And they cap it off with the one and only solution to the problem of inflation, namely the gold standard.
To begin with, what is inflation?
The authors explain that generally rising prices (what most people call “inflation”) is just one of the symptoms of the actual inflation, which is the supply of money in a nation. When government increases the amount of money in circulation, that is inflation. As the quantity of money increases, the purchasing power of each unit of money falls, thus leading to generally rising prices. In the market, individual prices may rise (while others fall), but you can’t have an overall rise in prices unless the government is inflating the money supply.
Throughout history, many governments have resorted to inflation, invariably because the rulers’ appetite for spending exceeded the inflow of money from taxation. The authors give numerous examples.
In ancient Rome, emperors wanted vast sums for their military campaigns, for their welfare programs to keep the people happy (the famous “bread and circuses”), and for their lavish living. So they steadily debased their coinage. Once pure silver, by late in the Empire, the coins contained barely a trace of silver. Far more were in circulation, but they didn’t buy much. People resorted to barter rather than deal in the questionable and rapidly depreciating coinage.
During the American Revolution, state governments printed up lots of paper money that had no backing. It quickly traded at less than the purported face value, and eventually people disdained accepting it at all, hence the phrase “Not worth a Continental.”
In Germany after World War I, the Weimar government resorted to inflation, and by 1923, prices were rising daily, even hourly.
The champion for inflation seems to be Zimbabwe, where the government recently printed so much money that it eventually issued a bill for 100 trillion dollars, which had virtually no value.
Politicians would like to deceive people by leading them to think that inflation (i.e., price increases) is caused by greedy business people or bad foreigners. The truth, however, is always that it’s caused by their own creation of money to pay for their expenditures.
Forbes, Lewis, and Ames show how our government does it. Our system is more sophisticated than running the printing presses. The U.S. government inflates the money supply through the Federal Reserve System’s “Open Market Operations” when it purchases government bonds — that is, the instruments of federal borrowing. Since the government spends more than it takes in, it has to borrow incessantly. The Fed turns that debt into money.
When the Fed buys those bonds, money flows into the accounts of the sellers — big financial institutions, which then lend most of it out. But where does the Fed get the money? It creates it out of nothing. The Fed’s dollars are created by mere electronic legerdemain. That’s how our money supply expands. The authors correctly say, “Washington relies on a constant flow of zero-interest rate ‘free loans’ from Federal Reserve bond buying operations…. This Fed-enabled borrowing encourages a vicious inflationary cycle, leading to larger government, more spending, and debt.”
Sadly, there are quite a few economists who see nothing wrong with this. They maintain that “low inflation” is good. Current Fed chairman Jerome Powell claims that the economy would suffer if we didn’t have some inflation, and a tribe who believe in something called Modern Monetary Theory (MMT) argue that government borrowing and spending is no problem at all. According to MMT advocates, as long as the government can create the money to pay for its vast spending programs, it should do so.
Our authors soundly refute those ideas.
Is inflation necessary for economic expansion? Certainly not. A falling value of money does nothing to stimulate production and innovation. In the decades after the Civil War, the United States experienced a tremendous increase in productivity while we were on the gold standard. The value of the dollar gradually rose for many years, meaning that prices slowly fell, which was good for consumers.
As long as the value of money remains relatively stable, producers will easily adjust. There’s no need for government to artificially engineer inflation or deflation.
Regarding MMT, the authors say that it’s just “old wine in new bottles.” Economic cranks have long prescribed inflation so that government can pursue a vast socialist agenda. The results have always been ruinous. Referring to lead MMT proponent Prof. Stephanie Kelton, the authors write, “If the Fed printed money nonstop to fund Kelton’s welfare-state vision, investors and anyone else holding dollars would run for the hills. The dollar would go the way of the Russian ruble in the 90s or the Cuban peso.”
Yes, and I would add only that the MMT crowd seems not to understand the concept of opportunity cost. The more the government spends, the more it diverts resources away from the private sector, where the profit and loss system directs them toward productive uses, and into the maw of the state, where politicians squander them on wars, welfare, and all sorts of vote-buying schemes. That makes us poorer.
What’s bad about inflation, other than the obvious fact that it leads to rising prices?
Forbes, Lewis, and Ames explain that inflation wreaks much hidden economic damage. It robs people of the value of their savings. It causes the misdirection of resources, away from useful production and into schemes to keep ahead of inflation. It causes malinvestment, as people are tricked by artificially low interest rates into speculative deals, especially in real estate. It erodes trust and encourages crime. And it leads to increasing dependency on government.
On that last point, the authors quote George Gilder, who has written that the “scandal of money” is negating the American dream since more and more people come to expect Uncle Sam to solve every problem and take care of them.
Inflation itself is an act of dishonesty. Rather than forthrightly telling the people, “We are going to increase your taxes to pay for these new government programs,” politicians covertly extract the wealth to pay for them through the Fed’s ability to create money.
So, what is the solution? How can we once again have stable money?
What we need to do is to return to gold, the authors argue. Make the one and only job of the Federal Reserve to keep the value of the dollar stable by anchoring it once again to gold. The gold standard compels governments to live within their means, which is to say the taxes they collect. To those who say that gold is “old-fashioned” and just couldn’t work today, they reply that it would work if our political leaders wanted it to.
And that, of course, is the real problem. Most of our politicians are hooked on inflation just like drug addicts are hooked on their narcotics. They and their allies in the media and intelligentsia say that gold can’t work because they don’t want the discipline that gold would impose on them.
But that’s the essence of the problem. Politicians don’t want to be constrained in their ability to extract wealth from productive people. They found ways to escape the discipline of the gold standard before and will do so again. The ultimate solution to the problem of inflation is to denationalize money, as F. A. Hayek advocated in his famous 1976 book. If government doesn’t produce or control money, it cannot debase it.
We need this book today and for years to come because the destructive effects of the government’s manic money creation are still in their early stages.
This article was originally published in the August 2022 edition of Future of Freedom.