"Government," observed the renowned Austrian economist Ludwig von Mises, "is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink."
Mises was describing the curse of inflation, the process whereby government expands a nation’s money supply and thereby erodes the value of each monetary unit — dollar, peso, pound, franc or whatever. It shows up in the form of rising prices, which most people confuse as the inflation itself. The distinction is an important one because, as economist Percy Greaves explained so eloquently, "Changing the definition changes the responsibility."
Define inflation as rising prices and, like Jimmy Carter, you’ll think that oil sheiks, credit cards and private businesses are the culprits and price controls are the answer. Define inflation in the classic fashion as an increase in the supply of money, with rising prices as a consequence, and you then have to ask the revealing question, "Who increases the money supply?" Only one entity can do that legally; all others are called "counterfeiters" and go to jail.
Nobel laureate Milton Friedman argued indisputably that inflation is always and everywhere a monetary matter. Rising prices no more cause inflation than wet streets cause rain.
Before paper money, governments inflated by diminishing the precious metal content of their coinage. The ancient prophet Isaiah reprimanded the Israelites with these words: "Thy silver has become dross, thy wine mixed with water." Roman emperors repeatedly melted down the silver denarius and added junk metals until the denarius was less than one percent silver. The Saracens of Spain clipped the edges of their coins so they could mint more until the coins became too small to circulate. Prices rose as a mirror image of the currency’s worth.
Rising prices are not the only consequence of monetary expansion. Inflation also erodes savings and encourages debt. It undermines confidence and deters investment. It destabilizes the economy by fostering booms and busts. If it’s bad enough, it can even wipe out the very government responsible for it in the first place. It can lead to even worse afflictions. Hitler and Napoleon both rose to power in part because of the chaos of runaway inflations.
All this raises many issues economists have long debated and about which I have my own views: Who or what should determine a nation’s supply of money? Why do governments so regularly mismanage it? What is the connection between fiscal and monetary policy? Suffice it to say here that governments inflate because their appetite for revenue exceeds their willingness to tax or their ability to borrow. British economist John Maynard Keynes was an influential charlatan in many ways, but he nailed it when he wrote, "By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens."
Paper money is falling in value all over the world these days, but no place is more ravaged by inflation than Zimbabwe in southern Africa. There, the government’s confiscation of wealth is no longer secret and unobserved. Prices rocketed at an annual rate of 15,000 percent in November, double the rate of October. After printing trillions of Zimbabwean dollars to finance its socialist schemes, the dictatorship of kleptomaniac Robert Mugabe lopped three zeros off all currency notes a week before Christmas. The $200,000 bill, for instance, became a new $200 bill, worth about a dime in American money.
South America is home to many serial inflationists — corrupt, crackpot regimes that destroy one paper money after another. Prices in Argentina and Venezuela are currently climbing by about 20 percent annually and all indications are that the rates will accelerate in coming months. As Mugabe did in December, Hugo Chavez started 2008 in Venezuela by scratching three zeros off the paper bolivar. In Bolivia, prices are going up at an 11 percent clip, but if the country’s recent past is prologue, the Bolivian regime may be on its way to ruining the nation’s third currency since the 1950s.
In April 1985, I visited Bolivia to observe the world’s then-highest rate of price hikes, an astonishing 50,000 percent. After stiffing its foreign creditors in the early 1980s, the government in La Paz could only finance its bad habits through taxing its own people and printing paper money. It did lots of both. By 1985, however, only 10 percent of its spending was covered by taxes; the rest was taken care of by the printing press. Paper money became the country’s third largest import. Its own presses couldn’t keep up with the government’s demands, so planeloads of the stuff were flown in every week from Europe.
On the day that I arrived, the Bolivian peso traded at 150,000 to the dollar. Just days later, it had sunk to 200,000. I brought 9 million pesos home with me — a million pesos (in 1,000-peso notes) in each of nine wads bound together with string by a local bank. I kept one million, which I have to this day, and sold the other eight to gold bugs and currency collectors for $500 each. Not bad, considering that, at 200,000 to the buck, I paid just $5 for each million-peso wad ($45 for the whole 9 million). That little bit of international arbitrage financed my trip, incidentally.
Bolivian hyperinflation ended just four months later, in August 1985, after the socialist government that engineered it was ousted. It had printed pesos until they were worth less than the ink and paper.
So, you say, inflation is nasty business but it’s just the really rotten few that do it. Not so. The late Frederick Leith-Ross, a famous authority on international finance, observed: "Inflation is like sin; every government denounces it and every government practices it." Even Americans have witnessed hyperinflations that destroyed two currencies — the ill-fated continental dollar of the Revolutionary War and the doomed Confederate money of the Civil War.
Today’s slow-motion dollar depreciation, with prices rising at persistent but mere single-digit rates, is just a limited version of the same process. Government spends, runs deficits, and pays some of its bills through the inflation tax. How long it can go on is a matter of speculation, but trillions in national debt and politicians who make misers of drunken sailors and get elected by promising even more are not factors that should encourage us.
Inflation is very much with us but it must end someday. A currency’s value is not bottomless. Its erosion must cease either because government stops its reckless printing or prints until it wrecks the money. But surely, which way it concludes will depend in large measure on whether its victims come to understand what it is and where it comes from.
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Lawrence W. Reed is president of the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.
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