As Adam Smith explains, the free market brings its wonders to the world by virtue of an invisible hand. Individuals cooperating under the international division of labour and seeking generally to satisfy their own wants end up promoting the general welfare, often without intending to or without realising it.
Not to be outdone, government too has developed a systemic hand that is usually not seen. Unlike the market, when this hand moves, we lose. Through inflation, government snatches the market’s bounty for its own purposes, enervating our lives accordingly.
As a “stealth tax,” inflation requires no legislation to impose, no agency to collect, and diverts responsibility for damages onto politicians’ favourite whipping boys. It gives government the ability to buy almost anything for nothing, while creating endless problems that serve as a pretext for intervention. Inflation is the foundation of arrogant government and a prescription for our own demise.
Government inflates through its central bank, the Federal Reserve System, which it created in 1913. The Fed does many other things, but its foremost responsibility is to keep diluting our money supply with unbacked dollars.
To repeat: The Fed is the engine of inflation in this country. Inflation is not some curse of capitalism. It’s government policy. It is any increase in the money supply. We see this alluded to in the Fed’s charter, which calls on it “to furnish an elastic currency.” Fed Governor Ben Bernanke almost boasts about it: “[T]he U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
If this sounds like counterfeiting, be advised that almost no one sees it that way, especially government and Fed officials. According to the MSN Encarta dictionary, a counterfeiter is a person who makes “a copy of something, especially money, in order to defraud or deceive people.” Does that shoe fit the Fed? You decide.
The Fed’s inflation is often part of a process called “monetising the federal debt,” a stultifying expression describing the hocus-pocus used to cover government’s deficits. In simple language, government puts ink on pieces of paper and calls them “securities,” in response to which the central bank puts ink on pieces of paper, calls it money, and buys the securities.
Like magic, the federal government has new money to spend – thanks to the tooth fairy known as the Fed.
When government imposed its central bank on us in 1913, pulling money from a hat was more of a challenge than it is now. If the Fed printed too many paper tickets, people would begin to wonder if the banking system could redeem them in gold on demand, as stated on the tickets. The fear of a bank run acted as a brake on inflation.
Since inflation is the increase in the money supply, gold imposed a limit on the amount of government debt the Fed could buy, which in turn put restrictions on government spending. If gold could be eliminated, those restrictions would go away.
When the Fed was being sold to the public, its advocates told people it would prevent panics and recessions by virtue of its power to provide money and cheap credit on demand. Eight years after its inception, the country slid into a recession (1921), and after another eight years the stock market crashed. By the time a new administration took power in 1933, the economy was on its knees.
Assured the free market had failed them, a bewildered public turned to government for deliverance. On April 5, 1933 President Roosevelt issued Executive Order 6102, in which he ordered all persons to turn in their gold or face a possible 10-year prison sentence and a $10,000 fine. He gave them until April 28 to comply. For this and countless other New Deal interventions, most historians regard Roosevelt as a demigod for “saving” capitalism.
After the gold heist, dollars were no longer redeemable, at least domestically. Foreigners were allowed (though not encouraged) to swap their dollars for gold until August 15, 1971, when President Nixon repudiated the government’s redemption obligations.
With gold completely severed from the dollar, our monetary system lost its best defence against political caprice. Not surprisingly, inflation rose to double digits by 1973. As economist Ludwig von Mises tells us, the gold standard makes the supply of money depend on the profitability of mining gold. The pure fiat dollar faces no obstacles to its production, other than the integrity of government and Fed officials.
Nevertheless, spokespeople for government’s monetary monopoly assure us the proliferation of unbacked dollars helps the economy. Indeed, people at the Fed, such as Governor Bernanke, refer to their inflationary practises as an “accommodative monetary policy.”
What happens when the Fed “accommodates” us by increasing the stock of money?
First, it reduces the value of the dollar. More dollars means each one buys less, putting upward pressure on prices. Technology and improvements in production tend to push prices downward, but because of inflation fewer people can afford admission to the market’s bounty.
As a rough idea of how far the dollar has plummeted, $5,000 in 1913 had greater buying power than $95,000 in 2004.
Second, a depreciating dollar discourages savings. Why put money away if it’s going to lose value? Instead, millions of investment neophytes put their funds in the stock market in an attempt to protect themselves against Fed printing presses. Has this been a successful hedge?
During the biggest bull market in history – 1984 to 2001 – the S&P rose 14.5 percent a year. But frequent trading by fund managers and high fees reduced the average rate of return to 4.2 percent annually. According to Vanguard group founder John Bogle, if you include the results of 2002, the average return from equities was under 3 percent per year – less than the inflation rate.
Third, new injections of money spur a tinsel prosperity, and the Fed keeps injecting new money to feed the boom. With so much borrowing and spending, prices may rise even faster than the rate of currency inflation.
As the public broods over higher prices, a semantic shift takes place. Inflation comes to mean not an increase in the money supply, but the rise in prices itself. Thus, businesses that charge higher prices become the villains, while government officials that threaten price controls wear the halos. Most people have no idea what the Fed does, so government can scapegoat business and appear to be defenders of the public weal. Nor do most people understand that price ceilings create shortages, by encouraging consumption and retarding production. Shortages, in turn, bring on government-imposed quotas, which foster corruption, black markets, and violent crime.
Fourth, as the influx of dollars drives prices higher, some industries find themselves at a disadvantage with foreign competitors, tempting them to lobby Washington for protection from imports. Protective tariffs and quotas, of course, push prices up further, while sometimes sparking trade wars as other countries retaliate on American exports. And trade wars can lead to shooting wars.
In June, 1930, with the economy fighting the recession brought on by Fed monetary policies, President Hoover signed the Hawley-Smoot Tariff Act, raising tariff levels to the highest in U.S. history. Other countries immediately retaliated, markets shut down, and economic conditions worsened worldwide.
Fifth, inflation raises nominal incomes, pushing people into higher tax brackets, which increases government tax revenue. As people’s wealth goes out the window in depreciating dollars, taxes consume more of what remains.
Sixth, inflation shifts wealth from people who can’t or don’t know how to defend themselves from monetary destruction to those who can. As a simple example, a person living on a fixed income may find his buying power so depleted he sells a family heirloom to pay for an unanticipated expense. Or a bank that was part of the lending spree that helped drive prices skyward may foreclose on the homes of some of its borrowers, whose incomes were ravaged by monetary debauchery.
Seventh, Mr. Bernanke’s “accommodative” measures keep people working much later in their careers because they cannot afford to live off their deteriorating pensions. Dollar depreciation is a huge reason why both husband and wife work in many families.
Eighth, because government often gets the new money first, it can fund controversial measures such as war and bailouts without drawing taxpayer ire. Government simply puts the funding on its charge card, prompting the alchemy of Fed debt monetisation. We get the bill, of course, but this way it’s spread over everything else we buy, so we never see it itemised.
Ninth, because inflation has an uneven affect on prices, raising some faster or sooner than others, people have a hard time distinguishing illusion from reality. As cheap credit abounds, business people, investors, and cube dwellers hear the siren call of can’t-miss profit opportunities. Fortunes are made then lost, and companies find it harder to keep employees when they’re losing money.
Tenth, government may pose as the saviour of a group of voters they’ve impoverished, such as the elderly, by subsidising their medical expenses. New entitlements create the need for more revenue, which fuels more inflation, pushing the dollar closer to a complete collapse.
Eleventh, as Mises observed, “under inflationary conditions, people acquire the habit of looking upon the government as an institution with limitless means at its disposal: the state, the government, can do anything.” People today want government to ensure a democratic Middle East, universal health care, free education, a missile defence system, a guaranteed retirement income, and a trip to Mars. They want government to do all that and more.
But we can relax – Mr. Bernanke’s printing presses stand ready to “accommodate” these wishes.
If gold is the barbarous relic its many detractors claim it is, we might expect the Fed’s fiat currency to be a better deal. But even Fed Chairman Greenspan admits that it isn’t, telling a New York audience in 2002 that “the price level in 1929 was not much different, on net, from what it had been in 1800. But, in the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And, in the four decades after that, prices quintupled.”
Lord Keynes, the 20th Century’s guru of deficit spending, never spelled out how deficits should be financed, admitting only that increased taxation was not the answer. Perhaps he had pangs of conscience about calling for inflation outright. Writing after World War I, he noted: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. 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.”
Iraq and terrorism dominate the news, but how little we hear about the policies nurturing these issues, one of which is government’s power to confiscate wealth with the Fed’s invisible hand.
We should wipe every trace of the Federal Reserve from our lives and allow the market to freely choose our monetary standard, which most likely would be gold. In the meantime, we should shut down Mr. Bernanke’s printing presses for good.