Central banks have spent decades flooding the global economy with newly created money. We are told this policy, or what is called a monetary inflation, is needed to stimulate economic growth and to keep unemployment low, but like so many of the justifications that politicians and bureaucrats offer for their actions, this one is a lie. For as we will explore in this video a rapid expansion of the money supply is economically destructive; it impoverishes the poor and middle class, exacerbates wealth inequality, permits a dangerous growth in state power, and sets an economy up for a crash. The real reason those in government favor the policy of a monetary inflation is because it is an effective means to transfer wealth from the citizens to the state.
“Monetary [inflation] breeds not only poverty and chaos, but also government tyranny. Few policies are more calculated to destroy the existing basis of a free society than the debauching of its currency. And few tools, if any, are more important to the champion of freedom than a sound monetary system.”
Hans F. Sennholz, Inflation, or Gold Standard
Money is a medium of exchange; money is not wealth. Money can be used as a measure of wealth, but paper currencies and digits added to bank accounts are not a form of wealth. Rather real wealth consists of the goods and services produced in an economy which can be put to use to better our lives. A central bank can double the supply of money overnight, but this action would not make an economy wealthier. There would still be the same amount of food, houses, cars, planes, steel, lumber, oil, and all the other things that make up the real wealth of a modern economy.
“The wealth produced in an economic system and the total monetary value of that wealth are separate and distinct phenomena. The one can increase without the other.”
George Reisman, Capitalism
While an increase in the supply of money by a central bank is not wealth generating, it is wealth redistributing. When money is created it does not enter the economy in a uniform manner with each member of a society receiving an equal number of new dollars, pounds, pesos, euros, or yen. Rather newly created money enters the economy through specific channels in the form of loans, bailouts, or asset purchases by the central bank. The beneficiary of the new money may be a government, a business, or a certain individual, but whoever it is, they experience an unearned gain. With the newly created money they can purchase more goods or services, or make investments at a greater level, than would otherwise have been possible.
“It should never be forgotten that inflation always represents an unearned gain to whoever is in a position to introduce the newly created money into the economic system through his spending – and a corresponding loss to the individuals who make up the rest of the economic system.”
George Reisman, Capitalism
When the recipients of new money spend it, or invest it, one of the results is a relative impoverishment of the rest of society. For as the new money percolates through the economy it puts upward pressure on prices as more dollars compete for an unchanged supply of goods and services. The higher prices that result from an expansion of the money supply lowers everyone else’s purchasing power. The recipients of the new money in effect transfer goods, services, and assets to themselves that could have been purchased by someone else had it not been for the actions of the central bank, or as Murray Rothbard explains in his book What Has Government Done to Our Money?
“[Monetary] inflation confers no general social benefit; instead, it redistributes the wealth in favor of the first – and at the expense of the laggards to the race. And inflation is, in effect, a race – to see who can get the new money earliest. The latecomers – the ones stuck with the loss – are often called the “fixed income groups.”
Murray Rothbard, What has Government Done to Our Money?
As much of this wealth redistribution favours the government, this central bank policy can be considered a form of covert taxation. Unlike the income tax, sales tax, or property tax, where the taxpayer is aware that his or her money is being taken, the covert tax of a monetary inflation is discreet. Creating new money to fund government spending allows politicians and bureaucrats to divert wealth and resources to whoever they choose, but as the money spreads through the economy it puts upward pressure on prices and diminishes the purchasing power of all those who are not a direct beneficiary of this government spending. Like any form of taxation, therefore, a monetary inflation is a wealth transfer from the citizenry to the state, or as Rothbard explains:
“. . .the essence of inflation is the process by which a large and hidden tax is imposed on much of society for the benefit of government. . .”
Murray Rothbard, The Mystery of Banking
Using a monetary inflation to fund spending allows governments to expand their powers far beyond the limits that would be imposed on them were they to rely solely on more traditional forms of taxation. For most citizens would not consent to paying the high levels of taxes needed to fund modern governments and only do so because a large portion of the tax is covert and masked in a diminished purchasing power. If governments were honest and directly taxed the citizenry, most people would realize they were being fleeced and quickly stop supporting the politicians responsible for impoverishing them.
Some people may contend that the ability of governments to finance their spending through the creation of money is a benefit of this central bank policy. For during times of crises governments claim a heightened need for resources and printing money to fund these needs allows them to act without having to take the unpopular action of raising tax levels. But as Robert Murphy explains in his book Understanding Money Mechanics to claim that monetary inflation is needed to deal with a crisis:
“. . . really just means that the citizens of the countries involved wouldn’t have tolerated the huge increases in explicit taxation . . . Instead, to finance such unprecedented expenditures, their governments had to resort to the hidden tax of inflation, where the transfer of purchasing power from their peoples would be cloaked in rising prices that could be blamed on speculators, trade unions, profiteers, and other villains, rather than the government’s profligacy.”
Robert Murphy, Understanding Money Mechanics
The insidious nature of a monetary inflation does not end here, it also drives wealth inequality. For second to politicians and bureaucrats, the rich are the greatest beneficiary of money creation. To understand why we must recognize that one of the key mechanisms by which central banks expand the supply of money is by artificially supressing interest rates. Low interest rates entice people to borrow newly created money through the banking system and who are the people most capable of borrowing this cheap credit? Those in the upper class as they possess more of the assets needed to act as collateral on loans. With access to this cheap credit the rich can spend it to purchase real estate, equities, fine art, vintage cars, precious metals, or other forms of wealth. The elevated demand for these assets pushes up prices and this increases the net worth of everyone exposed to these asset classes, which again, is primarily those in the upper class.
“. . .the greatest beneficiaries from the Fed’s policies [of the 21st century] were the financial elite, who got to enhance their fortunes with cheap leverage at a time when asset values were driven higher by easy money. As one commentator put it, ‘The top 1 per cent of income earning households that are most exposed to the market economy are dramatically outperforming the remaining 99 per cent that are exposed to the real economy.’”
Edward Chancellor, The Price of Time
In addition to allowing politicians, bureaucrats, and the upper class to leech wealth from the rest of us, there is a further reason why a monetary inflation is economically destructive. The low interest rates that drive this policy act as false signals enticing individuals to overconsume and businesses to overexpand to a degree not warranted by the long-term fundamentals of the economy. Easy money, explains the economist Henry Hazlitt:
“. . .creates economic distortions. . .encourages increased borrowing. . .it tends to encourage highly speculative ventures that cannot continue except under the artificial conditions [of low interest rates] that have given birth to them. On the supply side, the artificial reduction of interest rates discourages normal thrift, saving, and investment. It reduces the accumulation of capital.”
Henry Hazlitt, Economics in One Lesson
A commonly used analogy is to compare the flooding an economy with easy money, to a drug addiction. When an addict is using a drug, he is in euphoria, but when the drug is taken away his body and mind crash. For a booming economy the drug is the easy money fueled by the low interest rates. But when interest rates rise, and the easy money stops flowing through the arteries of the economy, a crash ensues. But the analogy can be taken further: The crash for a drug addict is necessary to return an individual to a state of sobriety and health, and so too is the economic crash needed to return an economy to health. The crash clears all the economic deadwood, or malinvestment, out of the system and transfers capital away from inefficient uses and away from unsustainable entrepreneurial endeavours, or as Rothbard explains:
“. . .the depression phase is actually the recovery phase. Most people would be happy to keep the boom period, where the inflationary gains are visible and the losses hidden and obscure. . .The stages that people complain about are the crisis and depression. But the latter periods, it should be clear, do not cause the trouble. The trouble occurs during the boom, when malinvestments and distortions take place; the crisis-depression phase is the curative period. . .”
Murray Rothbard, Man Economy and State
Central banks have been flooding the economic system with easy money for decades. This has been a boon for the growth of the state, it has enriched the upper class, and it has created bubbles in the price of assets such as equities and real estate. But in the process, it has impoverished the middle class and the poor, and we are now facing the menace of an accelerated rise in consumer prices. Central banks are trying to tame this increase in price levels by raising interest rates and tightening credit conditions. But with so much debt in our system, at an individual, corporate, and governmental level, a rise in interest rates threatens to collapse the house of cards upon which so much of the economy is built. Removing the drug of easy money, in other words, is setting us up for a crash. Will central banks keep fighting the rise in consumer prices with higher interest rates and allow a curative crash to unfold? Or will they follow the pattern of the past several decades and at the first sign of a serious collapse in equity or real estate prices, cut interest rates once again? If they choose the latter course, they will be flirting with fire, for as Ludwig von Mises explains:
“If once public opinion is convinced that the increase in the quantity of money will continue and never come to an end, and that consequently the prices of all commodities and services will not cease to rise, everybody becomes eager to buy as much as possible and to restrict his cash holding to a minimum size…Everybody is anxious to swap his money against “real” goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time…the things which were used as money are no longer used as [money]. Nobody wants to give away anything against them.”
Ludwig von Mises, Human Action
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