Inflation Is Not About Price Increases, Frank Shostak (12/06/2016)

There is almost complete unanimity among economists and various commentators that inflation is about general increases in the prices of goods and services. From this it is established that anything that contributes to price increases sets in motion inflation.

A fall in unemployment or a rise in economic activity is seen as a potential inflationary trigger. Some other triggers, such as rises in commodity prices or workers’ wages, are also regarded as potential threats.

If inflation is just a general rise in prices as the popular thinking has it, then why is it regarded as bad news? What kind of damage does it do?

Mainstream economists maintain that inflation causes speculative buying, which generates waste. Inflation, it is maintained, also erodes the real incomes of pensioners and low-income earners and causes a misallocation of resources. Inflation, it is argued, also undermines real economic growth.

Why should a general rise in prices hurt some groups of people and not others? Or how does inflation lead to the misallocation of resources? Why should a general rise in prices weaken real economic growth?

Also, if inflation is triggered by various factors such as unemployment or economic activity then surely it is just a symptom and therefore doesn’t cause anything as such.

To ascertain what inflation is all about we have to establish its definition. Now to establish the definition of inflation we have to establish how this phenomenon emerged. We have to trace it back to its historical origin.

The Essence of Inflation

Historically, inflation originated when a country’s ruler such as king would force his citizens to give him all their gold coins under the pretext that a new gold coin was going to replace the old one. In the process the king would falsify the content of the gold coins by mixing it with some other metal and return diluted gold coins to the citizens. On this Rothbard wrote,

More characteristically, the mint melted and re-coined all the coins of the realm, giving the subjects back the same number of “pounds” or “marks,” but of a lighter weight. The leftover ounces of gold or silver were pocketed by the King and used to pay his expenses. (Murray N. RothbardWhat Has Government Done to Our Money? (Auburn, Ala.: Mises Institute, Libertarian Publishers, 2010), p. 58.)

On account of the dilution of the gold coins, the ruler could now mint a greater amount of coins and pocket for his own use the extra coins minted. (He could now divert real resources to himself.) What was now passing as a pure gold coin was in fact a diluted gold coin.

The increase in the number of coins brought about by the dilution of gold coins is what inflation is all about. As a result of the increase in the amount of coins that masquerade as pure gold coins, prices in terms of coins now go up (more coins are being exchanged for a given amount of goods).

Note that what we have here is an inflation of coins, i.e., an expansion of coins. As a result of inflation, the ruler can engage in an exchange of nothing for something (he can engage in an act of diverting resources from citizens to himself).

Also note that the increase in prices in terms of coins comes on account of the coin inflation. Observe however that it is the increase in coins brought about by the dilution of gold coins that enables the diversion of resources here to the ruler and not an increase in prices as such.

Under the gold standard, the technique of abusing the medium of the exchange became much more advanced through the issuance of paper money un-backed by gold.

Inflation therefore means an increase in the amount of receipts for gold on account of receipts that are not backed by gold yet masquerade as the true representatives of money proper, gold.

The holder of un-backed receipts can now engage in an exchange of nothing for something. As a result of the increase in the amount of receipts (inflation of receipts) we now also have a general increase in prices.

Observe that the increase in prices develops here on account of the increase in paper receipts that are not backed up by gold.

Also, what we have here is a situation where the issuers of the un-backed paper receipts divert real goods to themselves without making any contribution to the production of goods.

In the modern world, money proper is no longer gold but rather paper money; hence inflation in this case is an increase in the stock of paper money.

We don’t say that the increase in the money supply causes inflation. What we are saying is that inflation is the increase in the money supply.

Inflation Is About Wealth Destruction 

Note that increases in the money supply set in motion an exchange of nothing for something. They divert real funding away from wealth generators toward the holders of the newly created money. This is what sets in motion the misallocation of resources, not price rises as such.

Real incomes of wealth generators fall, not because of general rises in prices, but because of increases in the money supply. When money is expanded (i.e., created out of “thin air”) the holders of the newly created money can divert goods to themselves without making any contribution to the production of goods.

As a result wealth generators who have contributed to the production of goods discover that the purchasing power of their money has fallen since there are now less goods left in the pool — they cannot fully exercise their claims over final goods since these goods are not there.

Once wealth generators have less real resources at their disposal this is obviously going to hurt the formation of real wealth. As a result real economic growth is going to come under pressure.

General increases in prices, which follow increases in money supply, only point to an erosion of real wealth. Price increases by themselves however do not cause this erosion.

Can Increases in Commodity Prices Cause Inflation?

According to most economists, an important factor behind a general increase in prices is increases in commodity prices.

We have seen that inflation is brought about by a deliberate act of currency debasement — on a gold standard by issuing un-backed by gold paper money, while on a paper standard an increase in the supply of paper money.

An increase in commodity prices as such is not related to an act of embezzlement. For instance, in a true market economy an increase in the price of oil versus the prices of other goods is just a reflection of changes in peoples’ demand. Obviously it has nothing to do with an act of currency debasement brought about by the increase in money supply out of “thin air.”

Also, if the price of oil goes up and if people continue to use the same amount of oil as before, people will be forced to allocate more money to oil. If peoples’ money stock remains unchanged, less money is available for other goods and services.

This of course implies that the average price of other goods and services must come down. Again, remember a price is the sum of money paid for a unit of a good. (The term “average” is used here in conceptual form. We are well aware that such an average cannot be computed.)

Note that the overall money spent on goods doesn’t change; only the composition of spending has altered, with more on oil and less on other goods. The average price of goods or money per unit of good remains unchanged.

Hence, the rate of increase in the prices of goods and services in general is going to be constrained by the rate of growth of money supply, all other things being equal, and not by the rate of growth of the price of oil.

It is not possible for increases in the price of oil to set in motion a general increase in the prices of goods and services without the corresponding support from money supply out of “thin air.”

We can then conclude that the so-called general increase in prices that seems to follow an increase in a commodity price such as oil, is in fact on account of an increase in the money supply out of “thin air.” (Note that since an injection of money doesn’t enter all the markets instantly, a general increase in prices ensues on account of previous increases in money supply.)

Most economists, when discussing the issue of general increases in prices, which they label inflation, never mention the word money. The reason for that is the lack of a good statistical correlation between changes in money and changes in various price indexes such as the CPI.

Whether changes in money supply cause changes in prices cannot be established by means of statistical correlation.

A statistical correlation, or a lack of it, between two variables shouldn’t be the determining factor in establishing causality. One must figure it out by means of reasoning as to the structure of causality.

Can Inflation Expectations Trigger a General Price Rise?

We have seen that, as a rule, a general increase in the prices of goods emerges on account of an increase in the amount of money paid for goods, all other things being equal.

The key then for general increases in prices, which is labeled by popular thinking as inflation, is increases in the money supply.

But what about the situation when increases in commodity prices ignite inflation expectations, which in turn strengthens a general increase in prices? Surely then inflation expectations must be also an important driving factor behind the general increase in prices?

According to most economists, inflation expectations are the key driving factor behind increases in general prices.

Once people start to anticipate higher inflation in the future they raise their demands for goods at present thus bidding the prices of goods higher.

Also, according to popular thinking, workers expectations for higher inflation prompt them to demand higher wages. Increases in wages in turn lift the cost of producing goods and services and force businesses to pass these increases on to consumers by raising prices.

It is true that businesses set prices and it is also true that businessmen while setting prices take into account various costs of production. However, businesses are ultimately at the mercy of the consumer who is the final arbiter. 

The consumer determines whether the price set is “right,” so to speak. Now, if the money stock did not increase then consumers wouldn’t have more money to support the general increase in prices of goods and services, all other things being equal.

Hence, on account of expectations for higher prices in the future, all other things being equal, consumers will not be able to raise their demand for goods at present and bid the prices of goods higher without having more money. Consequently, the amount of money spent per unit of goods will stay unchanged.

So irrespective of what peoples’ expectations are, if the money supply hasn’t increased then peoples’ monetary expenditure on goods cannot increase either. This means that no general strengthening in price increases can take place without an increase in the pace of monetary pumping.

Note that inflationary expectations as such don’t cause a currency debasement, so in this sense an increase in so-called inflation expectations has nothing to do with inflation — i.e., an increase in money out of “thin air.”

Imagine that somehow the Fed did manage to convince people that central bank policies are aimed at stopping inflation and maintaining price stability, yet at the same time the central bank also raises the rate of growth of money supply.

Even if inflationary expectations were stable the destructive process will be set in motion regardless of these expectations on account of the increase in the rate of growth of money. Note that people’ expectations and perceptions cannot offset this destructive process.

It is not possible to alter the facts of reality by means of expectations. The damage that was done cannot be undone by means of expectations and perceptions.

When inflation is seen as a general increase in prices, then anything that contributes to price increases is called inflationary. It is no longer the central bank and fractional-reserve banking that are the sources of inflation, but rather various other causes.

In this framework, not only does the central bank have nothing to do with inflation, but, on the contrary, the bank is regarded as an inflation fighter.

On this, Mises wrote,

To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call “inflation” the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase. They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying “catch the thief.” The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices. (Ludwig von Mises, Economic Freedom and Interventionism, p. 94.)

Advertisements

How Inflation and Unemployment Are Related, Frank Shostak (12/13/2016)

A fall in the US unemployment rate to 4.6% in November from 4.9% in the month before, and 5% in November last year, has prompted some commentators to suggest that we are almost at the so-called natural rate, which is believed to be at around 4.5%.

It is held that once the unemployment rate falls below an “optimal” rate — called the Non-Accelerating Inflation Rate of Unemployment (NAIRU) — it sets off an inflationary spiral.

This acceleration in the rate of inflation takes place through increases in the demand for goods and services. It also lifts the demand for workers and puts pressure on wages, reinforcing the growth in the rate of inflation.

So from this perspective it will be difficult for President-elect Trump to implement his plan to lower tax rates and boost government outlays on projects including the improvement of roads and bridges without risking a strong increase in the rate of inflation. Or so it is held.

Note that in October, the yearly growth rate of the consumer price index already stood at 1.6% against 0.2% in October last year.

It also raises the likelihood that the Federal Reserve would have to adopt a more aggressive interest rate stance to counter any possibility for acceleration in the rate of inflation.

The NAIRU is an arbitrary measure, derived from a statistical correlation between changes in the consumer price index and the unemployment rate. What matters in the NAIRU framework is whether the theory “works,” i.e., whether a decline in the unemployment rate below the NAIRU results in the acceleration in the rate of inflation.

Using statistical correlation as the basis of a theory means that “anything goes.” For example, let us assume that a high correlation has been found between the income of Mr. Jones and the rate of growth in the consumer price index. The higher the rate of increase of Mr. Jones’s income, the higher the rate of increase in the consumer price index.

Therefore we could easily conclude that in order to exercise control over the rate of inflation the central bank must carefully watch and control the rate of increases in Mr. Jones’s income. This example is no more absurd than the NAIRU framework.

The purpose of a theory is to present the facts of reality in a simplified form. The theory must originate from the reality and not from some arbitrary idea that is based on a statistical correlation.

Contrary to popular thinking, strong economic activity doesn’t cause a general rise in the prices of goods and services and an economic overheating labeled as inflation. Regardless of the rate of unemployment, so long as every increase in expenditure is supported by production, no “overheating” can actually occur.

RELATED: “Inflation Is Not About Price Increases

The overheating emerges once expenditure rises without being backed up by production, a situation that occurs when the money stock is increasing. Once money increases, it generates an exchange of nothing for something, or consumption without preceding production.

As a rule, increases in the money stock are followed by general increases in the prices of goods and services. Prices are another name for the amount of money that people spend on goods they buy. When money is injected it never goes to all the markets instantly but by stages — there is a time lag. Hence the reason for the time lag between changes in money and changes in prices.

If the amount of money in an economy increases while the amount of goods remains unchanged more money will be spent on the given amount of goods (i.e., prices will increase). Conversely, if the stock of money remains unchanged it is not possible to spend more on all the goods and services, hence no general rise in prices is possible. By the same logic, in a growing economy with a growing amount of goods and an unchanged money stock, prices will fall.

Limiting Government Spending and Money Creation Will Lead to Wealth Creation

Now, if President-elect Trump were to seal off all the loopholes for the creation of money out of “thin air” and lower government outlays, this will leave more real wealth in the hands of the wealth generating private sector. This will strengthen the wealth generating process.

A strengthening in the wealth generating process will permit the increase in the production of goods and services, i.e., a strengthening in economic growth. Consequently, this will correspond to the decline in the growth rate in the prices of goods and services. (Remember the loopholes for money creation out of “thin air” are sealed off.) This will also correspond to the decline in the unemployment rate.

Observe in a free unhampered economy with minimal government involvement in economic activity and in the absence of money generation out of “thin air” an efficient use of resources will take place. In such an environment no one would need establish the so-called NAIRU. Such an environment will be conducive for real wealth expansion, a low unemployment rate and a declining rate of inflation.

Also note that in a properly functioning market economy any form of unemployment will be of a voluntary nature. Individuals will be paid in accordance with their contribution to the production of wealth. Any one insisting on a wage rate above his or her contribution to the wealth generation will be unemployed.

However the chances that Donald Trump is going to embrace a smaller government with the loopholes for money creation out of “thin air” sealed off is probably nil.

More Government Spending Will Undermine Wealth Creation

Hence we suggest that any aggressive expansion in government outlays are likely to undermine further the process of wealth generation and lead to economic difficulties ahead.

Obviously if the wealth generation process is still capable of absorbing all the abuses on account of government expansion and the central banks’ reckless monetary policies, then the policies of Donald Trump and the Fed will appear to be successful.

This illusion is going to be shattered once the pool of real wealth will fall onto a declining path. Once this happens the economy will fall into a severe economic crisis.

Any aggressive loose stance by the Federal Reserve and the government will only make things much worse. Remember government is not a wealth generating entity — it only consumes real wealth.

Inflation and the Fall of the Roman Empire By Joseph R. Peden

Two centuries ago, in 1776, there were two books published in England, both of which are read avidly today. One of them was Adam Smith‘s The Wealth of Nations and the other was Edward Gibbon‘s Decline and Fall of the Roman Empire. Gibbon‘s multivolume work is the tale of a state that survived for twelve centuries in the West and for another thousand years in the East, at Constantinople.

Gibbon, in looking at this phenomenon, commented that the wonder was not that the Roman Empire had fallen, but rather that it had lasted so long. And scholars since Gibbon have devoted a great deal of energy to examining that problem: How was it that the Roman Empire lasted so long? And did it decline, or was it simply transformed into something else (that something else being the European civilization of which we are the heirs)?

I’ve been asked to speak on the theme of Roman history, particularly the problem of inflation and its impact. My analysis is based on the premise that monetary policy cannot be studied, or understood, in isolation from the overall policies of the state.

Monetary, fiscal, military, political, and economic issues are all very much intertwined. And they are all so intertwined because any state normally seeks to monopolize the supply of money within its own territory.

Monetary policy therefore always serves, even if it serves badly, the perceived needs of the rulers of the state. If it also happens to enhance the prosperity and progress of the masses of the people, that is a secondary benefit; but its first aim is to serve the needs of the rulers, not the ruled. This point is central, I believe, to an understanding of the course of monetary policy in the late Roman Empire.

We may begin by looking at the mentality of the rulers of the Roman Empire, beginning at the end of the 2nd century AD and looking through to the end of the 3rd century AD. Roman historians refer to this period as the “Crisis of the 3rd Century.” And the reason is that the problems of the Roman society in that period were so profound, so enormous, that Roman society emerged from the 3rd century very different in almost all ways from what it had been in the 1st and 2nd centuries.

To look at the mentality of the Roman emperors, we can look just at the advice that the Emperor Septimius Severus gave to his two sons, Caracalla and Geta. This is supposed to be his final words to his heirs. He said, “live in harmony; enrich the troops; ignore everyone else.” Now, there is a monetary policy to be marveled at!

Caracalla did not adhere to the first part of that advice; in fact, one of his first acts was to murder his brother. But as for enriching the troops, he took that so seriously to heart that his mother remonstrated with him and urged him to be more moderate and to restrain his increasing military expenditures and burdensome new taxes. He responded by saying there was no longer any revenue, just or unjust, to be found. But not to worry, “for as long as we have this,” he insisted, pointing to his sword, “we shall not run short of money.”

His sense of priorities was made more explicit when he remarked, “nobody should have any money but I, so that I may bestow it upon the soldiers.” And he was as good as his word. He raised the pay of the soldiers by 50 percent, and to achieve this he doubled the inheritance taxes paid by Roman citizens. When this was not sufficient to meet his needs, he admitted almost every inhabitant of the empire to Roman citizenship. What had formerly been a privilege now became simply a means of expanding the tax base.

He then went further by proceeding to debase the coinage. The basic coinage of the Roman Empire to this time — we’re speaking now about 211 AD — was the silver denarius introduced by Augustus at about 95 percent silver at the end of the 1st century BC. The denarius continued for the better part of two centuries as the basic medium of exchange in the empire.

By the time of Trajan in 117 AD, the denarius was only about 85 percent silver, down from Augustus‘s 95 percent. By the age of Marcus Aurelius, in 180, it was down to about 75 percent silver. In Septimius‘s time it had dropped to 60 percent, and Caracalla evened it off at 50/50.

Caracalla was assassinated in 217. There then followed an age that historians refer to as the Age of the Barrack Emperors, because throughout the 3rd century all the emperors were soldiers and all of them came to their power by military coups of one sort or another.

There were about 26 legitimate emperors in this century and only one of them died a natural death. The rest either died in battle or were assassinated, which was totally unprecedented in Roman history — with two exceptions: Nero, a suicide, and Caligula, assassinated earlier.

Caracalla had also debased the gold coinage. Under Augustus this circulated at 45 coins to a pound of gold. Caracalla made it 50 to a pound of gold. Within 20 years after him it was circulating at 72 to a pound of gold, reduced to 60 at the end of the century by Diocletian, only to be raised again to 72 by Constantine. So even the gold coinage was in fact inflated — debased.

But the real crisis came after Caracalla, between 258 and 275, in a period of intense civil war and foreign invasions. The emperors simply abandoned, for all practical purposes, a silver coinage. By 268 there was only 0.5 percent silver in the denarius.

Prices in this period rose in most parts of the empire by nearly 1,000 percent. The only people who were getting paid in gold were the barbarian troops hired by the emperors. The barbarians were so barbarous that they would only accept gold in payment for their services.

The situation did not change until the accession of Diocletian in the year 284. Shortly after his accession he raised the weight of the gold coinage, the aureus, to 60 to the pound — this was from a low of 72.

But ten years later, he finally abandoned the silvered coinage, which by this time was simply a bronze coin dipped in silver rather quickly. He abandoned that completely and tried to issue a new silver coin, called theargenteus, struck at 96 coins to the pound of silver. The argenteus was fixed as equal to 50 of the denarii (the old coinage). It was designed to respond to the need for higher-tariffed coins in the marketplace, to reflect the inflation.

Diocletian also issued a new bronze coin tariffed at ten denarii, called the nummus. But less than a decade later, the nummus had gone from being tariffed at ten denarii to now equaling 20 denarii, and the argenteus had gone from 50 denarii to 100. In other words, despite Diocletian’s efforts, the Empire suffered 100 percent inflation.

The next emperor who interfered with the coinage in a meaningful way was Constantine, the first Christian emperor of Rome. In the year 312, which is also the year he issued the Edict of Toleration for Christianity, Constantine issued a new gold piece, which he called by a new name, the solidus — solid gold. This was struck at 72 to the pound, so it was in fact debased more than Diocletian’s.

These were very large issues of coin and historians have puzzled over where Constantine got all the gold; but I think the puzzle is not so difficult once you begin to look at his legislation.

First of all, Constantine issued two new taxes. One was on the estates of the senators. This was rather new because senators were usually free of most taxes on their land. He also issued a tax on the capital of merchants; not their earnings, but their capital. This was to be levied every five years and it was to be paid in gold. He also required that the rents from the imperial estates, which were rented out to tenants, were to be paid only in gold.

Constantine took on the bullion reserves of his former partner Licinius, who had extracted, by force, bullion from the treasuries of the cities of the Eastern Empire. In other words, any city that had any gold bullion or silver bullion left in its treasury was simply requisitioned by Licinius. This gold passed on now into the hands of Constantine who had gotten rid of Licinius in a civil war.

We’re also told that he stripped the pagan temples of their treasuries. This he did rather late in his reign. In the early days he was apparently still somewhat afraid of angering the gods of Rome. As his Christianity became more fixed, he felt greater ease at robbing the temples.

Now, in one sense, Constantine’s reform began the reversal of the process: the gold coinage was sufficiently large that it began to take hold and to circulate more freely. However, the silver coinage failed and, what was worse, at no time in this period did the central government try to control the token coinage. The result was that token coinage was being minted not only by the imperial mints, but also by the mints of cities. In other words, if a city couldn’t pay its costs or pay the salaries of its employees, it simply struck up some token coinage and issued that.

By the late 3rd century we also begin to have the massive appearance of what numismatists call counterfeits. I would say it would be called credit money today. People need small change, and they simply go and manufacture it. All of this of course meant that the amount of token coinage in circulation was uncontrolled and increasingly massive.

Now, one of the things that had happened in the course of this 3rd-century inflation was that the government found that when it paid its troops in token coinage, or even in debased silver coins, prices immediately rose. Every time the silver value of the denarius dropped, prices naturally rose.

The result was that the government, in order to try to protect its civil servants and its soldiers from the effects of inflation, began to demand payment of taxes in kind and in services rather than in coin. They wound up, in effect, repudiating their own issued coins, not accepting them for tax collection purposes.

With Constantine’s reform, this situation changed somewhat and, slowly but surely, the government began to move away from collecting taxes and paying salaries in kind, and began to substitute collecting taxes and paying salaries in gold. Over the long run, this meant that the gold standard was strengthened and gold remained the real money of the Roman Empire.

However, the inflation did not end for the masses of the people. In other words, gold was a hedge against inflation for those who had it, and these were principally the troops and the civil servants.

The taxpayers had to buy these gold coins in order to pay their taxes. If they were wealthy enough, they could afford to buy these gold coins, which were increasingly expensive in terms of token money. If they were poorer they simply couldn’t pay the taxes; they lost their lands in one form or another or became delinquents. We hear constant references to people abandoning their land, disappearing.

“If a city couldn’t pay its costs or pay the salaries of its employees, it simply struck up some token coinage and issued that.”

As a matter of fact in the 3rd century this was a constant problem in Rome: all sorts of people were trying to escape the increased taxes that the military needed. The army itself had grown from the time of Augustus, when they had about a 250,000 troops, to the time of Diocletian, when they had somewhat over 600,000. So the army itself had doubled in size in the course of this inflationary spiral, and obviously that contributed greatly to the inflation.

In addition, the administration of the state had grown enormously. Under Augustus, essentially, you had the imperial administration at Rome, the secondary level of administration in the governors of different provinces, and then the primary governmental units in the Roman Empire in this time were the cities.

By the time of Diocletian this pattern had broken apart. You had not one emperor, but four emperors, which meant four imperial courts, four Praetorian Guards, four palaces, four staffs, etc.

Under them were four Praetorian prefectures, regional administrative units with their staffs and their budgets. Under these four prefectures, there were then 12 dioceses, each diocese having its administrative staff and so on.

Under the diocesan rulers, the vicars of the dioceses, we have the provinces. In Augustus’s time there were approximately 20 provinces. Three hundred years later, with no substantial increase in territory, there were over a hundred provinces. The Romans had simply divided and subdivided provinces for the purposes of maintaining internal military control of the regions. In other words, the cost of policing and administrating the Roman state became increasingly enormous.

All these costs, then, are some of the reasons why the inflation took place; I’ll get to others in a moment. To give you some idea of the situation after Constantine’s reform of the gold, let me just briefly give you the figures for what it cost in terms of the denarius, the silver coinage, or token coinage now, to buy a pound of gold.

In Diocletian’s time, in the year 301, he fixed the price at 50,000 denarii for one pound of gold. Ten years later it had risen to 120,000. In 324, 23 years after it was 50,000, it was now 300,000. In 337, the year of Constantine’s death, a pound of gold brought 20,000,000 denarii.

And by the way, just as we are all familiar with the German currency of the 1920s with the bigger stamp on it, the Roman coinage also has stamps over stamps on the metal, indicating multiples of value.

At one point, one of the Roman emperors had a marvelous idea: instead of issuing coins he devised a method to handle the inflation. He took brass slugs, put them in a leather pouch, and called it a follis; and people began passing these pouches back and forth as value. I guess it was the Roman equivalent to those baskets of paper we see in the pictures of Germany in the 1920s.

Interestingly enough, within ten years or so after that began, the word follis — which had meant this bag of coins — had now drifted to mean just one of those brass slugs. One of those slugs was now the follis. They couldn’t even keep the bags stable, they too were inflated.

Now one interesting thing with all this inflation should be a great comfort to us: historians of prices in the Roman Empire have come to the conclusion that despite all of this inflation — or perhaps we should say, because of all of this inflation — the price of gold, in terms of its purchasing power, remained stable from the first through the fourth century. In other words, gold remained, in terms of its purchasing power, a stable value whereas all this other coinage just became increasingly worthless.

What were the causes of this inflation? First of all, war. The soldiers’ pay rose from 225 denarii during the time of Augustus to 300 denarii in the time of Domitian, about a hundred years later. A century after Domitian, in the time of Septimius, it had gone from 300 to 500 denarii; and in the time of Caracalla, about 10 years later, it had gone to 750 denarii. In other words, the cost of the army was also rising in terms of the coinage; so, as the coinage became more worthless, the cost of the army had to be increased.

The advance in the soldiers’ pay in the rest of the 3rd century and into the 4th century is not known; we don’t have figures. One reason is that the soldiers were increasingly paid in terms of requisitions of supplies and goods in kind. They were literally given food, clothing, shelter, and other commodities in lieu of pay. This applied also to the civil service.

When one Roman emperor refused to pay a donative on his accession — this was a bonus given to the soldiers on the accession of the emperor — he was simply murdered by his troops. The Romans had had this kind of problem even in the days of the Republic: if the soldiers don’t get paid they rather resent it.

What we find is that the donatives had been given on the accession of a new emperor from the time of Augustus on. In the 3rd century, they began to be given every five years. By the time of Diocletian, donatives were given every year, so that the soldiers’ donatives had in fact become part of their basic salary.

The size of the army, I indicated already, had also increased. It had doubled from the time of Augustus to that of Diocletian. And the size of the civil service also increased. Now, all these events strained the fiscal resources of the state beyond its ability to sustain itself; and the ship of state was kept going, frequently by debasing, then by taxing, and then often simply by accusing people of treason and confiscating their estates.

One of the Christian fathers, Saint Gregory Nazianzus, commented that war is the mother of taxes. I think that’s a wonderful thing to keep in mind: war is the mother of taxes. And it’s also, of course, the mother of inflation.

Now, what were the consequences of inflation? One of the odd things about inflation is, in the Roman Empire, that while the state survived — the Roman state was not destroyed by inflation — what was destroyed by inflation was the freedom of the Roman people. Particularly, the first victim was their economic freedom.

Rome had basically a laissez-faire concept of state/economy relations. Except in emergencies, which were usually related to war, the Roman government generally followed a policy of free trade and minimal restriction on the economic activities of its population. But now under the pressure of this need to pay the troops and under the pressure of inflation, the liberty of the people began to be seriously eroded — and very rapidly.

We could start with the class known as the decurions. This was your prosperous, small- and middle-landowning class who were the dominant elements of the cities of the Roman Empire. They were the class from whom the municipal counsels, magistrates, and officials were chosen.

Traditionally, they had viewed service in the governments of their towns as an honor and they had donated, not merely their time, but also their wealth to the betterment of the urban environment. Building stadiums and bathhouses, and repairing the streets and providing for pure water were considered benefactions. It was a kind of philanthropic act and their reward was, of course, public recognition and esteem.

This class, in the mid-3rd century, was assigned the task of collecting the taxes in the municipality. The central government could no longer collect its taxes effectively, so they made the decurion class collectively responsible for getting revenues and passing them on to the imperial government.

The decurions, of course, had as much difficulty as anyone else in doing this, and the returns were, again, frequently inadequate. So the government solved that problem by simply passing a law that any taxes that decurions could not collect from others, they would have to pay out of their own pockets. That’s known as the incentive method for the tax collector. [laughter]

As you can well imagine, as the crises became greater and the economy was disrupted by civil conflicts and invasions and the effects of inflation, the decurions, strangely enough, no longer wanted to be decurions. They began to abandon their lands, abandon their cities, and escape to wherever they could find refuge in other larger cities or other provinces. But they were not to be allowed to do that with impunity, and a law was then passed that any decurion discovered somewhere else was to be arrested, bound like a slave, and carted back to his hometown where he would be restored to his dignity as a decurion. [laughter]

The 3rd century is also the period of the persecution of the church. We find that at least some of the emperors must have had a sense of humor because they passed a regulation that if a Christian was arrested and found guilty of a capital crime, namely believing in Christ, he was not to be executed but offered the option of becoming a decurion. [laughter]

Now, the merchants and the artisans were traditionally organized into guilds and chambers of commerce and that sort of thing. They now, too, came under government pressure because the government could not obtain enough material for the war machine through regular channels — people didn’t want all that token coinage. So merchants and artisans were now compelled to make deliveries of goods.

So that if you had a factory for making garments, you now had to deliver so many garments to the government requisitions. If you had ships, you had to carry government goods in your ships. In other words, what we have here is a kind of nationalization of private enterprises, and this nationalization means that the people who use their money and their talent are now compelled to serve the state whether they like it or not.

When people tried to get out of this they were then, by law, compelled to remain in the occupation that they were in. In other words, you couldn’t change your job or your business.

This was not sufficient because, after all, death is a relief from taxes. So the occupations were now made hereditary. When you died, your son had to take up your profession. If your father was a shoemaker, you had to be a shoemaker. These laws started by being restricted to the defense-oriented industries but, of course, gradually it was realized that everything is defense-oriented.

The peasantry, known as the coloni, were leaseholders on both imperial and private estates. They too were formerly a free class. Now under the same kinds of pressures that all smallholders were in in this situation, they began to drift away, trying to find better opportunities, better leases, or better occupations. So under Diocletian the coloni were now bound to the soil.

Anyone who had a lease on a particular piece of land could not give that lease up. More than that, they had to stay on the land and work it. In effect, this is the beginning of what in the Middle Ages is called serfdom, but it actually has its origins here in late Roman society.

“War is the mother of taxes.”

We know for example from studies of Palestine, particularly in the Rabbinical writings, that in the course of the 3rd and early 4th century the structure of landholding in Palestine changed very dramatically. Palestine in the 2nd century was mostly composed of peasant landholders with very small acreage, perhaps an average of two and a half acres.

By the 4th century those smallholders had virtually disappeared and been replaced by vast estates controlled by a few large landowners. The peasants working the estates were the same people, but in the meantime they had lost their land to the larger landowners. In other words, landholding became a kind of massive agribusiness.

In the course of this, the population of Palestine, still principally Jewish, also changed in that the ownership of land passed from Jews to Gentiles. The reason for that undoubtedly was that the only people with large amounts of cash who could buy out these smallholders who were in distress were, of course, the government officials. And we hear of them being called potentates, powerful ones. In effect there is a shift in the distribution of wealth in Palestine; and obviously, from other evidence, similar things were happening in other places.

With regard to taxes, they naturally increased across the board, but Diocletian decided that it was a very inefficient system that he had inherited. Every province more or less had its own system of taxation going back to pre-Roman times. And so he, with his military mind, demanded standardization.

And what he did was to have all wealth, which was of course landed wealth, assessed by a standard unit of productivity, the iugum. In other words, every person who had land was either singly, if he was a large landowner, or collectively, for those who were smaller landowners, put into a iugum.

This meant that the emperor for the first time had the basis of a national budget, something the Romans never had before. Therefore, he knew at any given time how many taxable units of wealth there were in any province. He could simply levy an assessment and expect to get a fixed amount of money.

Unfortunately, this took no account of the fact that in agriculture productivity varies considerably from season to season, and that if an army has passed through your district it may take years to recover. The result is that we hear of massive petitions from whole regions asking the emperor to forgive them their taxes, to remit five years of past dues, or to reduce the number of units of productivity to reflect the loss of population or materials.

As a matter of fact, when people began to say “it used to be I had five people paying this unit of taxation, but two of them have fled and it’s only half the land in production,” the response of the government was, “that doesn’t matter, you still have to pay for the land that is now out of production.” So, I mean, there was no relationship between taxes and actual productivity.

How did people protect themselves from this? Well, first of all, long-term mortgages virtually ceased to be given. Long-term loans of any kind disappeared. No one would lend unless they were guaranteed payment in gold or silver bullion.

In fact the government itself, under Diocletian and Constantine, refused to accept gold coins in payment of taxes, but insisted instead on gold bullion. So that the coins that you bought in the marketplace had to then be melted down and presented in the form of bullion. The reason was that the government was never sure how adulterated its own gold coinage really was.

Pledges and securities for crops and for loans were always in gold, silver, or indeed in crops themselves. In Egypt we have a document in which it seems that the banks had been refusing to accept coins with the divine image of the emperor; in other words, state issues. The government’s reaction to that, of course, was to force the banks to accept the coinage. This led to wholesale corruption in Roman society, as people refused to exchange coinage at the officially fixed tariffs but instead used the black market to exchange coinage on a market principle.

There was, obviously, flight from the land, massive evasion of taxes, people left their jobs, they left their homes, they left their social status. Now, Diocletian‘s final contribution to this continuing disaster was to issue his famous Edict on Maximum Prices, in 301 AD. This is a very famous instance of a massive effort by the government to limit inflation by price controls.

You have to realize that there was a little problem: the Roman Empire was a vast region running from Britain in the West to Iraq in the East; from the Rhine and the Danube to the Sahara.

It included areas of very sophisticated and very primitive economies, and thus the cost of living varied considerably from province to province: Egypt seems to have had the lowest cost of living; Palestine had a cost of living twice that of Egypt, and Roman Italy had a cost of living twice that of Palestine.

“The Roman people, the mass of the population, had but one wish after being captured by the barbarians: to never again fall under the rule of the Roman bureaucracy.”

Diocletian ignored that; he just issued a single standard price for the entire empire. The result was that in Egypt, the Edict probably had no effect, because the maximum price fixed in the Edict was very rarely reached in Egypt. It was the people in Rome, of course, who found the maximum price lower than the market price.

The result of that, of course, was riots in the street, and the disappearance of goods. The penalty for violating this law was death, a very common penalty in Rome for almost anything.

The mentality of Diocletian, and the cause of the maximum price edict, comes out in the preface to the law. I’ll just quote briefly some of it. When you hear these first words I’d like you to pay attention, because you may have a different interpretation of them than what Diocletian meant.

He says, “if the excesses perpetrated by persons of unlimited and frenzied avarice could be checked” — he doesn’t mean himself [laughter] — “if the general welfare could endure without harm this riotous license, if these uncontrolled madmen, the unscrupulous, the immoderate, the avaricious, could be persuaded to desist from plundering the wealth of all, then all would be well.” Now who are these people? They are the merchants; they are the avaricious greedy types who cause inflation as we all know.

Then he speaks about himself and his three partners. “[We, the protectors of the] human race” — sounds familiar, doesn’t it? [laughter] “We are agreed that decisive legislation is necessary, so that the long-hoped-for solutions, which mankind itself could not provide” — you know, it’s the same stuff [laughter]; we can’t do anything ourselves, we need the legislator.

“By the remedies provided by our foresight [laughter], these things may be remedied for the general betterment of all.”

In fact, as you read through the rest of the thing it becomes clear that the reason the Edict on Prices was issued was that the soldiers were the principal victims of the inflation. Diocletian was afraid he was losing control of his army. And so the people who are to be protected are the soldiers and the other servants of the state.

Now Diocletian’s monetary reforms were tentative steps in the right direction; except for the Edict on Prices, which, by the way, simply didn’t work and was gradually dropped. But his steps were not radical enough.

Because of his inability to create a sufficient supply of gold and silver coinage, combined with his continued reliance on payments in kind for taxes and salaries, and his continued issuance of fiat bronze coinage in endless amounts, he failed to make a significant dent in the problem.

Constantine’s reforms were also partial, but of sufficient vigor and radical character to make a difference. Through his willingness to extract by compulsion the gold reserves of the taxpayers, forcing them to disgorge their bullion, he placed an ever-increasing supply of gold in the hands of government officials.

This was increasingly used to pay military bonuses, salaries for bureaucrats, and even payments for certain public works. Increasingly, then, a two-tier monetary system emerged in which the government, the soldiers, and the bureaucrats enjoyed the benefits of a gold standard while the nongovernmental portion of the economy continued to struggle with a rapidly inflating fiat currency.

The new gold solidus — circulated widely by its possessors, the government-salaried employees — sold at various market rates to customers who desperately needed it to pay their taxes. Thus the state had found a way to protect itself and its servants from the unwholesome effects of its own earlier inflationary cycle, while slowly withdrawing from the cumbersome and wasteful system of accepting taxes and paying salaries in kind. Meanwhile, the masses suffered from a massive injection of fiat money, which they had to accept in payment for government requisitions of gold, silver, or other commodities.

Now, we may wish to find some lessons in this tale of the monetary policies of the late Roman Empire. The first lesson, I think, must be that if war is the health of the state, as Randolph Bourne said, it is poison to a stable and sound money. The Roman monetary crisis therefore was closely connected with the Roman military problem.

Another lesson is that problems become solvable when a ruler decides that something can be done and must be done. Diocletian and Constantine clearly were willing to act to protect their own ruling-class interests, the military and the civil service.

Monetary reforms were necessary to win the support of the troops and the bureaucrats, who composed the only real constituency of the Roman state, and the two-tier system was designed to this end. It brought about a stable monetary standard for the ruling group, who did not hesitate to secure it at the expense of the mass of the population.

The Roman state survived. The liberty of the Roman people did not. When freedom became possible in the West in the 5th century, with the barbarian invasions, people took advantage of the possibility of change. The peasantry had become totally alienated from the Roman state because they were no longer free. The business community likewise was no longer free. And the middle class of the cities was no longer free.

The economy of the West was perhaps more fatally weakened than that of the East. The early 5th century Christian priest Salvian of Marseille wrote an account of why the Roman state was collapsing in the West — he was writing from France (Gaul). Salvian says that the Roman state is collapsing because it deserves collapse; because it had denied the first premise of good government, which is justice to the people.

By justice he meant a just system of taxation. Salvian tells us, and I don’t think he’s exaggerating, that one of the reasons why the Roman state collapsed in the 5th century was that the Roman people, the mass of the population, had but one wish after being captured by the barbarians: to never again fall under the rule of the Roman bureaucracy.

In other words, the Roman state was the enemy; the barbarians were the liberators. And this undoubtedly was due to the inflation of the 3rd century. While the state had solved the monetary problem for its own constituents, it had failed to solve it for the masses. Rome continued to use an oppressive system of taxation in order to fill the coffers of the ruling bureaucrats and soldiers. Thank you. [applause]

This is a transcript of Professor Joseph Peden’s 50-minute lecture “Inflation and the Fall of the Roman Empire,” given at the Seminar on Money and Government in Houston, Texas, on October 27, 1984. The original audio recording is available as a free MP3 download. This transcript ran first at LewRockwell.com

War, Big Government and Lost Freedom. Dr. Richard B Ebeling

 

We are currently marking the hundredth anniversary of the fighting of the First World War. For four years between the summer of 1914 and November 11, 1918, the major world powers were in mortal combat with each other. The conflict radically changed the world. It overthrew the pre-1914 era of relatively limited government and free market economics, and ushered in a new epoch of big government, planned economies, and massive inflations, the full effects from which the world has still not recovered.

All the leading countries of Europe were drawn into the war. It began when the archduke of Austria- Hungary, Franz Ferdinand, and his wife, Sophia, were assassinated in Bosnia in June 1914. The Austro-Hungarian government claimed that the Bosnian-Serb assassin had the clandestine support of the Serbian government, which the government in Belgrade denied.

How a Terrible War Began and Played Out

Ultimatums and counter-ultimatums soon set in motion a series of European military alliances among the Great Powers. In late July and early August, the now-warring parties issued formal declarations of war. Imperial Germany, the Turkish Empire, and Bulgaria supported Austria-Hungary. Imperial Russia supported Serbia, which soon brought in France and Great Britain because these countries were aligned with the czarist government in St. Petersburg. Italy entered the war in 1915 on the side of the British and the French.

The United States joined the conflict in April 1917, a month after the abdication of the Russian czar and the establishment of a democratic government in Russia. But this first attempt at Russian democracy was overthrown in November 1917, when Vladimir Lenin led a communist coup d’état; Lenin’s revolutionary government then signed a separate peace with Imperial Germany and Austria-Hungary in March 1918, taking Russia out of the war.

The arrival of large numbers of American soldiers in France in the summer of 1918, however, turned the balance of forces against Germany on the Western Front. After having been driven out of the French territory they had occupied since the first year of the war, the Germans agreed to the armistice on November 11, 1918 that ended what was already called the Great War – the “War to End All Wars” as it was falsely believed.

mapa WWi 

The Human and Material Costs of War

The human and material cost of the First World War was immense. During the conflict more than 60 million men were called up to fight. At least 20 million soldiers and civilians lost their lives, with an equal number wounded.

The participating governments combined spent more than $145.9 billion in fighting each other. In 2015 dollars, this represents a monetary expenditure of more than $3.8 trillion. (As a point of comparison, what the belligerent powers spent, in total, fighting each other in the four years of World War I, the U.S government almost spent, alone, in fiscal year 2015 – $3.6 trillion!)

These numbers, of course, do not capture the human suffering from the four years of war. On the Western Front, which ran through northern France from the English Channel to the Swiss border, millions of soldiers lived endless months – years – in frontline trench warfare. They fought in the heat of the summer and the cold of winter, often with the decomposing bodies of their fallen comrades next to them for days on end.

They fought in battles such as the one for the French town of Verdun in which hundreds of thousands of men were killed during human wave attacks in attempts to capture enemy positions. Soldiers were mowed down by machine guns or crushed under the treads of that new machine of war, the tank.

The airplane entered modern warfare for the first time, raining down bombs on both military and civilian targets. And both sides introduced the use of poison mustard gas that blinded the eyes, blistered the lungs, and brought agonizing death.

War and the End of Limited Government Liberalism

The First World War also brought about the end of the (classical) liberal epoch in modern Western civilization. For most of the 100 years before 1914, the Western world had moved in the direction of greater individual freedom and wider economic liberty.

All-powerful kings were replaced with representative democratic government or constitutionally limited monarchy. Expanding civil liberty brought about a more impartial equality before the law and the end of human slavery.

The older eighteenth century mercantilist system of economic planning and control by government was ended. In its place, arose domestic free enterprise and widening global freedom of trade. The standard of living of tens of millions in the West began to dramatically rise above subsistence and starvation for the first time in human history, while at the same time population sizes grew exponentially.

War may not have been abolished in the nineteenth century, but new international “rules of war” meant that they were less frequent, of shorter duration, and when among the Great Powers, at least, often involved fewer deaths and greater respect for civilian life and property.

(The American Civil War in the 1860s was the one major exception with more than 650,000 deaths and massive destruction in the Southern states.)

Wars and armament races, many argued at the time, had become too costly and destructive among “civilized” nations. A universal epoch of international peace was hoped for when the new century dawned in 1900.

But in 1914, the First World War shattered the long liberal peace that had more or less prevailed in Europe since the last world war that ended with the defeat of Napoleon’s France in 1815. But even before 1914, there were emerging anti-liberal forces that were moving the world toward greater government control and a renewal of international conflict. (See my article, “Before Modern Collectivism: The Rise and Fall of Classical Liberalism.”) 

wwi

The Rise of Nationalism and Socialism

Early in the nineteenth century, the ideology of nationalism became a new rallying cry for peoples throughout Europe and increasingly around the world. If liberalism had espoused peaceful market exchange and the freedom of individuals under the rule of law, nationalism called for the forced unification under one government of all peoples speaking the same language or sharing the same culture or ethnicity. National collectivism was considered a higher ideal than respect for the liberty of the individuals comprising communities and nations.

In the middle of the nineteeth century, another form of collectivism started to gain popularity and support: socialism. Karl Marx and other socialists argued that capitalism was the root of all social evil, causing poverty and resulting in exploitation of the masses for the benefit of those who privately owned the means of production. Socialists called for the nationalization of the means of production, central planning of all economic activity, and the curtailing of individual freedom for the sake of the collective good.

War and the Planned Society

Imperialist designs by the Great Powers in conjunction with the new ideological forces of rising nationalism and socialism all came together in the caldron of conflict that enveloped so much of the world after 1914.

Immediately with the outbreak of hostilities, the liberal system of individual liberty, private property, free enterprise, free trade, limited government, low taxes, and sound money was thrown to the wind.

The epoch of political and economic collectivism had begun. Civil liberties were rapidly curtailed in all the belligerent nations, with laws restricting freedom of speech and the press. Opponents of war were silenced with long prison sentences for “anti-patriotic” behavior. Industry and agriculture were soon placed under increasingly strict price and wage controls.

Governments imposed wartime planning boards that directed the economic activities of all. They raised taxes to heights never experienced even under the most plundering hands of absolute monarchs of the past. Governments also ended international free trade, and introduced rigid regulations over all imports and exports.

The nineteenth century freedom of movement under which people in the West could travel from one nation to another without passport or visa was abolished; a new era of immigration and emigration barriers began. The individual was now completely under the control and command of the state.

With this came a new governmental responsibility: direct caring for the economic welfare of the citizenry. German free-market economist Gustav Stolper explained:

“Just as the [First World] War for the first time in history established the principle of universal military service, so for the first time in history it brought economic national life in all its branches and activities to the support and service of state politics – made it effectively subordinate to the state. . . . Not supply and demand, but the dictatorial fiat of the state determined economic relationships – production, consumption, wages, and cost of living   . . .

“At the same time, and for the first time, the state made itself responsible for the physical welfare of its citizens; it guaranteed food and clothing, not only to the army in the field but to the civilian population as well . . .

“Here is a fact pregnant with meaning: the state became for a time the absolute ruler of our economic life, and while subordinating the entire economic organization to its military purposes, also made itself responsible for the welfare of the humblest of its citizens, guaranteeing him a minimum of food, clothing, heating, and housing.”

Gold as Money in the Prewar Liberal World

Along with these losses of personal civil and economic freedom came yet another abridgement of the liberal system of government: the abolition of the gold standard. During the 25 years of war between France and Great Britain following the French Revolution of 1789, both governments had resorted to the money printing press to finance their war expenditures. As a result, inflation had eaten away at the wealth and security of the British and French citizenry.

When those wars ended in 1815, the lesson learned was that governments could not be trusted with direct control over the creation of money. The liberal monetary goal was the reestablishment of the gold standard, so the amount of money in society was independent of political manipulation.

Better to rely upon the market forces of supply and demand and the profitability of gold mining, the classical liberals argued, than the caprice of politicians and special interest groups desiring to print the paper money they wanted to use to plunder the peaceful production of the mass of humanity.

Through the decades of the nineteenth century, first Great Britain and then the rest of the Western nations legally established the gold standard as the basis of their monetary systems. The gold standard was mostly managed by national central banks, and thus not truly free market monetary systems.

But central banks were expected to, and for the most part did, abide by the monetary “rules of the game” of limiting increases (or decreases) in the domestic currency to additions to (or reductions in) the nation’s supply of gold. Sound money for the nineteenth century liberals was gold money.

Paper Money and Inflation Finances the War

But with the firing of the first shots in the summer of 1914, the belligerent governments all ended legal redemption of their currencies for fixed amounts of gold. The citizens in these warring counties were pressured or compelled to hand over to their respective governments the gold in their private hands, in exchange for paper money.

Almost immediately, the monetary printing presses were set to work creating the vast financial means needed to fight an increasingly expensive war.

In 1913, the British money supply amounted to 28.7 billion pounds sterling. But soon, as British economist, Edwin Cannan, expressed it, the country was suffering from a “diarrhea of pounds.” When the war ended in 1918, Great Britain’s money supply had almost doubled to 54.8 billion pounds, and continued to increase for three more years of peacetime until it reached 127.3 billion pounds in 1921, a fivefold increase from its level eight years earlier.

The French money supply had been 5.7 billion francs in 1913. By war’s end in 1918, it had increased to 27.5 billion francs. In this case, a fivefold increase in a mere five years. By 1920, the French money supply stood at 38.2 billion francs. The Italian money supply had been 1.6 billion lire in 1913 and increased to 7.7 billion lire, for a more than fourfold increase, and stood at 14.2 billion lire in 1921.

In addition, these countries took on huge amounts of debt to finance their war efforts. Great Britain had a national debt of 717 million pounds in 1913. At the end of the war that debt had increased to 5.9 billion pounds, and rose to 7.8 billion pounds by 1920.

French national debt increased from 32.9 billion francs before the war to 124 billion francs in 1918 and 240 billion francs in 1920. Italy was no better, with a national debt of 15.1 billion lire in 1913 that rose to 60.2 billion lire in 1918 and climbed to 92.8 billion in 1921.

Though the United States had only participated in the last year and a half of the war, it too created a large increase in its money supply to fund government expenditures that rose from $1.3 billion in 1916 to $15.6 billion in 1918. The U.S. money supply grew 70 percent during this period from $20.7 billion in 1916 to 35.1 billion in 1918.

Twenty-two percent of America’s war costs were covered by taxation, about 25 percent from printing money, and the remainder of 53 percent by borrowing.

hyperinflation

The German Ideology of Power for War

The most severe inflations during World War I occurred in Central and Eastern Europe. Among the worst of these were the one in Germany during and then after the war, with the near total collapse of the German currency in 1922 and 1923.

For decades before the start of the war, German nationalist and imperialist ambitions were directed to military and territorial expansion. A large number of German social scientists known as members of the Historical School had been preaching the heroism of war and the superiority of the German people who deserved to rule over other nationalities in Europe.

Hans Kohn, one of the twentieth century’s leading scholars on the history and meaning of nationalism, explained the thinking of leading figures of the Historical School, who were also known as “the socialists of the chair” in reference to their prominent positions at leading German universities. He wrote:

“The ‘socialists of the chair’ desired a benevolent paternal socialism to strengthen Germany’s national unity. Their leaders, Adolf Wagner and Gustav von Schmoller, [who were Heinrich von] Treitschke’s colleagues at the University of Berlin and equally influential in molding public opinion, shared Treitschke’s faith in the German power state and its foundations. They regarded the struggle against English and French political and economic liberalism as the German mission, and wished to substitute the superior and more ethical German way for the individualistic economics of the West . . . In view of the apparent decay of the Western world through liberalism and individualism, only the German mind with its deeper insight and its higher morality could regenerate the world.”

These German advocates of war and conquest also believed that Germany’s monetary system had to be subservient to the wider national interests of the state and its imperial ambitions. Austrian economist Ludwig von Mises met frequently with members of the Historical School at German academic gatherings in the years before World War I. He recalled:

“The monetary system, they said, is not an end in itself. Its purpose is to serve the state and the people. Financial preparations for war must continue to be the ultimate and highest goal of monetary policy, as of all policy. How could the state conduct war, after all, if every self- interested citizen retained the right to demand redemption of banknotes in gold? It would be blindness not to recognize that only full preparedness for war [could further the higher ends of the state].”

Germany’s Great Inflation began with the government’s turning to the printing press to finance its war expenditures. Almost immediately after the start of World War I, on July 29, 1914, the German government suspended all gold redemption for the mark. Less than a week later, on August 4, the German Parliament passed a series of laws establishing the government’s ability to issue a variety of war bonds that the Reichsbank – the German central bank – would be obliged to finance by printing new money.

The government created a new set of Loan Banks to fund private sector borrowing, as well as state and municipal government borrowing, with the money for the loans simply being created by the Reichsbank.

During the four years of war, from 1914 to 1918, the total quantity of paper money created for government and private spending went from 2.37 billion to 33.11 billion marks. By an index of wholesale prices (with 1913 equal to 100), prices had increased more than 245 percent (prices failed to increase far more because of wartime price and wage controls). In 1914, 4.21 marks traded for $1 on the foreign exchange market. By the end of 1918, the mark had fallen to 8.28 to the dollar.

Germany’s Hyperinflation and the Destruction of the Mark

But the worst was to come in the five years following the end of the war. Between 1919 and the end of 1922, the supply of paper money in Germany increased from 50.15 billion to 1,310.69 billion marks. Then in 1923 alone, the money supply increased to a total of 518,538,326,350 billion marks.

By the end of 1922, the wholesale price index had increased to 10,100 (still using 1913 as a base of 100). When the inflation ended in November 1923, this index had increased to 750,000,000,000,000. The foreign exchange rate of the mark decreased to 191.93 to the dollar at the end of 1919, to 7,589.27 to the dollar in 1922, and then finally on November 15, 1923, to 4,200,000,000,000 marks for the dollar.

During the last months of the Great Inflation, according to Gustav Stolper, “more than 30 paper mills worked at top speed and capacity to deliver notepaper to the Reichsbank, and 150 printing firms had 2,000 presses running day and night to print the Reichsbank notes.” In the last year of the hyperinflation, the government was printing money so fast and in such frequently larger and larger denominations that to save time, money, and ink, the bank notes were being produced with printing on only one side.

Finally, facing a total economic collapse and mounting social disorder, the German government in Berlin appointed the prominent German banker, Halmar Schacht, as head of the Reichsbank. He publicly declared in November 1923 that the inflation would be brought to an end and a new non-inflationary currency backed by gold would be issued. The printing presses were brought to a halt, and the hyperinflation was stopped just as the country stood at the monetary and social precipice of total disaster.

The Legacies of Tyranny, Paternalism and Lost Freedom

But the deaths, destruction, and disruptions of the First World War and its immediate aftermath were never fully recovered from. In 1922, Mussolini and his Fascist Party came to power in Italy. In 1933, Hitler’s Nazi movement took power in Germany in the midst of the Great Depression.

In the United States, also in 1933, Franklin D. Roosevelt’s New Deal ushered in the arrival of America’s version, at first, of a fascist-type planned economy, with a growing concentration of political control and economic paternalism in the form of the modern interventionist-welfare state in the postwar period that followed a worse and far more destructive and mass murdering Second World War. (See my article, “When the Supreme Court Stopped Economic Fascism in America.”)

Out of this second “war to end all wars,” came America’s role as global policeman and international social engineer during the Cold War with the Soviet Union. But even the post-Cold War era after the end of the Soviet Union in 1991 has seen part of the legacy of World War I in international affairs.

The wars and “ethnic cleansings” experienced in the former Yugoslavia in the 1990s, and at least part of the causes behind the current conflicts in the Middle East are outgrowths of the post-World War I peace settlements imposed by the victorious Allied powers.

But most importantly, I would suggest, is the lasting legacy out of the First World War that has been the rationales and implementations of paternalist Big Government in the Western world, with its diminished recognition and respect for individual liberty, free association, freedom of competitive trade and exchange, reduced civil liberties and weakened impartial rule of law.

From this has followed the regulating and redistributing State, which includes political control and manipulation of the monetary and banking systems to serve those in governmental power and others who feed at the trough of governmental largess.

It is a legacy that will likely take another century to completely overcome and reverse, if we are able to devise a strategy for restoring the idea and ideal of a society of liberty.

Lenin and Marx: Sound Money Advocates? by Louis Rouanet (Mises Institute)

Most modern socialists are in favor of inflation, because it is supposed, in Keynes’s words, to “euthanize the rentiers.” It doesn’t mean however, that the “founding fathers” of socialism were in favor of inflation. In fact, the opposite is true. Karl Marx had a wide knowledge of the economic literature and even though he’s usually wrong, he was correct in his preference for a gold standard.

As for Lenin, he was in his writings opposed to inflation and saw paper money as a means used by the bourgeois capitalists to enrich themselves. Even though Marx and Lenin were not supporters of inflation, they supported sound money for the wrong reasons. But, at least, we can say that concerning money they did not succumb to naïve inflationist views.

Karl Marx, Inflation, and the Gold Standard

Marx applied the labor value theory to money. According to Marx, the use of a particular commodity like gold or silver for money rests on the fact that — like all other commodities — there is an amount of “socially necessary labor” required to produce it. If, for example, one ounce of gold requires ten hours’ labor, its value is equal to another product requiring ten hours’ labor. Marx’s labor theory led him to say that “Although gold and silver are not by nature money, money is by nature gold and silver …”

What Marx put forward was that the total value of needed currency represented a total amount of labor value, and therefore a total weight of gold. According to Marx, if the total of gold is replaced by inconvertible paper money and the paper money is then issued in excess, prices will go up:

If the paper money is in excess, if there is more of it than represents the amount of gold coins of like denomination which could actually be current, it will (apart from the danger of falling into general disrepute) represent only that quantity of gold, which, in accordance with the laws of circulation of commodities, is really required and is alone capable of being represented by paper. If the quantity of paper money issued is, for instance, double what it ought to be, then in actual fact one pound has become the money name of about one-eighth of an ounce of gold instead of about one-quarter of an ounce. The effect is the same as if an alteration had taken place in the function of gold as a standard of prices. The values previously expressed by the price £1 will now be expressed by the price £2.

Therefore, Marx opposed the use of inflation as a means for increasing production. However, Marx’s monetary theory is very confusing. Concerning money, Karl Marx owes nothing to Ricardo. He was influenced by Tooke and the Banking school while he was very critical of the Currency school. Furthermore, Marx was fiercely opposed to Peel’s Act of 1844 which forbade notes unbacked by metallic money. Oddly enough however, Marx was criticizing fiduciary credit as being “fictitious capital” which seems to be in contradiction with his opposition to Peel’s Act.

We must keep in mind, however, that the main difference between Marx and other economists is that Marx was simply trying to describe how capitalism operates, with or without inflation. He was not saying that inflation will improve or destroy capitalism. In Marx’s view, capitalism is inevitably unstable and doomed. For him, workers must abolish capitalism and replace it with socialism, in which there are no problems of prices, inflation, crises, and unemployment.

Lenin, the Bolsheviks, and Inflation

The following quote is often attributed to Lenin: “The best way to destroy the Capitalist System is to debauch the currency.” This supposed statement has circulated widely among economists and the public. Hellwig remarked that: “It is almost a ritual, on the occasion of the required tributes to a stable monetary standard, to quote Lenin as a bogeyman.”[1] The problem is that this quote has never been found in Lenin’s works. The first attribution of this statement was made by J.M. Keynes in his book The Economic Consequences of the Peace (1919). No one at the time challenged what Keynes was attributing to Lenin, and even today, this quote is still used by some sound-money advocates. However, Lenin’s few remarks on monetary matters give the opposite impression from the remark attributed to him by Keynes. In September 1917, before the Bolsheviks overthrew the government in power, Lenin wrote an article on “The Threatening Catastrophe” where he speaks about money and banking. Of inflation he said:

Everybody recognizes that the issue of paper money is the worst kind of a compulsory loan, that it worsens the conditions principally of the workers, of the poorest section of the population, that it is the chief evil in the financial confusion. … The unlimited issue of paper money encourages speculation, allows the capitalists to make millions, and places tremendous obstacles in the path of the much-needed expansion of production; for the dearth of materials, machines, etc., grows and progresses by leaps and bounds. How can matters be improved when the riches acquired by the rich are being concealed?

This paragraph could have been written by an Austrian economist, and it is known that the Marxist tradition is sometimes close to the Austrian analysis concerning business cycles (see Huerta de Soto’s Money, Bank Credit and Economic Cycles). Like Lenin, we believe that inflation can foster income inequality, hamper economic growth, impoverish the poor, and cause asset inflation.

However, once they were in power, the Bolsheviks were responsible for hyperinflation. In Socialism, Ludwig von Mises wrote:

The Bolshevists, with their inimitable gift for rationalizing their resentments and interpreting defeats as victories, have represented their financial policy as an effort to abolish Capitalism by destroying the institution of money.

Mises is right, but he forgot to say that political opportunism and not ideology was the reason why communists used inflation. Basically, for the communists, inflation is wrong when communists are not running things, but it is all right when they are in control. Professor E.H. Carr wrote:

None of the Bolsheviks wanted, or planned, inflation. But, when that happened (since the printing press was their main source of revenue) they rationalized it ex post facto by describing it as (a) death to the capitalists and (b) a foretaste of the moneyless Communist Society. Talk of this kind was widely current in Moscow in 1919 and 1920. … Keynes in 1919 had no special knowledge of Lenin; everything that came out of Moscow was automatically attributed to Lenin or Trotsky, or both.

Hayek wrote once that as long as it remains theoretical, socialism is internationalist, but when it is put into practice, it becomes violently nationalist. We should also say: as long as it remains theoretical, Marxism is anti-inflationist, but when it is put into practice, it becomes violently inflationist.