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"Deficit Financing" and Inflation

Mises Daily: Friday, May 21, 2010 by and

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[Excerpted from Ludwig von Mises on Money and Inflation: A Synthesis of Several Lectures, compiled by Bettina Bien Greaves. This lecture was given at the Foundation for Economic Education (FEE).]

I assume that you know how the banking system developed and how the banks could improve the services rendered by gold, by transferring assets from one individual to another individual in the books of the banks. When you study the development of the history of money you will discover that there were countries in which there were systems in which all the payments were made by transactions in the books of a bank, or of several banks. The individuals acquired an account by paying gold into this bank. There is a limited quantity of gold, so the payments which are made are limited. And it was possible to transfer gold from the account of one man to the account of another.

But then the governments began something which I can only describe in general words. The governments began to issue paper, which they wanted to serve the role, perform the service, of money. When people bought something they expected to receive from their bank a certain quantity of gold to pay for it. But the government asked, What's the difference whether the people really get gold or whether they get a title from the bank that gives them the right to ask for gold? It will be all the same to them.

So the government issued paper notes, or gave the bank the privilege to issue paper notes, which gave the receiver the right to ask for gold. This led to an increase in the number of paper banknotes that gave to the bearer the right to ask for gold.

Not too long ago, our government proclaimed a new method for making everybody prosperous: a method called "deficit financing." Now that is a wonderful word. You know, technical terms have the bad habit of not being understood by people.

The government and the journalists who were writing for the government told us about this "deficit spending." It was wonderful! It was considered something that would improve conditions in the whole country. But if you translate this into more common language, the language of the uneducated, then you would say "printed money." The government says this is only due to your lack of education; if you had an education you wouldn't say "printed money;" you would call it "deficit financing" or "deficit spending."

Now what does this mean? Deficits! This means that the government spends more than it collects in taxes and in borrowing from the people; it means government spending for all those purposes for which the government wants to spend. This means inflation, pushing more money into the market; it doesn't matter for what purpose. And that means reducing the purchasing power of each monetary unit. Instead of collecting the money that the government wanted to spend, the government fabricated the money. Printing money is the easiest thing. Every government is clever enough to do it.

"'Deficit financing.' Now that is a wonderful word. You know, technical terms have the bad habit of not being understood by people."

If the government wants to pay out more money than before, if it wants to buy more commodities for some purpose or to raise the salaries of government employees, no other way is open to it under normal conditions than to collect more taxes and use this increased income to pay, for instance, for the higher wages of its employees. The fact that people have to pay higher taxes so that the government may pay higher wages to its employees means that individual taxpayers are forced to restrict their expenditures.

This restriction of purchases on the part of the taxpayers counteracts the expansion of purchases by those receiving the money collected by the government. Thus, this simple contraction of spending on the part of some, the taxpayers from whom money is taken to give to others, does not bring about a general change in prices.

The thing is that the individual cannot do anything that makes the inflationary machine and mechanism work. This is done by the government. The government makes the inflation. And if the government complains about the fact that prices are going up and appoints committees of learned men to fight against the inflation, we have only to say, "Nobody other than you, the government, brings about inflation, you know."

On the other hand, if the government does not raise taxes, does not increase its normal revenues, but prints an additional quantity of money and distributes it to government employees, additional buyers appear on the market. The number of buyers is increased as a result, while the quantity of goods offered for sale remains the same. Prices necessarily go up, because there are more people with more money asking for commodities which had not increased in supply.

The government does not speak of the increase in the quantity of money as "inflation;" it calls the fact that commodity prices are going up "inflation." The government then asks who is responsible for this "inflation," that is, for the higher prices? The answer — "bad" people; they may not know why prices are going up but nevertheless they are sinning by asking for higher prices.

The best proof that inflation, the increase in the quantity of money, is very bad is the fact that those who are making the inflation are denying again and again, with the greatest fervor, that they are responsible. "Inflation?" they ask. "Oh! This is what you are doing because you are asking higher prices. We don't know why prices are going up. There are bad people who are making the prices go up. But not the government!"

And the government says: "Higher prices? Look, these people, this corporation, this bad man, the president of this corporation…" Even if the government blames the unions — I don't want to talk about the unions — but even then we have to realize what the unions cannot do is to increase the quantity of money. And, therefore, all the activities of the unions are within the framework that is built by the government in influencing the quantity of money.

"The worst failures of money, the worst things done to money, were not done by criminals but by governments."

The situation, the political situation, the discussion of the problem of inflation, would be very different if the people who are making the inflation, the government, were openly saying, "Yes, we do it. We are making the inflation. Unfortunately we have to spend more than people are prepared to pay in taxes." But they don't say this. They do not even say openly to everybody, "We have increased the quantity of money. We are increasing the quantity of money because we are spending more, more than you are paying us." And this leads us to a problem which is purely political:

Those into whose pockets the additional money goes first profit from the situation, whereas others are compelled to restrict their expenditures. The government does not acknowledge this; it does not say, "We have increased the quantity of money and, therefore, prices are going up." The government starts by saying, "Prices are going up. Why? Because people are bad. It is the duty of the government to prevent bad people from bringing about this upward movement of prices, this inflation. Who can do this? The government!"

Then the government says, "We will prevent profiteering, and all these things. These people, the profiteers, are the ones who are making inflation; they are asking higher prices." And the government elaborates "guidelines" for those who do not wish to be in the wrong with the government. Then, it adds that this is due to "inflationary pressures." They have invented many other terms also which I cannot remember, such silly terms, to describe this situation — "cost-push inflation," "inflationary pressures," and the like. Nobody knows what an "inflationary pressure" is; it has never been defined.[1] What is clear is what inflation is.

Inflation is a considerable addition to the quantity of money in circulation.… And this system can work for some time, but only if there is some power that restricts the government's wish to expand the quantity of money and is powerful enough to succeed to some extent in this regard. The evils which the government, its helpers, its committees, and so on, acknowledge are connected with this inflation, but not in the way in which they are discussed.

This shows that the intention of the governments … is to conceal the real cause of what is happening. If we want to have a money that is acceptable on the market as the medium of exchange, it must be something that cannot be increased with a profit by anybody, whether government or a citizen. The worst failures of money, the worst things done to money, were not done by criminals but by governments, which very often ought to be considered, by and large, as ignoramuses but not as criminals.

Notes

[1] Talk of "inflationary pressures" and "guidelines" dates from the 1960s. At that time, business firms were raising prices and wage rates because the government had expanded the nation's quantity of money so much, and government officials were trying to persuade private business firms to keep price and wage increases below 3.2%. This was the maximum considered permissible "under the President's voluntary guidelines [or "guideposts"] for non-inflationary wage and price hikes." And President Johnson threatened a tax increase if "inflationary pressures" did not cease. See World Almanac, 1967, pp. 60, 61. — BBG