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Fiat Legacy
The Cultural and Spiritual Legacy of Fiat Inflation
By J. G. Hulsmann, senior fellow of the Mises Institute.
"... an immense power and despotic economic dictatorship is consolidated in the
hands of a few, who often are not owners but only the trustees and managing
directors of invested funds which they administer according to their own
arbitrary will and pleasure." -- Pope Pius XI (1931)
July 30, 2004
The notion that inflation is harmful is a staple of economic science. But most
textbooks underrate the extent of the harm, because they define inflation much
too narrowly as a lasting decrease of the purchasing power of money (PPM), and
also because they pay scant attention to the concrete forms of inflation. To
appreciate the disruptive nature of inflation in its full extent we must keep in
mind that it springs from a violation of the fundamental rules of society.
Inflation is what happens when people increase the money supply by fraud,
imposition, and breach of contract. Invariably it produces three characteristic
consequences: (1) it benefits the perpetrators at the expense of all other money
users; (2) it allows the accumulation of debt beyond the level debts could reach
on the free market; and (3) it reduces the PPM below the level it would have
reached on the free market.
While these three consequences are bad enough, things get much worse once
inflation is encouraged and promoted by the state (fiat inflation). The
government’s fiat makes inflation perennial, and as a result we observe the
formation of inflation-specific institutions and habits. Thus fiat inflation
leaves a characteristic cultural and spiritual stain on human society. In what
follows, we will take a closer look at some aspects of this legacy.
I. Hyper-Centralized Government
Inflation benefits the government that controls it, not only at the expense of
the population at large, but also at the expense of all secondary and tertiary
governments. It is a well-known fact that the European kings, during the rise of
their nation states in the 17th and 18th centuries, crushed the major vestiges
of intermediate power. The democratic nation states of the 19th and 20th
centuries completed the centralization of power that had been begun under the
kings. The economic driving force of this process was inflation, which at that
point was entirely in the hands of the central state apparatus. More than any
other economic reason, it made the nation state irresistible. And thus it
contributed, indirectly at least, to the popularity of nationalistic ideologies,
which in the 20th century ushered into a frenetic worshipping of the nation
state.
Inflation spurs the growth of central governments. It allows these governments
to grow larger than they could become in a free society. And it allows them to
monopolize governmental functions to an extent that would not occur under a
natural production of money. This comes at the expense of all forms of
intermediate government, and of course at the expense of civil society at large.
The inflation-sponsored centralization of power turns the average citizen more
and more into an isolated social atom. All of his social bonds are controlled by
the central state, which also provides most of the services that formerly were
provided by other social entities such as family and local government. At the
same time, the central direction of the state apparatus is removed from the
daily life of its protégés.
II. Fiat Inflation and War
Among the most gruesome consequences of fiat money, and of paper money in
particular, is its ability to extend the length of wars. The destructions of war
have the healthy effect of cooling down initial war frenzies. The more
protracted and destructive a war becomes, therefore, the less is the population
inclined to support it financially through taxes and the purchase of public
bonds. Fiat inflation allows the government to ignore the fiscal resistance of
its citizens and to maintain the war effort on its present level, or even to
increase that level. The government just prints the notes it needs to buy
cannons and boots.
This is exactly what happened in the two world wars of the 20th century, at
least in the case of the European states. The governments of France, Germany,
Italy, Russia, and the United Kingdom covered a large part of their expenses
through inflation. It is of course difficult to evaluate any precise
quantitative impact, but it is not unreasonable to assume that fiat inflation
prolonged both wars by many months or even one or two years. If we consider that
the killings have reached their climax toward the end of the war, we must assume
that many millions of lives could have been saved.
Many people believe that, in war, all means are just. In their eyes, fiat
inflation is legitimate as a means to fend off lethal threats from a nation. But
this argument is rather defective. It is not the case that all means are just in
a war. There is in Catholic theology a theory of just war, which stresses
exactly this point. Fiat inflation would certainly be illegitimate if less
offensive means were available to attain the same end. And fact is that such
means exist and have always been at the disposition of governments, for example,
credit money and additional taxation.
Another typical line of defense of fiat money in wartime is that the government
might know better than the citizens just how close victory is at hand. The
ignorant population grows weary of the war and tends to resist additional
taxation. But the government is perfectly acquainted with the situation. Without
fiat money, its hands would be tied up, with potentially disastrous
consequences. The inflation just gives it the little extra something needed to
win.
It is of course conceivable that the government is better informed than its
citizens. But it is difficult to see why this should be an obstacle in war
finance. The most essential task of political leadership is to rally the masses
behind its cause. Why should it be impossible for a government to spread its
better information, thus convincing the populace of the need for additional
taxes? This brings us to the following consideration.
III. Inflation and Tyranny
War is just the most extreme case in which fiat inflation allows governments to
pursue their goals without genuine support from their citizens. The printing
press allows the government to tap the property of its people without having
obtained their consent, and in fact against their consent. What kind of
government is it that arbitrarily takes the property of its citizens? Aristotle
and many other political philosophers have called it tyranny. And monetary
theorists from Oresme to Mises have pointed out that fiat inflation, considered
as a tool of government finance, is the characteristic financial technique of
tyranny.
IV. Race to the Bottom in Monetary Organization
As Austrian economists have argued in some detail, fiat inflation is an
inherently unstable way of producing money because it turns moral hazard and
irresponsibility into an institution. The result is frequently recurring
economic crises. Past efforts to repair these unwelcome effects, yet without
questioning the principle of fiat inflation per se, have entailed a peculiar
evolution of monetary institutions—some sort of an institutional "race to the
bottom."
Important milestones of this process were fractional-reserve banking, national
central banking, international central banking, and finally paper money. The
devolution of monetary institutions has been on its way for centuries, and it
has still not quite reached the absolute bottom, even though the process has
accelerated very considerably in our age of paper money.
V. Business Under Fiat Inflation
Fiat inflation has a profound impact on corporate finance. It makes liabilities
(credits) cheaper than they would be on a free market. This prompts
entrepreneurs to finance their ventures to a greater extent than otherwise
through credits, rather than through equity (the capital brought into the firm
by its owners).
In a natural system of money production, banks would grant credit only as
financial intermediaries. That is, they could lend out only those sums of money
that they had either saved themselves or which other people had saved and then
lent to the banks. The bankers would of course be free to grant credits under
any terms (interest, securities, duration) they like; but it would be suicidal
for them to offer better terms than those that their own creditors had granted
them. For example, if a bank receives a credit at 5 percent, it would be
suicidal for it to lend this money at 4 percent. It follows that on a free
market, profitable banking is constrained within fairly narrow limits, which in
turn is determined by the savers. It is not possible for a bank to stay in
business and to offer better terms than the savers who are most ready to part
with their money for some time.
But fractional-reserve banks can do precisely that. Since they can produce
additional banknotes at virtually zero cost, they can grant credit at rates that
are lower than the rates that would otherwise have prevailed. And the
beneficiaries will therefore finance some ventures through debts that they would
otherwise have financed with their own money, or which they would not have
started at all. Paper money has very much the same effect, but in a far greater
dimension. A paper-money producer can grant credits to virtually any extent and
at virtually any terms. In the past few years, the Bank of Japan has offered
credits at 0 percent interest, and it right now proceeds in some cases to
actually pay people for taking its credits.
It is obvious that few firms can afford to resist such offers. Competition is
fierce in most industries, and the firms must seek to use the best terms
available, lest they lose that "competitive edge" that can be decisive for
profits and also for mere survival. It follows that fiat inflation makes
business more dependent on banks than they otherwise would be. It creates
greater hierarchy and central decision-making power than would exist on the free
market. The entrepreneur who operates with 10 percent equity and 90 percent
debts is not really an entrepreneur anymore. His creditors (usually bankers) are
the true entrepreneurs who make all essential decisions. He is just a more or
less well-paid executive—a manager.
Thus fiat inflation reduces the number of true entrepreneurs—independent men who
operate with their own money. Such men still exist in astonishing numbers, but
they can only survive because their superior talents match the inferior
financial terms with which they have to cope. They must be more innovative
and/or work harder than their competitors. They know the price of independence
and they are ready to pay it. Usually they are more attached to the family
business and care more for their employees than the puppets of bankers.
Because credits springing from fiat inflation provide an easy financial edge,
they have the tendency to encourage reckless behavior by the chief executives.
This is especially the case with managers of large corporations who have easy
access to the capital markets. Their recklessness is often confused with
innovativeness.
The economist Josef Schumpeter has famously characterized fractional-reserve
banking as some sort of a mainspring of innovative economic development, because
it provides additional money for entrepreneurs with great ideas.
It is conceivable that in some cases it played this role, but the odds are
overwhelmingly on the other side. As a general rule, any new product and any
thoroughgoing innovation in business organization is a threat for banks, because
they are already more or less heavily invested in established companies, which
produce the old products and use the old forms of organization. They have
therefore every incentive to either prevent the innovation by declining to
finance it, or to communicate the new ideas to their partners in the business
world.
Thus, factional-reserve banking makes business more conservative than it
otherwise would be. It benefits the established firms at the expense of
innovative newcomers. Innovation is much more likely to come from independent
businessmen, especially if income taxation is low.
VI. The Debt Yoke
Some of the foregoing considerations also apply outside of the business world.
Fiat inflation provides easy credits not only to governments and firms, but also
to private persons. The mere fact that such credits are offered at all incites
some people to go into debt who would otherwise have chosen not to do so. But
easy credits become nearly irresistible in connection with another typical
consequence of inflation, namely, the constantly rising price level. Whereas in
former times the increase of prices has been barely noticeable, in our day all
citizens of the western world are aware of the phenomenon. In countries such as
Turkey or Brazil, where prices increase at annual rates of 80 to 100 percent,
even younger people have personally experienced it.
Such conditions impose a heavy penalty on cash savings. In the old days, saving
was typically done in the form of hoarding gold and silver coins. It is true
that such hoards did not provide any revenue—the metal was "barren"—and that
they therefore did not lend themselves to the lifestyle of rentiers. But in all
other respects money hoards were a reliable and effective form of saving. Their
purchasing power did not just evaporate in a few decades, and in times of
economic growth they even gained some purchasing power.
Most importantly, they were extremely suitable for ordinary people. Carpenters,
masons, tailors, and farmers are usually not very astute observers of the
international capital markets. Putting some gold coins under their pillow or
into a safe deposit box saved them lots of sleepless nights, and it made them
independent of financial intermediaries.
Now compare this old-time scenario with our present situation. The contrast
could not be starker. It would be completely pointless in our day to hoard
dollar or euro notes to prepare for retirement. A man in his thirties who plans
to retire thirty years from today (2004) must calculate with a depreciation
factor in the order of 3. That is, he needs to save three dollars today to have
the purchasing power of one of these present-day dollars when he retires. And
the estimated depreciation factor of 3 is rather on the low side!
It follows that the rational saving strategy for him is to go into debt in order
to buy assets the price of which will increase with the inflation. This is
exactly what happens today in most western countries. As soon as young people
have a job and thus a halfway stable source of revenue, they take a credit to
buy a house—whereas their great-grandfather might still have first accumulated
savings for some thirty years and then bought his house in cash. Needless to say
that the latter has always been the Christian way. In Saint Paul’s letter to the
Romans (13:8) we read: "Owe nothing to anyone, except to love one another; for
the one who loves another has fulfilled the law."
Things are not much better for those who have already accumulated some wealth.
It is true that inflation does not force them into debt, but in any case it
deprives them of the possibility of holding their savings in cash. Old people
with a pension fund, widows, and the wardens of orphans must invest their money
into the financial markets, lest its purchasing power evaporate under their
noses. Thus they become dependent on intermediaries and on the vagaries of stock
and bond pricing.
It is clear that this state of affairs is very beneficial for those who derive
their living from the financial markets. Stockbrokers, bond dealers, banks,
mortgage corporations, and other "players" have reason to be thankful for the
constant decline of money’s purchasing power under fiat inflation. But is this
state of affairs also beneficial for the average citizen? In a certain sense,
his debts and increased investment in the financial markets are beneficial for
him, given our present inflationary regime.
When the increase of the price level is perennial, private debt is for him the
best available strategy. But this means of course that without government
interventionism into the monetary system other strategies would be superior. The
presence of central banks and paper money make debt-based financial strategies
more attractive than strategies based on prior savings.
It is not an exaggeration to say that, through their monetary policy, Western
governments have pushed their citizens into a state of financial dependency
unknown to any previous generation. Already in 1931, Pius XI stated:
[. . .] it is obvious that not only is wealth concentrated in our times but an
immense power and despotic economic dictatorship is consolidated in the hands of
a few, who often are not owners but only the trustees and managing directors of
invested funds which they administer according to their own arbitrary will and
pleasure.
This dictatorship is being most forcibly exercised by those who, since they hold
the money and completely control it, control credit also and rule the lending of
money. Hence they regulate the flow, so to speak, of the life-blood whereby the
entire economic system lives, and have so firmly in their grasp the soul, as it
were, of economic life that no one can breathe against their will.[1]
One wonders what vocabulary Pius XI would have used to describe our present
situation. The usual justification for this state of affairs is that it
allegedly stimulates industrial development. The money hoards of former times
were not only sterile; they were actually harmful from an economic point of
view, because they deprived business of the means of payments they needed for
investments. The role of inflation is to provide these means.
However, money hoarding does not have any negative macroeconomic implications.
It does definitely not stifle industrial investments. Hoarding increases the
purchasing power of money and thus gives greater "weight" to the money units
that remain in circulation. All goods and services can be bought, and all
feasible investments can be made with these remaining units. The fundamental
fact is that inflation does not bring into existence any additional resource. It
merely changes the allocation of the existing resources. They no longer go to
companies that are run by entrepreneurs who operate with their own money, but to
business executives who run companies financed with bank credits.
The net effect of the recent surge in household debt is therefore to throw
entire populations into financial dependency. The moral implications are clear.
Towering debts are incompatible with financial self-reliance and thus they tend
to weaken self-reliance also in all other spheres. The debt-ridden individual
eventually adopts the habit of turning to others for help, rather than maturing
into an economic and moral anchor of his family, and of his wider community.
Wishful thinking and submissiveness replace soberness and independent judgement.
And what about the many cases in which families can no longer shoulder the debt
load? Then the result is either despair or, on the contrary, scorn for all
standards of financial sanity.
VII. Some Spiritual Casualties of Fiat Inflation
Fiat inflation constantly reduces the purchasing power of money. To some extent,
it is possible for people to protect their savings against this trend, but this
requires thorough financial knowledge, the time to constantly supervise one’s
investments, and a good dose of luck. People who lack one of these ingredients
are likely to lose a substantial part of their assets. The savings of a lifetime
often vanish in thin air during the last few years spent in retirement. The
consequence is despair and the eradication of moral and social standards. But it
would be wrong to infer that inflation produces this effect mainly among the
elderly. As one writer observed:
These effects are "especially strong among the youth. They learn to live in the
present and scorn those who try to teach them ‘old-fashioned morality and
thrift.’ Inflation thereby encourages a mentality of immediate gratification
that is plainly at variance with the discipline and eternal perspective required
to exercise principles of biblical stewardship—such as long-term investment for
the benefit of future generations."[2]
Even those citizens who are blessed with knowledge, time, and luck to protect
the substance of their savings cannot evade inflation’s harmful impact, because
they have to adopt habits that are at odds with moral and spiritual health.
Inflation forces them to spend much more time thinking about their money than
they otherwise would. We have noticed already that the old way for ordinary
citizens to make savings was the accumulation of cash. Under fiat inflation this
strategy is suicidal. They must invest into assets the value of which grows
during the inflation; the most practical way to do this is to buy stocks and
bonds. But this entails many hours spent on comparing and selecting appropriate
titles. And it compels them to be ever watchful and concerned about their money
for the rest of their lives. They need to follow the financial news and monitor
the price quotations on the financial markets.
Similarly, people will tend to prolong the phase of their life in which they
strive to earn money. And they will place relatively greater emphasis on
monetary returns than on any other criterion for choosing their profession. For
example, some of those who would rather be inclined to gardening will
nevertheless seek an industrial employment because the latter offers greater
long-run monetary returns. And more people will accept employment far from home,
because it allows them to earn just some little extra money, than under a
natural monetary system.
The spiritual dimension of these inflation-induced habits seems to be obvious.
Money and financial questions come to play an exaggerated role in the life of
man. Inflation makes society materialistic. More and more people strive for
money income at the expense of personal happiness. Inflation-induced
geographical mobility artificially weakens family bonds and patriotic loyalty.
Many of those who tend to be greedy, envious, and niggardly anyway fall prey to
sin. Even those who are not so inclined by their natures will be exposed to
temptations they would not otherwise have felt. And because the vagaries of the
financial markets also provide a ready excuse for an excessively parsimonious
use of one’s money, donations for charitable institutions will decline.
Then there is the fact that perennial inflation tends to deteriorate product
quality. Every seller knows that it is difficult to sell the same physical
product at higher prices than in previous years. But increasing money prices are
unavoidable when the money supply is subject to relentless growth. So what do
sellers do? In many cases the rescue comes through technological innovation,
which allows for a cheaper production of the product, thus neutralizing or even
overcompensating the countervailing influence of inflation. This is, for
example, the case with personal computers and other equipment built with a large
input of information technology.
But in other industries, technological progress plays a much smaller role. Here
the sellers confront the above-mentioned problem. They then fabricate an
inferior product and sell it under the same name, along with the euphemisms that
have become customary in commercial marketing. For example, they might offer
their customers "light" coffee and "non-spicy" vegetables—which translates into
thin coffee and vegetables that have lost any trace of flavor. Similar product
deterioration can be observed in the construction business. Countries plagued by
perennial inflation seem to have a greater share of houses and streets that are
in constant need of repair than other countries.
In such an environment, people develop a more than sloppy attitude toward their
language. If everything is what it is called, then it is difficult to explain
the difference between truth and lie. Inflation tempts people to lie about their
products, and perennial inflation encourages the habit of routine lies. The
present writer has argued in other works that routine lies play a great role in
fractional-reserve banking, the basic institution of the fiat money system. Fiat
inflation seems to spread this habit like a cancer over the rest of the economy.
VIII. Suffocating the Flame
In most countries, the growth of the welfare state has been financed through the
accumulation of public debt on a scale that would have been unthinkable without
fiat inflation. A cursory glance at the historical record shows that the
exponential growth of the welfare state, which in Europe started in the early
1970s, went in hand with the explosion of public debt. It is widely known that
this development has been a major factor in the decline of the family. But it is
commonly overlooked that the ultimate cause of this decline is fiat inflation.
Perennial inflation slowly but assuredly destroys the family, thus suffocating
the earthly flame of Christian morals.
The Christian family is the most important "producer" of a certain type of
morals. Family life is possible only if all members endorse norms such as the
legitimacy of authority, the heterosexual union between man and woman, and the
prohibition of incest. And Christian families are based on additional norms such
as the love of the spouses for one another and for their offspring, the respect
of children for their parents, the reality of the Triune God, the truth of the
Christian faith, etc. Parents constantly repeat, emphasize, and live these
norms. This daily experience "brainwashes" all family members into accepting
them as the normal state of affairs. In the wider social sphere, then, these
persons act as advocates of the same norms in business associations, clubs, and
politics.
Friends and foes of the traditional Christian family agree on these facts. It is
among other things because they recognize the family’s effectiveness in
establishing social norms that Christians seek to protect it. And it is
precisely for the same reason that advocates of moral license seek to destroy
it. The welfare state has been their preferred tool for the past thirty years.
Today the welfare state provides a great number of services that in former times
were provided by families (and which, we may assume, would still be provided to
a large extent by families if the welfare state ceased to exist). Education of
the young, care for the elderly and the sick, assistance in times of
emergencies—all of these services are today effectively "outsourced" to the
state. The families have been degraded into small production units that share
utility bills, cars, refrigerators, and of course the tax bill. The tax-financed
welfare state then provides them with education and care.[3]
From an economic point of view, this arrangement is a pure waste of money. The
fact is that the welfare state is inefficient; it provides comparatively lousy
services at comparatively high costs. We need not dwell on the inability of
government welfare agencies to provide the emotional and spiritual assistance
that only springs from charity. Compassion cannot be bought. But the welfare
state is also inefficient in purely economic terms. It operates through large
bureaucracies and is therefore liable to lack incentives and economic criteria
that would prevent the wasting of money. In the words of Pope John Paul II:
By intervening directly and depriving society of its responsibility, the Social
Assistance State leads to a loss of human energies and an inordinate increase of
public agencies, which are dominated more by bureaucratic ways of thinking than
by concern for serving their clients, and which are accompanied by an enormous
increase in spending. In fact, it would appear that needs are best understood
and satisfied by people who are closest to them and who act as neighbours to
those in need. It should be added that certain kinds of demands often call for a
response which is not simply material but which is capable of perceiving the
deeper human need.[4]
Everyone knows this from first-hand experience, and a great number of scientific
studies drive home the same point. It is precisely because the welfare state is
an inefficient economic arrangement that it must rely on taxes. If the welfare
state had to compete with families on equal terms, it could not stay in business
for any length of time. It has driven the family and private charities out of
the "welfare market" because people are forced to pay for it anyway. They are
forced to pay taxes, and they cannot prevent the government from floating
ever-new loans, which absorb the capital that otherwise would be used for the
production of different goods and services.
The excessive welfare state of our days is an all-out direct attack on the
producers of Christian morals. But it weakens these morals also in indirect
ways, most notably by subsidizing bad moral examples. The fact is that some
alternative "life styles" carry great economic risks and therefore tend to be
more expensive than the traditional family arrangements. The welfare state
socializes the costs of such behavior and therefore gives it far greater
prominence than it would have in a free society.
Rather than carrying an economic penalty, public license might then actually go
hand in hand with economic advantages, because it dispenses the protagonists
from the costs of family life (for example, the costs associated with raising
children). With the backing of the welfare state, these protagonists may mock
conservative morals as some sort of superstition that has no real-life impact.
The spiritual dimension seems to be clear: The welfare state systematically
exposes people to the temptation of believing that there are no time-tested
moral precepts at all.
Let us emphasize that the point of the preceding observations was not to attack
welfare services, which are in fact an essential component of Christian
societies. The point is, rather, that fiat inflation destroys the democratic
control over the provision of these services; that this invariably leads to
excessive growth of the aggregate welfare system and to excessive forms of
welfare; and that this in turn is not without consequences for the moral and
spiritual character of the population.
The foregoing considerations are by no means an exhaustive account of the
cultural and spiritual legacy of fiat inflation. But they should suffice to
substantiate the main point: that fiat inflation is a powerhouse of social,
economic, cultural, and spiritual destruction.
* * * * *
Notes
[1]Pius XI, Quadragesimo Anno (1931), §§ 105, 106. See also Deuteronomy 28: 12,
43–44.
[2]Thomas Woods, "Money and Morality: The Christian Moral Tradition and the Best
Monetary Regime," Religion & Liberty, vol. 13, no. 5 (Sept./Oct. 2003). The
author quotes Ludwig von Mises.
[3]In many countries it is today possible for families to deduct expenses for
private care and private education from the annual tax bill. But ironically (or
maybe not quite so ironically) this trend has reinforced the erosion of the
family. For example, recent provisions of the U.S. tax code allow family budgets
to increase through such deductions—but only if the deductible services are not
provided at home, but bought from other people.
[4]John Paul II, Centesimus Annus, § 48.
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