B. The Vacuousness of the Quantity Theory
4. War Inflation and The Road to
Even after the monetary inflation manifests itself in a general rise in prices, the public can still be misled into believing that these price increases are the result of temporary shortages of essential materials or the machinations of unscrupulous war profiteers and price-gougers. It is only a matter of time, however, before workers and investors out- side the military-industrial complex come to recognize that a depre- ciating monetary unit is a permanent feature of the war economy and their eroding real wages and illusory profits are brought clearly and painfully into focus. To postpone the day of accurate reckoning of the costs of war yet again, the government implements price controls.
As a result of the inevitable shortages and inefficiencies generated by price controls, the government frantically institutes and then rapidly expands controls over production, distribution, and labor, until very little is left of the market economy and its capital structure. The final
38 F. Machlup, “The Consumption of Capital in Austria,” The Review of Economic Statistics (January): pp. 13–19.
outcome of this process is an economy in which, although productive resources are still nominally privately owned, the State has effectively arrogated to itself the power to make all crucial production decisions.
The all-encompassing war economy is, ultimately and inescapably, a fascist economy.39
Guenter Reiman40 has fittingly entitled his book on the fascist economic system of Nazi Germany, The Vampire Economy, because, as a permanent war economy, it systematically and madly consumes the capital, the very lifeblood, of the host capitalist economy. And to enforce the compliance of its citizens in this painfully self-destruc- tive course, an all-powerful state is indispensable. As Reiman41 puts it: “[I]t is impossible to foretell when a military system will collapse as a result of a deficiency in foodstuffs, raw materials or other economic factors. As long as the state machine is in order, it has the power to cut down the consumption of the general public and to reduce—
almost to eliminate—expenditures for the renewal of the industrial machine… . It is possible to increase production of arms and ammu- nition even with reduced supplies of raw materials. This can be done by drastically limiting production of consumption goods, by putting
39 As Charlotte Twight, America’s Emerging Fascist Economy (New Rochelle, N.Y.:
Arlington House Publishers, 1975), pp. 16–17 perceptively argues, “Fascism is unique among collectivist systems in selecting capitalism as its nominal economic mate, but capitalism is turned inside out in this unlikely union. … [F]ascism toler- ates the form of private ownership at the government’s pleasure, but it eliminates any meaningful right of private property. Fascist capitalism is ‘regulated’ capitalism;
it is government intervention in the economy on a massive scale. Avraham Barkai (Nazi Economics: Ideology, Theory, and Policy, trans. Ruth Hadass-Vashitz [New Haven, Conn.: Yale University Press, 1990], p. 248) characterizes the Nazi economy in similar terms: “The market still existed but was not a free market, and most deci- sions taken by the owners of enterprise were not ‘free’ either. The term ‘organized capitalism’ suits this economic method, subject only to the reservation that organiza- tion was imposed from above by extraeconomic, that is, political factors; it was these factors that were responsible for directing the economy in accordance with basically non-economic considerations. It was therefore a capitalist economy in which capital- ists, like all other citizens, were not free even though they enjoyed a privileged status, had a limited measure of freedom in their activities, and were able to accumulate huge profits as long as they accepted the primacy of politics.”
40 G. Reimann, The Vampire Economy: Doing Business under Fascism (New York:
The Vanguard Press, 1939).
41 Ibid., p. xi
the population on starvation rations, and by letting vast sectors of the economy decay.” In Germany, for example, despite the fact that total production had increased from prewar levels as a result of the plun- dering of the productive wealth of vanquished nations and the reloca- tion and forced labor of conquered peoples, by 1944 the output of the vital construction industries had shrunk to 25 percent of its prewar level while consumer goods output had declined by only 15 percent.42 The capital consumption that inflation brings about surreptitiously in the beginning, a repressive fascist State is required to sustain over the long run in the service of the war effort.
The American journalist, John T. Flynn,43 wrote that “A bad fas- cism is a fascist regime which is against us in the war. A good fascist regime is one that is on our side.” But, to repeat, all war economies are and must be in the end fascist economies. Higgs44 vividly characterizes the process by which, in an effort to conceal the costs of World War II from its citizens, the U.S. government was driven by the iron logic of economic theory to blunder into draconian fascist economic planning:
Huge military and naval forces required correspondingly large amounts of equipment, supplies, subsistence, and trans- portation. When the government’s procurement officers, their pockets bulging with newly created purchasing power, set in motion a bidding war that could have driven prices up to spectacular levels, thereby revealing the full costs of the government’s program and provoking political reaction and resistance, the government moved to conceal the costs by price controls… . But price controls on goods and ser- vices could not be effectively enforced while wages remained free to rise. Hence controls of labor compensation followed in due course. The market economy, a vast and delicately interdependent system of transactions, invariably surprised and confounded the administrators of partial controls. In response the government progressively expanded and tight- ened the command system until, during the final two years
42 Barkai, Nazi Economics, p. 238.
43 J.T. Flynn, As We Go Marching (Garden City, N.Y.: Doubleday, Doran and Co., Inc., 1944), p. 165.
44 Higgs, Crisis and Leviathan, pp. 234–35.
of the war, a thoroughgoing garrison economy had been brought into operation. Fundamentally the authorities, not the market, determined what, how, and for whom the econ- omy would produce under this regime.
We conclude, then, that monetary inflation is the crucial first step in the process by which government seeks to conceal from its cit- izen-subjects the enormous costs associated with war, particularly the progressive destruction of the nation’s productive wealth. Specifically, the inflationary process is indispensable for masking the capital decu- mulation crisis precipitated by war mobilization, which would oth- erwise be swiftly revealed to one and all by monetary calculation. In the absence of the veil cast over real economic processes by inflation, the public’s enthusiasm for the alleged glories of war would be rap- idly and significantly dampened by skyrocketing interest rates, plum- meting stock and bond markets, and pandemic business bankruptcies and bank runs—not to mention the levying of confiscatory kinds and levels of taxation. Ironically, it is not money itself that is a “veil”—as classical economists used to claim and many contemporary quan- tity theorists still affirm—because it is precisely monetary calculation that permits market participants to meaningfully assess their wealth and income and appraise the outcomes of alternative allocations of resources. Rather it is central bank manipulation of the money supply that falsifies the calculation of economic quantities and distorts the insight of the citizenry into the true economic sacrifices that they are making for the cause.
Finally, it is worth emphasizing that the characterization of mon- etary inflation as a means for obscuring the real costs of war is an inference from strictly value-free economic theory and, as such, does not logically imply the value judgment that war ought to be financed by noninflationary fiscal methods. How a war should be financed and whether it should even be waged are equally questions that can only be resolved in light of a politico-ethical theory. Of course, this is not to deny that such a theory should be “consequentialist” in a broad sense and take into account in its formulation the positive conclusions of economics as well as of all other relevant sciences regarding the out- comes of various governnent policies. Indeed, given the conclusions of Austrian economic theory that the very concept of a “public good”
is untenable and that national defense can and will, be supplied most efficiently by the market, like any other desired good, the road has been cleared for the construction of a politico-ethical argument that defense of person and property from local criminals as well as from foreign invaders should be left to the free market.45
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CHAPTER 10
An Austrian Taxonomy of Deflation—
With Applications to the U.S.
Deflation has been all over the news for the last two years.
Financial journalists, market pundits, business forecasters, economic columnists, Fed governors and mainstream mac- roeconomists are all spooked by the specter of price deflation in the U.S. During this time we have been inundated with dire warnings of the looming prospect of a possibly catastrophic deflation in the U.S. Articles bearing such grizzly and creepy titles as “The Deflation Monster Still Lives,” “The Specter of Deflation,” “Deflation Boogey- man Haunts Fed,” “The Greatest Threat Facing the U.S. Economy:
Deflation,” “Why We Should Fear Deflation,” and “Deflation: Making Sure ‘It’ Doesn’t Happen Here” abounded in the financial press and among the publications of such august and stodgy economic think tanks as the American Enterprise Institute and the Brookings Insti- tution.1 Recently, the International Monetary Fund held an economic
1 See, for example, John H. Makin, “The Deflation Monster Lives,” Economic Out- look (December 2001); Robert J. Samuelson, “The Specter of Deflation,” Washington Post Online (November 21, 2001); Donald L. Luskin, “The Greatest Threat Facing the U.S. Economy: Deflation,” Capitalism-Magazine.com (November 23, 2001);
J. Bradford DeLong, “Why We Should Fear Deflation,” Brookings Papers on Eco- nomic Activity (Spring 1999). http://www.j-bradford-delong.net; Richard W. Rahn,
“Defeating Deflation,” Wall Street Journal (November 19, 2001); and Bruce Bartlett,
267
From: “An Austrian Taxonomy of Deflation—With Applications to the U.S.,” The Quarterly Journal of Austrian Economics 6, no. 4 (2003): 81–109.
forum entitled “Should We Be Worried About ‘Deflation’?” to discuss a report it commissioned on the global risks of deflation.2
As their titles suggest, these articles delineate chilling scenarios for the American economy. Not only do these and other articles con- tend that deflation is close at hand but many of them assert or imply two additional propositions: first, that the effects of deflation are an unmitigated disaster for economic activity and welfare; and, second, that the Federal Reserve System needs to take prompt action to head off such devastation to the economy. In particular, their authors argue that the Fed must dexterously shift gears and become a deflation fighter rather than the staunch and valiant inflation-fighter it sup- posedly has been for the last two decades. A few authors even ques- tion whether the Fed is now constitutionally capable of making such a shift—as if any central bank would be unwilling or unable to create massive quantities of new money, given even the lamest of excuses.
Most of the growing host of deflation-phobes prudently leave the precise details of the impending deflationary debacle to our imagina- tion with vague and foreboding references to the Great Depression in the U.S. in the early 1930s or to the experience of Japan since 1998.
However, others, such as market pundit Donald L. Luskin, a self-pro- claimed “unreconstructed supply-sider,” delight in conjuring up lurid deflationary scenarios. According to Luskin,3 deflation is:
going to be a world of hurt. If you thought inflation was a nightmare, wait till you live with a deflation. Prices of every- thing eventually go down—stocks, real estate, wages … the whole thing. You’re a little poorer every day. … And if you’re in debt then you’re really in trouble. You’ll have to make those same mortgage payments even though the value of your house is going down every month. … But that doesn’t mean that deflation is any bed of roses for lenders either. Sure, it’s nice to have locked in a stream of payments in money that
“The Deflation Dilemma: To Be Concerned or Not to Be?” National Review Online Financial (November 20, 2001).
2 Kenneth Rogoff, Manmohan S. Kumar, Laurance Ball, Vincent Reinhart, and Kim Scoenholtz, Transcript of an IMF Economic Forum: “Should We Be Worried About
‘Deflation’?”, Washington, D.C. (May 29, 2003). Available at: http://www.imf.org.
3 Luskin, “The Greatest Threat.”
will buy you more and more apples and paper clips and houses as prices collapse. But you’ll never get the money, because the borrowers will all default.4
But regardless of whether they indulge in such rhetorical excesses or state their case dispassionately in formal academic jargon, contemporary deflation-phobes fail to distinguish between the sev- eral different phenomena that are commonly jumbled together under the rubric of “deflation.” And because modern macroeconomics was born of John Maynard Keynes’s obsessive deflation-phobia,5 academic macroeconomists are the most likely of all to be muddled about defla- tion. They are not inclined or equipped to give a coherent account of the separate economic processes designated as “deflationary”; nor are they able to ascertain which kinds of deflationary processes are
“benign” and represent an improvement of economic efficiency and welfare and which kinds are “malign” and impair economic produc- tivity and well-being by distorting monetary calculation.
Fortunately, Austrian monetary theory, which was developed primarily by Ludwig von Mises and Murray N. Rothbard, provides us with the means to cut through the tangle of anti-deflationist fal- lacies that we have lately been bombarded with and to neatly sort out the different types of deflation.6 The remainder of the paper is divided as follows. Deflation is defined in Section 2. Austrian mon- etary theory is utilized to identify and analyze the different kinds of
4 Ibid.
5 John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt, Brace and World, [1936] 1964), p. 269.
6 The seminal work on Austrian monetary theory is Mises’s Theory of Money and Credit, 2nd ed., trans. H.E. Batson (Indianapolis, Ind.: Liberty Classics, [1953] 1980).
Mises’s more mature statement of monetary theory can be found in Human Action:
A Treatise on Economics, Scholar’s Edition (Auburn, Ala.: Ludwig von Mises Insti- tute, [1953] 1980), pp. 395–475. Murray N. Rothbard’s comprehensive restatement and elaboration of Misesian monetary theory is contained in his treatise Man, Econ- omy, and State: A Treatise on Economic Principles, 2nd ed. (Auburn, Ala.: Ludwig von Mises Institute), pp. 160–200, 661–764. For two shorter and very lucid treat- ments of Austrian monetary theory, see Murray N. Rothbard, What Has Govern- ment Done to Our Money? 4th ed. (Auburn, Ala.: Ludwig von Mises Institute);
idem, “The Austrian Theory of Money,” in The Logic of Action One: Method, Money, and the Austrian School (Cheltenham, U.K.: Edward Elgar, 1997), pp. 297–320.