Understanding Inflation
INQUIRIES about inflation, I understand, have beaten wave-like upon bank tellers since 1933. The last wave occurred during the election campaign. Another is beginning to surge over the bank counters. Generally the inquiries take the form of one of two questions: ’What is inflation?’ and ‘Are we having inflation?’
I am sometimes tempted to say that such questions would not be asked if we were really having inflation. For inflation has the characteristic of being at once self-explanatory and evident to everybody. In post-war Germany the general public felt the effects of inflation and did not need to be told what it was they were feeling. The housewife used to run to the stores with her husband’s wages in the knowledge that prices were being marked up with almost every step she took, and that in consequence the money in her bag was constantly dwindling in purchasing power. In those nightmarish days the Germans asked one question, and one only: ‘When is inflation going to stop?’ How pathetically they worded their question only those who heard them at the meetings of the Dawes Committee in 1924 can appreciate.
It is not difficult, in the light of this experience, to arrive at a definition of inflation. Inflation is a spectacular and continuous rise in general prices caused by the stream of goods produced failing to keep pace until the stream of money used.
Naturally ihere has been an increase in general prices since the annus terribilis of 1932. There was bound to be some rise, with or without official stimulation, out of (lie trough of the ‘greatest depression in history.’ But the rise so far has not been spectacular. From June 1933 to December 1936, according to the government’s figures, the average cost of living in 32 large cities has
gone up 10.6 per cent. That is, at the end of 1936 we had to have $1.10 to buy what we bought in June 1933 for $1.00. Perhaps t o-day t he $1.00 purchase of June 1933 would call for an outlay of $1.12. In view of the deep trough in which prices had dropped by 1933, I hardly think that one is justified in regarding as inflation a rise of 10 1/2 per cent in three and a half years.
The factor t hat breeds inflation, as I have said, is a distortion between the stream of money used and the stream of goods produced. When the Roosevelt Administration was elected, it found the money stream of the nation at a shockingly low level, compared with 1929. Not counting currency, which is only the country’s pocket change, bank deposits subject to check payments had been contracted by 37 per cent. The Administration, acting upon the theory that, to use an old definition, money is the right of action, — that is, to produce and consume goods, — decided to replenish the money stream.
By this time the process of doing so is familiar. The government sells bonds to the commercial banks. When a bank buys bonds, it gives the government — or, properly speaking, the Treasury — a checking account to the amount of the purchase, and the government proceeds to draw against its new account in paying contractors, relief workers, and other recipients of government expenditures. In time the spent money flows back into the banks in the form of private deposits. Even if the government, cheeks are not promptly banked, they are eventually banked after one or more rounds of spending, by retailers, wholesalers, or manufacturers.
The result of this process is revealed in the last issue of the Federal Reserve Bulletin. By the end of 1936, demand deposits had not only been raised back to the 1929 level; they had been raised above it. This check money was 12 per cent higher than at the end of 1929.
In 1939 the process of replenishing the money stream was called ‘ reflation,’not inflation. The distinction is important. As Professor Arthur W. Marget says, in a recent publication of the University of Minnesota, ‘The very differentiation between “reflation” and “inflation” implies a commandment: “Thus far shalt thou go, and no farther.‘" The money stream, as we have seen, is now reflated beyond the Level even of the prosperity year of 1929. And yet. the cost of living is still 17 per cent below the 1929 level!
Two reasons have combined to prevent a conflagration of inflation with all this financial fuel: —
1. The stream of goods has been expanded with the stream of money.
2. Money is not being used at its 1929 rate of efficiency.
As to 1, we can make an index only of industrial production. This has risen no less than 80 per cent from the mid-1933 level. In certain lines of goods, however, the limit of capacity has already been reached, notably in steel and copper. Steel producers are said to be rationing buyers. The strength of copper buying has misled most copper producers, and caused the industry to throw away the last restraints upon production, rated capacity having been exceeded till now the industry is operating at 105 per cent.
In a historic press conference on April 2, the President mentioned these two products, among others, as commodities which were endangering the stability of the economic system. His reference revealed the President’s regard for his new rôle of economic manager of the nation. When an increasing demand for goods fails to bring forth an increase in output, then, to quote J. M. Keynes, whose theories seem to have been taken over bodily by the Roosevelt Administration, ‘the new demand merely competes with the existing demand for the use of resources which are already employed to the utmost,’and the effect is to produce an inflation of prices in those commodities. This is sometimes called ‘blister’ inflation. In the twenties we witnessed such a phenomenon in real estate and industrial equities. It was against the rise of prices in the commodities mentioned that the President issued his warning. He wished to see demand diverted to resources which still remain unused to the full. And, in so far as government can furnish an example, he ordered a switch in government demand from capital goods buying to consumer goods buying, besides making another plea for higher wages so that the workers could buy consumer goods.
The efficiency in the use of money is registered in its velocity of circulation. This is the most important factor in the aberrations of general prices from strict proportionality with changes in the money stream. When we referred to the stream of money, we added the word used. Obviously, if a dollar passes through five hands during the year, it has a money power of $5.00. It so happens that, in spite of the increase in both money and goods streams, the turnover of money remains about where it was at the bottom of the depression! In 140 cities outside New York (where ‘normal’ is obscured by stockmarket activity) the rate of turnover of the cheek dollar is around 22 times, as compared with an average of 34 times in the decade 1020-1929, a reduction of approximately 32 per cent.
‘Particularly strange’ is the way that the Harvard Committee on Research in the Trade Cycle refers to the phenomenon. Evidently neither that confidence in the use of money which marks recovery, nor that fear of not using money quickly to buy goods which marks inflation, is present.
The sluggishness in money turnover is the reason that so many financial pundits point to this index as the imponderable of inflation. Even if people begin again to spend normally, they say, we should have inflation. In this warning they ignore the anti-inflationary influence of the money controllers in Washington — men such as Chairman Eccles. True, in a free economic society it is difficult indeed to control the use of money. All the more need exists, therefore, to arrest the increase in the money supply which comes through Treasury borrowing. The money stream will continue to swell and threaten to inflate general prices so long as the Treasury has to depend upon the banks for its financing, instead of upon the taxpayers. To that extent the Treasury is making Chairman Eccles’s ‘boom control’ task almost Sisyphean.