WEBVTT NOTE Deflation and Liberty 1 00:00:00.000 --> 00:00:05.000 DEFLATION AND LIBERTY by Herg Guido Hulsman 2 00:00:05.000 --> 00:00:08.000 Preface 3 00:00:08.000 --> 00:00:15.000 It is my great pleasure to see this little essay in print, written and presented more than five years ago. 4 00:00:15.000 --> 00:00:21.000 It was welcomed at the time by scholars with a background in Austrian economics. 5 00:00:21.000 --> 00:00:28.000 However, it was not understood and was rejected by those who did not have this background. 6 00:00:28.000 --> 00:00:33.000 In order to reach a broader audience, a short essay would simply not do. 7 00:00:33.000 --> 00:00:41.000 I therefore decided not to publish Deflation in Liberty and started to work on The Ethics of Money Production, 8 00:00:41.000 --> 00:00:48.000 a book-length presentation of the argument, which has just become available from the Mises Institute. 9 00:00:48.000 --> 00:00:54.000 In the present crisis, the citizens of the United States have to make an important choice. 10 00:00:54.000 --> 00:01:06.000 They can support a policy designed to perpetuate our current fiat money system and the sorry state of banking and of financial markets that it logically entails. 11 00:01:06.000 --> 00:01:14.000 Or they can support a policy designed to reintroduce a free market in money and finance. 12 00:01:14.000 --> 00:01:19.000 This latter policy requires the government to keep its hands off. 13 00:01:19.000 --> 00:01:45.000 It should not produce money, nor should it appoint a special agency to produce money. It should not force the citizens to use fiat money by imposing legal tender laws. It should not regulate banking and should not regulate the financial markets. It should not try to fix the interest rate, the prices of financial titles or commodity prices. 14 00:01:45.000 --> 00:01:51.040 Clearly, these measures are radical by present-day standards and they are not likely to find 15 00:01:51.040 --> 00:01:57.440 sufficient support, but they lack support out of ignorance and fear. 16 00:01:57.440 --> 00:02:02.760 We are told by virtually all the experts on money and finance, the central bankers and 17 00:02:02.760 --> 00:02:11.540 most university professors, that the crisis hits us despite the best efforts of the Fed. 18 00:02:11.540 --> 00:02:17.660 That money, banking and financial markets are not meant to be free because they end 19 00:02:17.660 --> 00:02:23.860 up in disarray despite the massive presence of the government as a financial agent, as 20 00:02:23.860 --> 00:02:26.780 a regulator and as money producer. 21 00:02:26.780 --> 00:02:31.780 That our monetary system provides us with great benefits that we would be foolish not 22 00:02:31.780 --> 00:02:34.340 to preserve. 23 00:02:34.340 --> 00:02:41.020 Those same experts therefore urge us to give the government an even greater presence in 24 00:02:41.020 --> 00:02:48.020 in the Financial Markets to increase its regulatory powers and to encourage even more money production 25 00:02:48.660 --> 00:02:55.660 to be used for bailouts. However, all of these contentions are wrong, as economists have demonstrated 26 00:02:56.780 --> 00:03:03.780 again and again since the times of Adam Smith and David Ricardo. A paper money system is 27 00:03:03.860 --> 00:03:09.900 not beneficial from an overall point of view. It does not create real resources on which 28 00:03:09.900 --> 00:03:17.280 Which our welfare depends, it merely distributes the existing resources in a different manner. 29 00:03:17.280 --> 00:03:24.680 Some people gain, others lose. It is a system that makes banks and financial markets vulnerable 30 00:03:24.680 --> 00:03:31.840 because it induces them to economize on the essential safety valves of business, cash 31 00:03:31.840 --> 00:03:37.960 and equity. Why hold any substantial cash balances if the central bank stands ready 32 00:03:37.960 --> 00:03:48.960 Why use your own money if you can finance your investments with cheap credit from the printing press? 33 00:03:48.960 --> 00:03:52.960 To raise these questions is to answer them. 34 00:03:52.960 --> 00:04:01.960 The crisis did not hit us despite the presence of our monetary and financial authorities, it hit us because of them. 35 00:04:01.960 --> 00:04:15.960 Then there is the fear factor. If we follow a hands-off policy, the majority of experts tell us the banking industry, the financial markets and much of the rest of the economy will be wiped out in a bottomless deflationary spiral. 36 00:04:15.960 --> 00:04:26.960 The present essay argues that this is a half-truth. It is true that without further government intervention there would be a deflationary spiral. 37 00:04:26.960 --> 00:04:53.960 It is not true that this spiral would be bottomless and wipe out the economy. It would not be a mortal threat to the lives and the welfare of the general population. It destroys essentially those companies and industries that live a parasitical existence at the expense of the rest of the economy and which owe their existence to our present fiat money system. 38 00:04:53.960 --> 00:05:01.960 Even in the short run, therefore, deflation reduces our real incomes only within rather narrow limits. 39 00:05:01.960 --> 00:05:07.960 And it will clear the ground for very substantial growth rates in the medium and long run. 40 00:05:07.960 --> 00:05:13.960 We should not be afraid of deflation. We should love it as much as our liberties. 41 00:05:13.960 --> 00:05:28.080 1. The 20th century has been the century of omnipotent government. In some countries totalitarian 42 00:05:28.080 --> 00:05:33.080 governments have established themselves in one stroke through revolutions, apparently 43 00:05:33.080 --> 00:05:40.060 a bad strategy, for none of these governments exist anymore. But in other countries totalitarianism 44 00:05:40.060 --> 00:05:46.260 has not sprung into life full-fledged like Venus from the waves. In the United States 45 00:05:46.260 --> 00:05:51.900 and in virtually all the Western European countries, government has grown slowly but 46 00:05:51.900 --> 00:05:57.980 steadily, and if unchecked, this growth will make it totalitarian one day, even though 47 00:05:57.980 --> 00:06:04.500 this day seems to be far removed from our present. Fact is that in all Western countries, 48 00:06:04.500 --> 00:06:10.140 The growth of government has been faster over the last 100 years than the growth of the 49 00:06:10.140 --> 00:06:17.140 economy. Its most conspicuous manifestations are the welfare state and the warfare state. 50 00:06:19.320 --> 00:06:24.460 In the American case, the warfare state has been a more powerful engine of government 51 00:06:24.460 --> 00:06:31.140 growth than the welfare state. Now the growth of the welfare-warfare state would not have 52 00:06:31.140 --> 00:06:36.780 have been possible without inflation, which for the purposes of our study, we can define 53 00:06:36.780 --> 00:06:43.660 as the growth of the supply of base money and of financial titles that are redeemable 54 00:06:43.660 --> 00:06:47.340 into base money on demand. 55 00:06:47.340 --> 00:06:53.380 With this definition, we follow Murray and Rothbard, who defines inflation as an increase 56 00:06:53.380 --> 00:06:59.300 of the quantity of money greater than an increase in specie. 57 00:06:59.300 --> 00:07:04.780 While Rothbard's definition fits the case of a fractional reserve banking system based 58 00:07:04.780 --> 00:07:11.300 on a commodity money standard, our definition is meant to fit the specific case of a fiat 59 00:07:11.300 --> 00:07:15.360 money standard with fractional reserve banking. 60 00:07:15.360 --> 00:07:21.500 Both definitions deviate from the most widespread connotation of the term according to which 61 00:07:21.500 --> 00:07:26.320 inflation is an increase of the money price level. 62 00:07:26.320 --> 00:07:31.880 The latter definition is not very useful for our purposes, because we intend to analyze 63 00:07:31.880 --> 00:07:39.640 the causal impact of changes in the supply of base money, which is at all times subject 64 00:07:39.640 --> 00:07:42.360 to political control. 65 00:07:42.360 --> 00:07:47.920 The production of ever new quantities of paper dollars and the creation of ever new credit 66 00:07:47.920 --> 00:07:54.820 facilities at the Federal Reserve have provided the liquidity for an even greater expansion 67 00:07:54.820 --> 00:08:00.700 Expansion of Bank-Created Demand Deposits and Other Money Substitutes, which in turn 68 00:08:00.700 --> 00:08:08.180 allowed for an unparalleled expansion of public debt. U.S. public debt is currently, December 69 00:08:08.180 --> 00:08:17.220 2002, at some $6.2 trillion, up from under $2 trillion at the beginning of the 1980s 70 00:08:17.220 --> 00:08:23.580 and less than $1 trillion before the era of the paper dollar set in when President Nixon 71 00:08:23.580 --> 00:08:28.620 closed to the gold window in the early 1970s. 72 00:08:28.620 --> 00:08:33.900 The link between the paper dollar and the exponential expansion of public debt is well 73 00:08:33.900 --> 00:08:35.100 known. 74 00:08:35.100 --> 00:08:40.100 From the point of view of the creditors, the Federal Government controls the Federal Reserve, 75 00:08:40.100 --> 00:08:46.980 the monopoly producer of paper dollars, and it can therefore never go bankrupt. 76 00:08:46.980 --> 00:08:52.220 If necessary, the Federal Government can have any quantity of dollars printed to pay back 77 00:08:52.220 --> 00:09:14.220 The Federal Government can constantly expand its activities and finance them through additional debt, even if there is no prospect at all that these debts will ever be paid back out of tax revenues. 78 00:09:14.220 --> 00:09:21.220 The result is seemingly unchecked growth of those governments that control the production of paper money. 79 00:09:21.220 --> 00:09:31.220 Among the many causes that coincided in bringing about this state of affairs is a certain lack of resistance on the part of professional economists. 80 00:09:31.220 --> 00:09:43.220 In the present essay, I will deal with a wrong idea that has prevented many economists and other intellectuals from fighting inflation with the necessary determination. 81 00:09:43.220 --> 00:09:56.220 Most economists backed off from opposing inflation precisely when it was needed most, namely at the few junctures of history when the inflationary system was about to collapse. 82 00:09:56.220 --> 00:10:12.220 Rather than impartially analyzing the event, they started fearing deflation more than inflation and thus ended up supporting reflation, which in fact is nothing but further inflation. 83 00:10:12.220 --> 00:10:24.220 For the purposes of our study, we will define deflation as a reduction of the quantity of base money, or of financial titles that are redeemable into base money on demand. 84 00:10:24.220 --> 00:10:33.220 Again, this deviates from the usual connotation of the term which defines deflation as a decrease of the price level. 85 00:10:33.220 --> 00:10:40.220 level. But as the reader will see, our analysis will cover both phenomena, deflation in our 86 00:10:40.300 --> 00:10:47.300 definition and decrease of the price level. The point of our definition is merely to render 87 00:10:47.900 --> 00:10:54.900 our analysis more suitable for practical application. A monetary authority at all times can prevent 88 00:10:55.660 --> 00:11:02.660 deflation in our definition, while it can at times be unable to prevent a decrease of 89 00:11:02.660 --> 00:11:10.020 of the price level, even by pumping great quantities of base money into the economy. 90 00:11:10.020 --> 00:11:15.660 The United States of America has experienced two such junctures, the years of the Great 91 00:11:15.660 --> 00:11:21.020 Depression and the little depression we are facing right now in the wake of the first 92 00:11:21.020 --> 00:11:28.140 global stock market boom. Today again, the deflationary collapse of our monetary system 93 00:11:28.140 --> 00:11:36.460 is a very real possibility. In November 2002, officials of the Federal Reserve, Greenspan, 94 00:11:36.460 --> 00:11:42.700 Bernanke and of the Bank of England, BEAN, proclaimed there would be no limit to the 95 00:11:42.700 --> 00:11:49.760 amount of money they would print to fend off deflation. These plans reflect what today is 96 00:11:49.760 --> 00:11:56.760 widely regarded as orthodoxy in monetary matters. Even many critics of the inflationary policies 97 00:12:26.760 --> 00:12:33.160 To finance the increased spending, the governments should incur more debts, and that the central 98 00:12:33.160 --> 00:12:40.080 banks should print more money. See, for example, the columns and editorials by journalists 99 00:12:40.080 --> 00:12:47.740 with a hard money reputation, such as Steve Forbes in the U.S. and Stephan Barron in Germany. 100 00:12:47.740 --> 00:12:53.400 The same message emanates from the publications of otherwise reasonable economists, such as 101 00:12:53.400 --> 00:13:00.560 Jude Woniski and Norbert Walter. Such views have a certain prominence even among Austrian 102 00:13:00.560 --> 00:13:07.560 economists. Ludwig von Mises, Hans Sennholz, Murray Rothbard and other Austrians are known 103 00:13:07.560 --> 00:13:16.080 for their intransigent opposition to inflation. But only Sennholz did not flinch from praising 104 00:13:16.080 --> 00:13:23.280 deflation and depression when it came to abolishing fiat money and putting a sound money system 105 00:13:23.280 --> 00:13:31.180 in its place. By contrast, Mises and Rothbard championed deflation only to the extent it 106 00:13:31.180 --> 00:13:37.520 accelerated the readjustment of the economy in a bust that followed a period of inflationary 107 00:13:37.520 --> 00:13:47.120 boom. But they explicitly, Mises, and implicitly, Rothbard, sought to avoid deflation in all 108 00:13:47.120 --> 00:13:53.620 and other context. In particular, when it came to monetary reform, both Mises and Rothbard 109 00:13:53.620 --> 00:14:00.620 championed schemes to redefine a paper currency's price of gold to restore convertibility. 110 00:14:01.520 --> 00:14:08.040 The main weakness of this scheme is that it implies that the reform process be directed 111 00:14:08.040 --> 00:14:14.840 by the very institutions and persons whom the reform is supposed to make more or less 112 00:14:14.840 --> 00:14:24.840 It is also questionable whether our monetary authorities can legitimately use their gold reserves to salvage their paper money. 113 00:14:24.840 --> 00:14:34.840 In fact, they have come to control these reserves through a confiscatory coup, and it is therefore not at all clear how plans for monetary reform, 114 00:14:34.840 --> 00:14:45.840 The monetary reform a la Mises and Rothbard can be squared with the libertarian legal or moral principles that Rothbard champions in other works. 115 00:14:45.840 --> 00:14:49.840 But there is also another issue that needs to be addressed. 116 00:14:49.840 --> 00:14:55.840 What is actually wrong with deflating the money supply from an economic point of view? 117 00:14:55.840 --> 00:15:02.840 This question will be at center stage here, which can fortunately build on Rothbard's analysis of deflation, 118 00:15:02.840 --> 00:15:09.960 which demonstrated in particular the beneficial role that deflation can have in speeding up 119 00:15:09.960 --> 00:15:16.360 the readjustment of the productive structure after a financial crisis. 120 00:15:16.360 --> 00:15:22.440 But no economist seems to have been interested in further pursuing the sober analysis of 121 00:15:22.440 --> 00:15:29.920 the impact of deflation on the market process and of its social and political consequences. 122 00:15:29.920 --> 00:15:36.020 The truth is that deflation has become the scapegoat of the economics profession. It 123 00:15:36.020 --> 00:15:43.480 is not analyzed, but derided. One hundred years of pro-inflation propaganda have created 124 00:15:43.480 --> 00:15:50.220 a quasi-total agreement on the issue. The main engines of the propaganda have been the 125 00:15:50.220 --> 00:15:56.560 state universities of the West, as well as an exaggerated faith in the authority of monetary 126 00:15:56.560 --> 00:16:03.020 Experts in the service of the IMF, the World Bank, the Federal Reserve and other government 127 00:16:03.020 --> 00:16:08.780 agencies charged with the technical details of spreading inflation. 128 00:16:08.780 --> 00:16:15.900 Is it really necessary to point out the non sequitur implied in granting expert status 129 00:16:15.900 --> 00:16:22.260 in matters monetary to the employees of these organizations? 130 00:16:22.260 --> 00:16:29.020 An obvious parallel is the case of the economist on the payroll of labor unions who, because 131 00:16:29.020 --> 00:16:35.540 labor unions pay them, are considered to be experts in labor economics. Clearly, if one 132 00:16:35.540 --> 00:16:43.140 called labor unions associations for the destruction of the labor market, which most of them are 133 00:16:43.140 --> 00:16:48.900 by any objective standard, the expertise of their employees would stand in a more sober 134 00:16:48.900 --> 00:17:00.900 The same thing holds true for those writers on monetary affairs who happen to be on the payroll of the various associations for the destruction of our money. 135 00:17:00.900 --> 00:17:07.900 This is, of course, not to deny that there might be good economists working for the IMF or the Federal Reserve. 136 00:17:07.900 --> 00:17:16.900 Our point is merely that their qualification to speak on the issue is not at all enhanced by their professional affiliation. 137 00:17:16.900 --> 00:17:22.500 Deflation. Quite to the contrary, given the incentive structure, we would have to expect 138 00:17:22.500 --> 00:17:29.500 that good monetary economists only accidentally find their way to these institutions. 139 00:17:29.500 --> 00:17:36.200 Wherever we turn, deflation is uniformly presented in bad terms, and each writer hurries to present 140 00:17:36.200 --> 00:17:42.880 the fight against deflation as the bare minimum of economic statesmanship. Economists who otherwise 141 00:17:42.880 --> 00:17:48.080 Students who cannot agree on any subject are happy to find common ground in the heartfelt 142 00:17:48.080 --> 00:17:54.160 condemnation of deflation. In their eyes, the case against deflation is so clear that 143 00:17:54.160 --> 00:18:00.680 they do not even bother about it. The libraries of our universities contain hundreds of books 144 00:18:00.680 --> 00:18:06.920 splitting hairs about unemployment, business cycles and so on, but they rarely feature 145 00:18:06.920 --> 00:18:12.480 a monograph on deflation. Its evilness is beyond dispute. 146 00:18:12.480 --> 00:18:18.280 The outstanding modern theoretician of deflation is Murray N. Rothbard. As we have stated 147 00:18:18.280 --> 00:18:23.440 above, Rothbard's views on deflation seem to be deficient only when it comes to the 148 00:18:23.440 --> 00:18:32.160 practical issue of monetary reform. Yet this silent accord stands on shaky ground. A frank 149 00:18:32.160 --> 00:18:38.920 and enthusiastic endorsement of deflation is, at any rate in our time, one of the most 150 00:18:38.920 --> 00:18:50.800 2. When it comes to matters of money and banking, all practical political issues ultimately 151 00:18:50.800 --> 00:18:58.220 hinge on one central question. Can one improve or deteriorate the state of an economy by 152 00:18:58.220 --> 00:19:06.360 increasing or decreasing the quantity of money? Speaking of an economy, we mean the group 153 00:19:06.360 --> 00:19:30.960 Aristotle said that money was no part of the wealth of a nation, because it was simply 154 00:19:30.960 --> 00:19:39.960 is a medium of exchange in interregional trade, and the authority of his opinion thoroughly marked medieval thought on money. 155 00:19:39.960 --> 00:19:50.960 Scholastic scholars, therefore, spent no time inquiring about the benefits that changes of the money supply could have for the economy. 156 00:19:50.960 --> 00:19:57.700 The relevant issue in their eyes was the legitimacy of debasements, because they saw that this 157 00:19:57.700 --> 00:20:02.240 was an important issue of distributive justice. 158 00:20:02.240 --> 00:20:07.840 And after the birth of economic science in the 18th century, the classical economist 159 00:20:07.840 --> 00:20:15.200 who did not deny this essential point, David Hume, Adam Smith, and Etienne de Condelac 160 00:20:15.200 --> 00:20:22.520 observed that money is neither consumers' good nor producers' good, and that, therefore, 161 00:20:22.520 --> 00:20:26.880 its quantity is irrelevant for the wealth of a nation. 162 00:20:26.880 --> 00:20:33.120 This crucial insight would also inspire the intellectual battles of the next four or five 163 00:20:33.120 --> 00:20:42.160 generations of economists, men such as Jean-Baptiste Say, David Ricardo, John Stuart Mill, Frederic 164 00:20:42.160 --> 00:20:50.120 Bastiat and Carl Menger, who constantly made the case for sound money. As a result, the 165 00:20:50.120 --> 00:20:58.040 western world had much more sound money in the 19th century than in the 20th century. 166 00:20:58.040 --> 00:21:04.720 Large strata of the population paid and were paid in coins made out of precious metals, 167 00:21:04.720 --> 00:21:11.120 especially out of gold and silver. It was money that made these citizens, however humble 168 00:21:11.120 --> 00:21:17.760 all their social status sovereign in monetary affairs, the art of coinage flourished and 169 00:21:17.760 --> 00:21:23.720 produced coins that could be authenticated by every market participant. 170 00:21:23.720 --> 00:21:28.800 Some present-day libertarians harbor a romantic picture of these days of the classical gold 171 00:21:28.800 --> 00:21:35.320 standard, and it is true that it was the golden age of monetary institutions in the West, 172 00:21:35.320 --> 00:21:40.560 especially when we compare them with our own time, in which the monetary equivalent of 173 00:21:40.560 --> 00:21:44.960 alchemy has risen to the status of orthodoxy. 174 00:21:44.960 --> 00:21:51.320 But it is also true that Western monetary institutions in the era of the classical gold standard 175 00:21:51.320 --> 00:21:54.040 were far from being perfect. 176 00:21:54.040 --> 00:21:59.740 Governments still enjoyed monopoly power in the field of coinage, a remnant of the medieval 177 00:21:59.740 --> 00:22:06.840 regalia privileges that prevented the discovery of better coins in coin systems through entrepreneurial 178 00:22:06.840 --> 00:22:08.960 competition. 179 00:22:08.960 --> 00:22:33.960 They actively promoted fractional reserve banking, which promised ever new funds for the public treasury, and they promoted the emergence of central banking through special monopoly charters for a few privileged banks. 180 00:22:33.960 --> 00:22:43.960 The overall result of these laws was to facilitate the introduction of inflationary paper currencies and to drive specie out of circulation. 181 00:22:43.960 --> 00:22:52.960 At the beginning of the 19th century, most of Europe, insofar as it knew monetary exchange at all, used paper currencies. 182 00:22:52.960 --> 00:23:02.960 At the time, John Wheatley observed, in England, Scotland and Ireland, in Denmark and in Austria, scarcely anything but paper is visible. 183 00:23:02.960 --> 00:23:09.960 And during the remainder of that century, things did not change much. England alone among the major nations was on the gold standard during the greater part of the 19th century, and banknotes of the Bank of England played an important role in the development of the world. 184 00:23:32.960 --> 00:23:38.640 played a much greater role in monetary exchanges than specie. In fact, the reserve ratio of 185 00:23:38.640 --> 00:23:44.120 the bank seems to have been around 3% for most of the time, and occasionally it was 186 00:23:44.120 --> 00:23:52.120 even lower. Jacob Weiner emphasizes that the pre-World War I gold standard was not fundamentally 187 00:23:52.120 --> 00:23:58.260 different from the interwar gold exchange standard. It was a managed standard. This 188 00:23:58.260 --> 00:24:04.280 This attenuates the thesis of Jacques Rouff that the gold exchange standard introduced 189 00:24:04.280 --> 00:24:11.420 something like a quantum leap deterioration into the international monetary system. 190 00:24:11.420 --> 00:24:17.740 In short, the monetary constitutions of the 19th century were not perfect and neither 191 00:24:17.740 --> 00:24:24.260 would the monetary thought of the classical economist satisfy us today. David Hume believed 192 00:24:24.260 --> 00:24:29.860 that inflation could stimulate production in the short run, Adam Smith believed that 193 00:24:29.860 --> 00:24:35.340 inflation in the form of credit expansion was beneficial if it was backed up with a 194 00:24:35.340 --> 00:24:42.820 corresponding amount of real goods, and Jean-Baptiste Say similarly endorsed expansions of the quantity 195 00:24:42.820 --> 00:24:49.320 of money that accommodated the needs of commerce. Smith and Ricardo suggested increasing the 196 00:24:49.320 --> 00:24:57.600 The Wealth of the Nation by substituting inherently valueless paper tickets for metallic money. 197 00:24:57.600 --> 00:25:04.560 John Stuart Mill championed the notion that sound money means money of stable value. 198 00:25:04.560 --> 00:25:10.640 These errors in the monetary thought of Hume, Smith, Ricardo and Mill were, of course, almost 199 00:25:10.640 --> 00:25:16.920 negligible in comparison to their central insight, to repeat, that the wealth of a nation 200 00:25:16.920 --> 00:25:21.480 does not depend on changes in the quantity of money. 201 00:25:21.480 --> 00:25:27.360 But eventually a new generation of students infected with the virus of statism, worship 202 00:25:27.360 --> 00:25:34.480 of the state, rushed over that central insight and thus the errors of the classical economist 203 00:25:34.480 --> 00:25:39.240 rather than their science triumphed in the 20th century. 204 00:25:39.240 --> 00:25:46.800 Men such as Irving Fischer, Newt Wixel, Carl Helfrich, Friedrich Bendixson, Gustav Kassel 205 00:25:46.800 --> 00:25:55.500 and especially John Maynard Keynes set out on a relentless campaign against the gold standard. 206 00:25:55.500 --> 00:26:00.600 These champions of inflation conceded the insight of the classical economist that the 207 00:26:00.600 --> 00:26:04.620 wealth of a nation did not depend on its money supply. 208 00:26:04.620 --> 00:26:09.100 But they argued that this was true only in the long run. 209 00:26:09.100 --> 00:26:13.940 In the short run, the printing press could work wonders, it could reduce unemployment 210 00:26:13.940 --> 00:26:17.600 and stimulate production and economic growth. 211 00:26:17.600 --> 00:26:21.260 Who could reject such a horn of plenty and why? 212 00:26:21.260 --> 00:26:27.100 Most economists point out the cost of inflation in terms of loss of purchasing power. 213 00:26:27.100 --> 00:26:33.900 Estimates run as high as a 98% reduction of the U.S. dollar's purchasing power since the 214 00:26:33.900 --> 00:26:37.500 Federal Reserve took control of the money supply. 215 00:26:37.500 --> 00:26:44.300 What is less well known are the concomitant effects of the century-long great dollar inflation. 216 00:26:44.300 --> 00:26:49.580 Paper money has produced several great crises, each of which turned out to be more severe 217 00:26:49.580 --> 00:26:51.500 than the preceding one. 218 00:26:51.500 --> 00:26:59.000 Moreover, paper money has completely transformed the financial structure of the Western economies. 219 00:26:59.000 --> 00:27:04.740 At the beginning of the 20th century, most firms and industrial corporations were financed 220 00:27:04.740 --> 00:27:11.060 out of their revenues and banks and other financial intermediaries played only a subordinate 221 00:27:11.060 --> 00:27:12.060 role. 222 00:27:12.060 --> 00:27:17.340 Today, the picture has been reversed and the most fundamental reason for this reversal 223 00:27:17.340 --> 00:27:19.540 is paper money. 224 00:27:19.540 --> 00:27:26.980 Paper money has caused an unprecedented increase of debt on all levels, government, corporate 225 00:27:26.980 --> 00:27:28.380 and individual. 226 00:27:28.380 --> 00:27:35.660 It has financed the growth of the state on all levels, federal, state and local. 227 00:27:35.660 --> 00:27:42.820 It thus has become the technical foundation for the totalitarian menace of our days. 228 00:27:42.820 --> 00:27:48.900 In the light of these long-term consequences of inflation, its alleged short-run benefits 229 00:27:48.900 --> 00:27:54.640 lose much of their attractiveness, but the great irony is that even these short-run benefits 230 00:27:54.640 --> 00:28:01.760 in terms of employment and growth are illusory. Sober reflection shows that there are no 231 00:28:01.760 --> 00:28:08.880 systematic short-run benefits of inflation at all. In other words, whatever benefits 232 00:28:08.880 --> 00:28:15.240 might result from inflation are largely the accidental result of inflation hitting a particularly 233 00:28:15.240 --> 00:28:20.540 favorable set of circumstances, and we have no reason to assume that these accidental 234 00:28:20.540 --> 00:28:27.240 Short-run benefits are more likely to occur than accidental harm, quite to the contrary. 235 00:28:27.240 --> 00:28:33.180 The main impact of inflation is to bring about a redistribution of resources. 236 00:28:33.180 --> 00:28:39.740 There are therefore short-run benefits for certain members of society, but these benefits 237 00:28:39.740 --> 00:28:44.400 balanced by short-run losses for other citizens. 238 00:28:44.400 --> 00:28:50.220 The great French economist, Frederic Bastiat, made the quite general point that the visible 239 00:28:50.220 --> 00:28:57.300 All blessings that result from government intervention into the market economy are in fact only one 240 00:28:57.300 --> 00:29:02.340 set of consequences that follow from this intervention. 241 00:29:02.340 --> 00:29:07.600 But there is another set of consequences that the government does not like to talk about 242 00:29:07.600 --> 00:29:12.100 because they demonstrate the futility of the intervention. 243 00:29:12.100 --> 00:29:18.540 When the government taxes its citizens to give subsidies to a steel producer, the benefits 244 00:29:18.540 --> 00:29:26.340 Interest to the steel firm, its employees and stockholders are patent, but other interests 245 00:29:26.340 --> 00:29:29.580 have suffered from the intervention. 246 00:29:29.580 --> 00:29:36.780 In particular, the taxpayers have less money to patronize other businesses, and these other 247 00:29:36.780 --> 00:29:43.780 businesses and their customers are also harmed by the policy because the steel firm is now 248 00:29:43.780 --> 00:29:50.780 and so it is with inflation. There is absolutely no reason why an increase in the quantity of money should create more rather than less growth. It is true that the firms who receive money fresh from the printing press are thereby benefitted. 249 00:30:13.780 --> 00:30:25.780 But other firms are harmed by the very same fact because they can no longer pay the higher prices for wages and rents that the privileged firm can now pay. 250 00:30:25.780 --> 00:30:38.780 And all other owners of money, whether they are entrepreneurs or workers, are harmed too because their money now has a lower purchasing power than it would otherwise have had. 251 00:30:38.780 --> 00:30:46.780 Similarly, there is no reason why inflation should ever reduce, rather than increase, unemployment. 252 00:30:46.780 --> 00:30:52.780 People become unemployed or remain unemployed when they do not wish to work, 253 00:30:52.780 --> 00:30:59.780 or if they are forcibly prevented from working for the wage rate an employer is willing to pay. 254 00:30:59.780 --> 00:31:02.780 Inflation does not change this fact. 255 00:31:02.780 --> 00:31:32.780 What inflation does is to reduce the purchasing power of each money unit. If the workers anticipate these effects, they will ask for higher nominal wages as a compensation for the loss of purchasing power. In this case, inflation has no effect on unemployment, quite to the contrary, it can even have negative effects, namely if the workers overestimate the inflation-induced reduction of the purchasing power of each money unit. 256 00:31:32.780 --> 00:31:39.780 All plans to reduce unemployment through inflation, therefore, boil down to fooling the workers, a childish strategy, to say the least. 257 00:32:02.780 --> 00:32:09.780 The long-standing presence of mass unemployment in Germany, France, and other European countries 258 00:32:09.780 --> 00:32:14.780 seems to be a smashing refutation of the Keynesian hypothesis. 259 00:32:14.780 --> 00:32:21.780 If anything, the labor unions in these countries clearly seem to overestimate the inflation rate. 260 00:32:21.780 --> 00:32:27.780 For the same reason, inflation is no remedy for the problem of sticky wages, 261 00:32:27.780 --> 00:32:31.780 that is, for the problem of coercive labor unions. 262 00:32:31.780 --> 00:32:36.780 Wages are sticky only to the extent that the workers choose not to work. 263 00:32:36.780 --> 00:32:41.780 But the crucial question is, how long can they afford not to work? 264 00:32:41.780 --> 00:32:49.780 And the answer to this question is that this period is constrained within the very narrow limits of their savings. 265 00:32:49.780 --> 00:32:58.780 As soon as a worker's personal savings are exhausted, he willy-nilly starts offering his services even at lower wage rates. 266 00:32:58.780 --> 00:33:05.780 It follows that in a free labor market, wages are sufficiently flexible at any point of time. 267 00:33:05.780 --> 00:33:11.780 Stickiness comes into play only as a result of government intervention, in particular in the form of 268 00:33:11.780 --> 00:33:16.780 a. tax-financed unemployment relief and of 269 00:33:16.780 --> 00:33:21.780 b. legislation giving the labor unions a monopoly of the labor supply. 270 00:33:21.780 --> 00:33:25.780 Since we are not concerned here with questions of labor economics, 271 00:33:25.780 --> 00:33:30.780 We can directly turn to the connection between employment and monetary policy. 272 00:33:30.780 --> 00:33:34.780 Does inflation solve the problem of sticky wages? 273 00:33:34.780 --> 00:33:37.780 The answer is in the negative. 274 00:33:37.780 --> 00:33:40.780 And for the same reasons we pointed out above, 275 00:33:40.780 --> 00:33:44.780 inflation can overcome the problem of sticky wages only 276 00:33:44.780 --> 00:33:49.780 to the extent that the paper money producers can surprise the labor unions. 277 00:33:49.780 --> 00:34:02.780 To the extent that the latter anticipate the moves of the masters of the printing press, inflation will either not reduce unemployment at all or even increase it further. 278 00:34:02.780 --> 00:34:13.780 3. From the standpoint of the commonly shared interest of all members of society, the quantity of money is irrelevant. 279 00:34:13.780 --> 00:34:25.780 Any quantity of money provides all the services that indirect exchange can possibly provide, both in the long run and in the short run. 280 00:34:25.780 --> 00:34:32.780 This fact is the unshakable starting point for any sound reflection on monetary matters. 281 00:34:32.780 --> 00:34:38.780 And it is the most important criterion when it comes to dealing with deflation. 282 00:34:38.780 --> 00:34:52.780 In light of the principle discovered by the classical economist, we can say that deflation is certainly not what it is commonly alleged to be, a curse for all members of society. 283 00:34:52.780 --> 00:35:13.780 Deflation is a monetary phenomenon and, as such, it does affect the distribution of wealth among the individuals and various strata of society, as well as the relative importance of the different branches of industry, but it does not affect the aggregate wealth of society. 284 00:35:13.780 --> 00:35:34.780 Deflation is a drastic reduction of the quantity of money or of money substitutes, and it entails a precipitous decline of money prices. Such an event, be it ever so dramatic for a great number of individuals, is most certainly not a mortal threat for society as a whole. 285 00:35:34.780 --> 00:35:45.780 This is also recognized, implicitly at least, in the few works of management literature that deal with entrepreneurship in a deflationary environment. 286 00:35:45.780 --> 00:35:51.780 Imagine if all prices were to drop tomorrow by 50 percent. 287 00:35:51.780 --> 00:35:58.780 Would this affect our ability to feed, clothe, shelter and transport ourselves? 288 00:35:58.780 --> 00:36:08.780 It would not, because the disappearance of money is not paralleled by a disappearance of the physical structure of production. 289 00:36:08.780 --> 00:36:20.780 In a very dramatic deflation, there is much less money around than there used to be, and thus we cannot sell our products and services at the same money prices as before. 290 00:36:20.780 --> 00:36:46.780 But our tools, our machines, the streets, the cars and trucks, our crops and our food supplies, all this is still in place, and thus we can go on producing, and even producing profitably, because profit does not depend on the level of money prices at which we sell, but on the difference between the prices at which we sell and the prices at which we buy. 291 00:36:46.780 --> 00:36:56.140 In a deflation, both sets of prices drop and, as a consequence, for-profit production can go on. 292 00:36:56.140 --> 00:37:00.780 There is only one fundamental change that deflation brings about. 293 00:37:00.780 --> 00:37:05.340 It radically modifies the structure of ownership. 294 00:37:05.340 --> 00:37:11.980 Firms financed per credits go bankrupt because at the lower level of prices, 295 00:37:11.980 --> 00:37:19.980 is that they can no longer pay back the credits they had incurred without anticipating the deflation. 296 00:37:19.980 --> 00:37:25.980 Private households with mortgages and other considerable debts to pay back go bankrupt 297 00:37:25.980 --> 00:37:31.980 because with the decline of money prices their monetary income declines too, 298 00:37:31.980 --> 00:37:35.980 whereas their debts remain at the nominal level. 299 00:37:35.980 --> 00:37:48.980 The very attempt to liquidate assets to pay back debt entails a further reduction of the value of those assets, thus making it even more difficult for them to come even with their creditors. 300 00:37:48.980 --> 00:37:55.980 In the memorable words of Irving Fisher, the more the debtors pay, the more they owe. 301 00:37:55.980 --> 00:38:04.980 Yet from this correct observation, Fisher jumped to the fallacious statement that the liquidation defeats itself. 302 00:38:04.980 --> 00:38:11.940 Let us emphasize again that bankruptcies, irrespective of how many individuals are involved, do not 303 00:38:11.940 --> 00:38:17.700 affect the real wealth of the nation, and in particular that they do not prevent the 304 00:38:17.700 --> 00:38:21.140 successful continuation of production. 305 00:38:21.140 --> 00:38:27.900 The point is that other people will run the firms and own the houses, people who at the 306 00:38:27.900 --> 00:38:34.900 time the deflation set in were out of debt and had cash in their hands to buy firms and 307 00:38:34.900 --> 00:38:48.900 These new owners can run the firms profitably at the much lower level of selling prices because they bought the stock and will buy other factors of production at lower prices too. 308 00:38:48.900 --> 00:38:59.900 In short, the true crux of deflation is that it does not hide the redistribution going hand in hand with changes in the quantity of money. 309 00:38:59.900 --> 00:39:07.900 It entails visible misery for many people to the benefit of equally visible winners. 310 00:39:07.900 --> 00:39:16.900 This starkly contrasts with inflation, which creates anonymous winners at the expense of anonymous losers. 311 00:39:16.900 --> 00:39:24.900 Both deflation and inflation are, from the point of view we have so far espoused, zero-sum games. 312 00:39:24.900 --> 00:39:36.900 But inflation is a secret rip-off, and thus the perfect vehicle for the exploitation of a population through its false elites. 313 00:39:36.900 --> 00:39:42.900 Whereas deflation means open redistribution through bankruptcy according to the law. 314 00:39:42.900 --> 00:40:02.900 4. With these statements we could close our analysis. We have seen that deflation is not inherently bad and that it is therefore far from being obvious that a wise monetary policy should seek to prevent it or dampen its effects at any price. 315 00:40:02.900 --> 00:40:14.900 Deflation creates a great number of losers, and many of these losers are perfectly innocent people who have just not been wise enough to anticipate the event. 316 00:40:14.900 --> 00:40:30.900 But deflation also creates many winners, and it also punishes many political entrepreneurs who had thrived on their intimate connections to those who control the production of fiat money. 317 00:40:30.900 --> 00:40:39.900 Deflation is certainly not some sort of a reversal of a previous inflation that repairs the harm done in prior redistributions. 318 00:40:39.900 --> 00:40:47.900 It brings about a new round of redistribution that adds to the previous round of inflation-induced redistribution. 319 00:40:47.900 --> 00:40:58.900 But it would be an error to infer from this fact that a deflation following a foregoing inflation was somehow harmful from an economic point. 320 00:40:58.900 --> 00:41:02.900 Because it would involve additional redistributions. 321 00:41:02.900 --> 00:41:07.900 The point is that any monetary policy has redistributive effects. 322 00:41:07.900 --> 00:41:12.900 In particular, once a deflation of the supply of money substitutes sets in, 323 00:41:12.900 --> 00:41:18.900 the only way to combat this is through inflation of the supply of base money. 324 00:41:18.900 --> 00:41:25.900 And this policy, too, involves redistribution and thus creates winners and losers. 325 00:41:25.900 --> 00:41:37.900 It follows that there is no economic rationale for monetary policy to take up an ardent fight against deflation, rather than letting deflation run its course. 326 00:41:37.900 --> 00:41:46.900 Either policy does not benefit the nation as a whole, but merely benefits a part of the nation at the expense of other groups. 327 00:41:46.900 --> 00:41:53.140 No civil servant can loyally serve all of his fellow citizens through a hard-nosed stance 328 00:41:53.140 --> 00:41:59.500 against deflation, and neither can he invoke the authority of economic science to buttress 329 00:41:59.500 --> 00:42:01.540 such a policy. 330 00:42:01.540 --> 00:42:06.380 But there is also another point of view that merits consideration and which is in fact 331 00:42:06.380 --> 00:42:08.620 decisive for our problem. 332 00:42:08.620 --> 00:42:14.780 It results from the fact that in practice there are at any point in time two, and only 333 00:42:14.780 --> 00:42:18.780 There are only two fundamental options for monetary policy. 334 00:42:18.780 --> 00:42:23.780 The first option is to increase the quantity of paper money. 335 00:42:23.780 --> 00:42:29.780 The second option is not to increase the paper money supply. 336 00:42:29.780 --> 00:42:39.780 Now the question is how well each of these options harmonizes with the basic principles on which a free society is built. 337 00:42:39.780 --> 00:42:57.780 5. How would money be produced in a free society? Let us first observe that the fact that the quantity of money is irrelevant for the wealth of a nation must not be confused with the ideal of stabilizing the quantity of money. 338 00:42:57.780 --> 00:43:04.780 The latter ideal is in fact a spurious ideal and does not follow from the aforementioned fact. 339 00:43:04.780 --> 00:43:09.780 There is nothing wrong with increases or decreases of the quantity of money. 340 00:43:09.780 --> 00:43:17.780 The point is that such increases or decreases should not be mistaken to benefit society as a whole. 341 00:43:17.780 --> 00:43:22.780 Right and wrong in monetary policy does not concern the question, 342 00:43:22.780 --> 00:43:27.780 To which end should the quantity of money be modified? 343 00:43:27.780 --> 00:43:34.780 Rather, it concerns the question, who has the right to modify the quantity of money? 344 00:43:34.780 --> 00:43:43.780 And in a free society, the obvious answer is, all producers of money have the right to produce more money, 345 00:43:43.780 --> 00:43:49.780 and all owners of money have the right to use their property as they see fit. 346 00:43:49.780 --> 00:44:08.780 In a truly free society, the production of money is a matter of private initiative. Money is produced and sold just as any other commodity or service. And this means, in particular, that in a free society the production of money is competitive. 347 00:44:08.780 --> 00:44:16.460 It is a matter of mining precious metals and of minting coins, and both mining and minting 348 00:44:16.460 --> 00:44:22.420 are subject to the competition emanating from all other market participants. 349 00:44:22.420 --> 00:44:28.700 In selling his product, the money producer competes with all other people who own money 350 00:44:28.700 --> 00:44:32.580 and seek to buy the same goods that he desires. 351 00:44:32.580 --> 00:44:38.500 And in buying factors of production, the money producer competes with the producers of chairs, 352 00:44:38.500 --> 00:44:44.100 theatre performances, telephones, carpets, cars, and so on. 353 00:44:44.100 --> 00:44:50.100 In a word, in a free society the production of money is constrained within fairly narrow 354 00:44:50.100 --> 00:44:56.440 limits, limits that are determined by the willingness of other members of society to 355 00:44:56.440 --> 00:45:02.980 cooperate with our money producer rather than with someone else. 356 00:45:02.980 --> 00:45:07.060 What kind of money would prevail in a free society? 357 00:45:07.060 --> 00:45:29.060 All considerations and historical experience all point to the same answer. A free society would use precious metals as money. Payments would be made in coins made out of gold, silver, platinum, copper, or whatever other substance would combine scarcity with the physical advantages of these metals. 358 00:45:29.060 --> 00:45:49.060 By contrast, paper money has always been fiat money. That is, it has always been imposed by the coercive power of the state. It is not the money of the free market, but the money of a partially enslaved society. 359 00:45:49.060 --> 00:45:56.500 6. The production of money in a free society is a matter of free association. Everybody 360 00:45:56.500 --> 00:46:02.020 from the miners to the owners of the mines to the minters and up to the customers who 361 00:46:02.020 --> 00:46:08.080 buy the minted coins, all of them benefit from the production of money. None of them 362 00:46:08.080 --> 00:46:14.500 violates the property rights of anybody else because everybody is free to enter the mining 363 00:46:14.500 --> 00:46:20.820 in Minting Business, and nobody is obliged to buy the product. 364 00:46:20.820 --> 00:46:26.740 Things are completely different once returned to money production in interventionist regimes 365 00:46:26.740 --> 00:46:32.980 which have prevailed in the West for the better part of the past 150 years. 366 00:46:32.980 --> 00:46:39.740 Here we need to mention in particular two institutional forms of monetary interventionism, 367 00:46:39.740 --> 00:46:44.740 fraudulent, fractional reserve banking and fiat money. 368 00:46:44.740 --> 00:46:52.740 The common characteristic of both these institutions is that they violate the principle of free association. 369 00:46:52.740 --> 00:47:04.740 They enable the producers of paper money and of money titles to expand their production through the violation of other people's property rights. 370 00:47:04.740 --> 00:47:17.740 Banking is fraudulent whenever bankers sell uncovered or only partially covered money substitutes that they present as fully covered titles for money. 371 00:47:17.740 --> 00:47:29.740 These bankers sell more money substitutes than they could have sold if they had taken care to keep a 100% reserve for each substitute they issued. 372 00:47:29.740 --> 00:47:36.140 This point is, by the way, undisputed by all participants in the present debate on fractional 373 00:47:36.140 --> 00:47:38.020 reserve banking. 374 00:47:38.020 --> 00:47:43.480 In contrast to the present author, however, Lawrence White seems to believe that historical 375 00:47:43.480 --> 00:47:48.360 fractional reserve banking has rarely, if ever, been fraudulent. 376 00:47:48.360 --> 00:47:55.700 The producer of fiat money, in our days typically paper money, sells a product that cannot withstand 377 00:47:55.700 --> 00:48:08.700 The competition of free market monies such as gold and silver coins and which the market participants only use because the use of all other monies is severely restricted or even outlawed. 378 00:48:08.700 --> 00:48:18.700 The most eloquent illustration of this fact is that paper money in all countries has been protected through legal tender laws. 379 00:48:18.700 --> 00:48:25.700 Laws. Paper money is inherently fiat money. It cannot thrive but when it is imposed by 380 00:48:26.820 --> 00:48:33.820 the State. Notice that this point holds true only for genuine paper moneys, not necessarily 381 00:48:33.820 --> 00:48:40.820 for national paper currencies consisting of money substitutes backed by commodity money. 382 00:48:41.340 --> 00:48:47.620 Neither does our contention necessarily apply to credit moneys, such as the paper pound 383 00:48:47.620 --> 00:48:55.260 during the Napoleonic Wars. In both cases, the production of money is excessive because 384 00:48:55.260 --> 00:49:01.880 it is no longer constrained by the informed and voluntary association of the buying public. 385 00:49:01.880 --> 00:49:07.940 On a free market, paper money could not sustain the competition of the far superior metal 386 00:49:07.940 --> 00:49:12.820 monies. The production of any quantity of paper money is therefore excessive by the 387 00:49:12.820 --> 00:49:19.580 The standards of a free society. Similarly, fractional reserve banking produces excessive 388 00:49:19.580 --> 00:49:25.260 quantities of money substitutes at any rate in those cases in which the customers are 389 00:49:25.260 --> 00:49:31.420 not informed that they are offered fractional reserve bank deposits rather than genuine 390 00:49:31.420 --> 00:49:38.220 money titles. This excessive production of money and money titles is inflation by the 391 00:49:38.220 --> 00:49:45.220 and the Rothbardian definition, which we have adapted in the present study to the case of paper money. 392 00:49:45.220 --> 00:49:55.220 Inflation is an unjustifiable redistribution of income in favor of those who receive the new money and money titles first 393 00:49:55.220 --> 00:50:00.220 and to the detriment of those who receive them last. 394 00:50:00.220 --> 00:50:07.220 In practice the redistribution always works out in favor of the fiat money producers themselves 395 00:50:07.220 --> 00:50:15.220 which we misleadingly call Central Banks and of their partners in the banking sector and at the stock exchange. 396 00:50:15.220 --> 00:50:23.220 And of course inflation works out to the advantage of governments and their closest allies in the business world. 397 00:50:23.220 --> 00:50:34.220 Inflation is the vehicle through which these individuals and groups enrich themselves unjustifiably at the expense of the citizenry at large. 398 00:50:34.220 --> 00:50:51.220 If there is any truth to the socialist caricature of capitalism, an economic system that exploits the poor to the benefit of the rich, then this caricature holds true for a capitalist system strangulated by inflation. 399 00:50:51.220 --> 00:51:05.220 The relentless influx of paper money makes the wealthy and powerful richer and more powerful than they would be if they depended exclusively on the voluntary support of their fellow citizens. 400 00:51:05.220 --> 00:51:18.220 And because it shields the political and economic establishment of the country from the competition emanating from the rest of society, inflation puts a brake on social mobility. 401 00:51:18.220 --> 00:51:27.220 The rich stay rich longer and the poor stay poor longer than they would in a free society. 402 00:51:27.220 --> 00:51:33.220 In this regard, inflation works in an unholy alliance with the tax code. 403 00:51:33.220 --> 00:51:38.220 The main advantage of the successful newcomer is that he has high revenues, 404 00:51:38.220 --> 00:51:47.220 but present-day corporate and income tax rates effectively prevent him from accumulating capital quickly enough 405 00:51:47.220 --> 00:51:50.220 to sustain the competition of the establishment. 406 00:51:50.220 --> 00:51:58.220 As a result, there are virtually no more firms that make it from the very bottom into the major league of corporate capitalism. 407 00:51:58.220 --> 00:52:07.220 It took a technological revolution to overcome these obstacles and bring a few firms such as Microsoft to the top of corporate America. 408 00:52:07.220 --> 00:52:14.220 Most other firms are increasingly dependent on credit to finance any large-scale ventures. 409 00:52:14.220 --> 00:52:19.220 But financial intermediation is today a highly regulated business. 410 00:52:19.220 --> 00:52:24.220 And all major banks are already allied with the industrial establishment. 411 00:52:24.220 --> 00:52:31.220 What would be their incentive to finance a venture that destroys the value of some of their other holdings? 412 00:52:31.220 --> 00:52:36.220 A similar situation prevails in individual finance. 413 00:52:36.220 --> 00:52:39.220 Consider just the most important case of private debt. 414 00:52:39.220 --> 00:52:46.220 The result is that virtually nobody even thinks of financing a home the way it has been done in former times, namely, by first saving money and then paying for it. 415 00:53:09.220 --> 00:53:14.820 Paying for the house in cash and paper money has made it possible to always provide new 416 00:53:14.820 --> 00:53:17.740 credits for willing homeowners. 417 00:53:17.740 --> 00:53:22.620 The printing press of the Federal Reserve has fueled a housing boom just as it has fueled 418 00:53:22.620 --> 00:53:25.680 the 1990s boom of the stock market. 419 00:53:25.680 --> 00:53:29.740 The stock market boom has already ended in a resounding crash. 420 00:53:29.740 --> 00:53:32.580 The housing boom is next in line. 421 00:53:32.580 --> 00:53:40.100 The famous economist Joseph Schumpeter once presented inflation as the harbinger of innovation. 422 00:53:40.100 --> 00:53:46.700 As he had it, inflationary issues of banknotes would serve to finance upstart entrepreneurs 423 00:53:46.700 --> 00:53:49.900 who had great ideas but lacked capital. 424 00:53:49.900 --> 00:53:55.580 Now, even if we abstract from the questionable ethical character of this proposal, which 425 00:53:55.580 --> 00:54:02.540 boils down to subsidizing any self-appointed innovator at the involuntary expense of all 426 00:54:02.540 --> 00:54:05.540 and all other members of society. 427 00:54:05.540 --> 00:54:08.540 We must say that, in light of practical experience, 428 00:54:08.540 --> 00:54:11.540 Schumpeter's scheme is wishful thinking. 429 00:54:11.540 --> 00:54:14.540 Credit expansion financed through printing money 430 00:54:14.540 --> 00:54:17.540 is in practice the very opposite of a way 431 00:54:17.540 --> 00:54:20.540 to combat the economic establishment. 432 00:54:20.540 --> 00:54:23.540 It is the preferred means of survival 433 00:54:23.540 --> 00:54:27.540 for an establishment that cannot or can no longer 434 00:54:27.540 --> 00:54:31.540 sustain the competition of its competitors. 435 00:54:31.540 --> 00:54:42.540 It would not be uncharitable to characterize inflation as a large-scale rip-off in favor of the politically well-connected few 436 00:54:42.540 --> 00:54:47.540 and to the detriment of the politically destitute masses. 437 00:54:47.540 --> 00:54:56.540 It always goes in hand with the concentration of political power in the hands of those who are privileged to own a banking license 438 00:54:56.540 --> 00:55:18.560 7. 439 00:55:18.560 --> 00:55:25.100 Inflation in the form of fractional reserve banking and fiat money is ultimately a self-defeating 440 00:55:25.100 --> 00:55:32.900 Practice, it bears in itself the germs of its own destruction and as we shall see deflation 441 00:55:32.900 --> 00:55:36.740 is the essential vehicle of this destruction. 442 00:55:36.740 --> 00:55:43.120 We can distinguish three scenarios of the halt of inflationary processes. 443 00:55:43.120 --> 00:55:49.100 Fractional reserve banking melts down whenever and for whatever reason a sufficiently big 444 00:55:49.100 --> 00:55:55.300 A significant number of bank customers decide to demand redemptions of their deposits. 445 00:55:55.300 --> 00:56:01.020 Any increase of the quantity of money can engender a sequence of boom and bust. 446 00:56:01.020 --> 00:56:08.520 If A, the new money first reaches the capital markets and if B, the entrepreneurs do not 447 00:56:08.520 --> 00:56:14.100 anticipate that the new money will lead to a rise in prices over the level they would 448 00:56:14.100 --> 00:56:16.140 otherwise have reached. 449 00:56:16.140 --> 00:56:22.680 The erroneous calculations of the entrepreneurs lead them to shift resources from sustainable 450 00:56:22.680 --> 00:56:28.760 investment projects into ones that cannot be completed with the available quantities 451 00:56:28.760 --> 00:56:31.320 of factors of production. 452 00:56:31.320 --> 00:56:38.920 And the erroneous calculations are also reflected in, not caused by, a below equilibrium interest 453 00:56:38.920 --> 00:56:40.340 rate. 454 00:56:40.340 --> 00:56:46.440 When the market participants discover their errors, the more or less large number of unsustainable 455 00:56:46.440 --> 00:56:52.500 firms goes bankrupt, thus upsetting the balance sheets of the banks and entailing a financial 456 00:56:52.500 --> 00:56:54.060 meltdown. 457 00:56:54.060 --> 00:56:59.860 First, there can be a liquidity crisis of the fractional reserve banking system that 458 00:56:59.860 --> 00:57:06.500 ends up in a bank run, that is, in a sharp decline of the demand for money substitutes. 459 00:57:06.500 --> 00:57:12.420 The concomitant drastic reduction of the money supply entails a corresponding decrease of 460 00:57:12.420 --> 00:57:18.620 money prices, which negatively affects all market participants who have financed their 461 00:57:18.620 --> 00:57:21.740 operations through debt. 462 00:57:21.740 --> 00:57:28.740 The lower nominal selling receipts after the run do not suffice to pay back the debts contracted 463 00:57:28.740 --> 00:57:32.780 at the higher nominal price level of the past. 464 00:57:32.780 --> 00:57:38.580 This in turn jeopardizes the positions of many creditors who, when they do not get their 465 00:57:38.580 --> 00:57:42.980 money back, cannot pay back their creditors. 466 00:57:42.980 --> 00:57:49.060 Thus, the liquidity crisis of our fractional reserve banks entails a general financial 467 00:57:49.060 --> 00:57:50.540 meltdown. 468 00:57:50.540 --> 00:57:56.620 Rock bottom is reached in a commodity money system when all money substitutes have vanished 469 00:57:56.620 --> 00:58:02.200 and the market participants have turned to using the money commodity itself or use competing 470 00:58:02.200 --> 00:58:32.200 After the deflation has cleaned up the economic landscape, fractional reserve banking and other forms of financial intermediation will play a less-significant role in the economy. Firms and individuals will, at the margin, turn to financing whatever purchases they make, through personal savings. In short, financial decision-making will be the most important part of the economy. 471 00:58:32.200 --> 00:58:56.200 This first scenario was very common in the 19th century and up to the Great Depression, which, according to Irving Fisher in the early Chicago School, was all about debt deflation entailed by liquidity crisis of fractional reserve banking. 472 00:58:56.200 --> 00:59:09.200 The scenario became less important after the introduction of deposit insurance which for all practical purposes established 100% reserve banking in the U.S. 473 00:59:09.200 --> 00:59:15.200 Notice that in the Great Depression deflation was not allowed to complete its work. 474 00:59:15.200 --> 00:59:25.200 The Fed inflated the economy after deflation had destroyed a great number of banks, reducing their total number to some 15,000. 475 00:59:25.200 --> 00:59:50.200 These select few, protected by Federal deposit insurance, then surfed on the Fed created inflation and expanded their total assets from $51.4 billion in 1933 to $242.6 billion in 1957. 476 00:59:50.200 --> 00:59:56.640 It could have some relevance, however, in explaining the more recent financial crises 477 00:59:56.640 --> 01:00:03.700 in Russia, Brazil, Argentina and certain Asian countries, in particular if the currencies 478 01:00:03.700 --> 01:00:09.360 of these countries at the time of the crisis could be interpreted as money substitutes 479 01:00:09.360 --> 01:00:11.480 for U.S. dollars. 480 01:00:11.480 --> 01:00:19.400 Second, there can be inter-temporal misallocations of resources when fraudulent fractional reserve 481 01:00:19.400 --> 01:00:26.160 Banks increase the money supply and thereby depress market interest rates below their 482 01:00:26.160 --> 01:00:28.920 equilibrium level. 483 01:00:28.920 --> 01:00:34.700 Then entrepreneurs invest too many of the available resources high up in the physical 484 01:00:34.700 --> 01:00:41.840 production chain and not enough resources in the lower stages of the structure of production. 485 01:00:41.840 --> 01:00:47.600 The result becomes visible after some time when a more or less great number of firms 486 01:00:47.600 --> 01:00:53.760 Banks must file bankruptcy. This in turn jeopardizes their creditors, in particular fractional 487 01:00:53.760 --> 01:00:59.200 reserve banks and leads to the chain of events we described above. The difference between 488 01:00:59.200 --> 01:01:07.160 the second and the first scenario is in the causation of the bank run. In the former, 489 01:01:07.160 --> 01:01:13.040 the bank run starts more or less by accident when one major market participant, be it out 490 01:01:13.040 --> 01:01:20.280 A lot of negligence or due to unforeseen contingencies fails and pulls down a house of cards. 491 01:01:20.280 --> 01:01:25.860 By contrast, in the scenario we are now considering, the bank run is the necessary consequence 492 01:01:25.860 --> 01:01:31.940 of a previous misallocation of resources that resulted from a fraudulent increase of the 493 01:01:31.940 --> 01:01:34.380 money supply. 494 01:01:34.380 --> 01:01:42.180 The question whether this scenario applied to any historical crisis is somewhat controversial. 495 01:01:42.180 --> 01:01:47.280 Many Austrian economists believe it fits the Great Depression and several other economic 496 01:01:47.280 --> 01:01:49.460 crises of the past. 497 01:01:49.460 --> 01:01:54.460 At any rate, it is certainly a conceivable scenario, and it also involves a heavy dose 498 01:01:54.460 --> 01:01:56.900 of money-substitute deflation. 499 01:01:56.900 --> 01:02:05.220 Hence, in this scenario, too, inflation ends up in a deflationary meltdown of the old ways 500 01:02:05.220 --> 01:02:06.820 of finance. 501 01:02:06.820 --> 01:02:15.540 The share of banking and financial intermediation in overall economic activity will be reduced, 502 01:02:15.540 --> 01:02:20.900 and financial decision-making will be even more conservative and decentralized than it 503 01:02:20.900 --> 01:02:22.780 is anyway. 504 01:02:22.780 --> 01:02:28.020 The two foregoing scenarios both involve a more or less sudden decline of the demand 505 01:02:28.020 --> 01:02:33.860 for money substitutes, which entail a more or less rapid physical disappearance of these 506 01:02:33.860 --> 01:02:41.060 and substitutes from circulation, as market participants switch to using base money. 507 01:02:41.060 --> 01:02:48.540 By contrast, in the case of paper money, it is very unlikely that there will ever be a 508 01:02:48.540 --> 01:02:54.780 rapid deflation in our definition, a reduction of the money supply. 509 01:02:54.780 --> 01:03:00.740 The reason is that paper money is protected through legal tender laws and other legislation. 510 01:03:00.740 --> 01:03:07.580 Market leaves barter as the only legal alternative to using paper money, and barter is so much 511 01:03:07.580 --> 01:03:14.580 less beneficial than monetary exchange that market participants typically prefer using 512 01:03:14.580 --> 01:03:19.320 even very inflationary monies rather than turning to barter. 513 01:03:19.320 --> 01:03:24.440 In all known cases, it was only under extreme duress when the purchasing power of their 514 01:03:24.440 --> 01:03:48.440 The foregoing three scenarios cover probably most historical cases in which inflation has been brought to an end. 515 01:03:48.440 --> 01:04:08.440 If we tie this up with our comparative analysis of free and compulsory production of money and money substitutes, we come to the conclusion that deflation is not a mere redistribution game that benefits some individuals and groups at the expense of other individuals and groups. 516 01:04:08.440 --> 01:04:32.440 Rather, deflation appears as a great harbinger of liberty. It stops inflation and destroys the institutions that produce inflation. It abolishes the advantage that inflation-based debt finance enjoys at the margin over savings-based equity finance. 517 01:04:32.440 --> 01:04:46.440 and it therefore decentralizes financial decision-making and makes banks, firms and individuals more prudent and self-reliant than they would have been under inflation. 518 01:04:46.440 --> 01:04:57.440 Most importantly, deflation eradicates the re-channeling of incomes that result from the monopoly privileges of central banks. 519 01:04:57.440 --> 01:05:03.960 It thus destroys the economic basis of the false elites and obliges them to become true 520 01:05:03.960 --> 01:05:10.000 elites rather quickly or abdicate and make way for new entrepreneurs and other social 521 01:05:10.000 --> 01:05:11.440 leaders. 522 01:05:11.440 --> 01:05:17.920 It is highly significant that the authors of the 1931 Macmillan Report, which analyzed 523 01:05:17.920 --> 01:05:25.520 the worldwide financial crisis of the time, recognized and emphasized that deflation was 524 01:05:25.520 --> 01:05:43.520 is foremost a political problem. They clearly saw that deflation brings down the politico-economic establishment, which thrives on inflation and debts, and that it therefore brings about some circulation of the elites. 525 01:05:43.520 --> 01:05:59.520 The late Lord Keynes and his co-authors, among them several leaders of the London banking industry and of the British cooperative and labour union movements, were of course convinced that their country could not do without them. 526 01:05:59.520 --> 01:06:15.520 Deflation puts a break, at the very least a temporary break, on the further concentration and consolidation of power in the hands of the federal government and in particular in the executive branch. 527 01:06:15.520 --> 01:06:21.520 It dampens the growth of the welfare state if it does not lead to its outright implosion. 528 01:06:21.520 --> 01:06:27.520 In short, deflation is at least potentially a great liberating force. 529 01:06:27.520 --> 01:06:32.520 It not only brings the inflated monetary system back to rock bottom, 530 01:06:32.520 --> 01:06:36.520 it brings the entire society back in touch with the real world 531 01:06:36.520 --> 01:06:43.520 because it destroys the economic basis of the social engineers, spin doctors and brainwashers. 532 01:06:43.520 --> 01:06:50.520 In light of these considerations, deflation is not merely one fundamental policy option 533 01:06:50.520 --> 01:07:13.360 The case of Japan might serve as a warning counter-example. 534 01:07:13.360 --> 01:07:19.800 The severe Japanese recession of the early 1990s was both an economic and a political 535 01:07:19.800 --> 01:07:25.280 threat to the establishment. In Japan, the process of consolidation and centralization 536 01:07:25.280 --> 01:07:31.160 of power started right after World War II, when the economic experts within the U.S. 537 01:07:31.160 --> 01:07:39.160 occupation forces imposed Keynesian and socialist policies on their former enemy. By the late 538 01:07:39.160 --> 01:07:44.960 1980s, the process had advanced to such an extent that it was politically impossible 539 01:07:44.960 --> 01:07:49.760 to allow deflation to cleanse the economy and politics. 540 01:07:49.760 --> 01:07:56.760 The Japanese governments of the 1990s sought to fix the economic crisis through increasingly 541 01:07:56.760 --> 01:07:59.740 heavy doses of inflation. 542 01:07:59.740 --> 01:08:06.780 But the only result of this policy was to give a zombie life to the hopelessly bureaucratic 543 01:08:06.780 --> 01:08:13.340 and bankrupt conglomerates that control Japanese industry, banking and politics. 544 01:08:13.340 --> 01:08:20.540 After almost 15 years of mindless inflation, Japan's economic crisis has turned into a 545 01:08:20.540 --> 01:08:27.020 fundamental political crisis that sooner or later will bring the country onto the verge 546 01:08:27.020 --> 01:08:29.180 of revolution. 547 01:08:29.180 --> 01:08:34.340 This is also what will happen to the West if the citizens of our countries let their 548 01:08:34.340 --> 01:08:38.540 governments have a free hand in monetary affairs. 549 01:08:38.540 --> 01:08:48.540 8. In conclusion, let us restate the main points. Deflation is far from being inherently bad. 550 01:08:48.540 --> 01:08:57.540 Quite to the contrary, it fulfills the very important social function of cleansing the economy and the body politic 551 01:08:57.540 --> 01:09:03.540 from all sorts of parasites that have thrived on the previous inflation. 552 01:09:03.540 --> 01:09:11.040 In a word, the dangers of deflation are chimerical, but its charms are very real. 553 01:09:11.040 --> 01:09:18.040 There is absolutely no reason to be concerned about the economic effects of deflation, 554 01:09:18.040 --> 01:09:24.040 unless one equates the welfare of the nation with the welfare of its false elites. 555 01:09:24.040 --> 01:09:31.040 There are, by contrast, many reasons to be concerned about both the economic and political consequences 556 01:09:31.040 --> 01:09:41.040 of the only alternative to deflation, namely, reinflation, which is, of course, nothing but inflation, pure and simple. 557 01:09:41.040 --> 01:09:47.040 The purpose of these pages is not to appeal to the reason of our monetary authorities. 558 01:09:47.040 --> 01:09:54.040 There is absolutely no hope that the Federal Reserve or any other fiat money producer of the world 559 01:09:54.040 --> 01:09:58.040 will change their policies anytime soon. 560 01:09:58.040 --> 01:10:05.040 But it is time that the Friends of Liberty change their minds on the crucial issue of deflation. 561 01:10:05.040 --> 01:10:13.040 False thinking on this point has given our governments undue leeway, of which they have made ample and bad use. 562 01:10:13.040 --> 01:10:20.040 Ultimately, we need to take control over the money supply out of the hands of our governments 563 01:10:20.040 --> 01:10:27.040 and make the production of money again, subject to the principle of free association. 564 01:10:27.040 --> 01:10:44.040 The first step to endorsing and promoting this strategy is to realize that governments do not, indeed cannot, fulfill any positive role whatever through the control of our money.