Thank you ladies and gentlemen for coming out for today's program.
I wondered when I was thinking ahead to this day whether we'd have a crowd because we came
last year and told you about Austrian economics and its application to history and so you've
heard this before, you know, maybe you wouldn't come this year but we live in extraordinarily
Interesting Times, just looking through the Wall Street Journal at breakfast this morning,
I was struck by how many major stories were there. In more normal times, you'd pick up
the morning paper and you'd look and there might be one thing that seemed to have some
importance and then a lot of other material of minor news events, but now it's as if every
Every day, hell breaks loose. What next? It's really too interesting for me. I'm getting
too old to cope with this much excitement. I'd like to see it calm down a little bit,
but I don't think we can expect to see that soon. Unfortunately, one of the things that
What has struck me after spending many years studying what happens during crises of this
sort is that there's a pattern, there's a logic to how they unfold, to how the state
responds to war, to economic collapse, to any kind of major threat, and unfortunately
We are now in the midst of the unfolding of another one of these patterns, and I'm sorry
to report that so far it's going very much according to form. So there's other bad news
that will be coming into play, and I'm praying that it won't be as bad as I fear it will
Now, the title of my talk today, Death Fuel, I can't take credit for, Lew Rockwell, I believe, was the one who selected that title.
I'm not an inflammatory guy. I don't choose flamboyant titles like that.
and I go for the boring and you'll see that soon enough but anyhow, death fuel is an apt title so I didn't object when Lew gave it that title, death and taxes we're told are two unavoidable things and we're in a recession now,
Now times are hard and we're all looking for a bargain so I thought I could offer you two
for one. What a deal. I'll give you death and taxes all rolled into one which is to
say war. War is my subject. You not only get death and taxes together but you get both
both of them in extraordinary amounts. So, such a deal. It's no wonder people keep going back for more time and again.
I've got an old friend, Larry Neal, who taught for many years at the University of Illinois.
He put together, about ten years ago, a documentary collection called War Finance.
and this was published in some obscure collection and I'm sure that no one's
ever looked at it except maybe a few librarians who put it on the shelf but
it's an extremely interesting collection three huge volumes probably 2,500 words
I mean, pages, 2,500 pages, and what Larry did was bring together analyses by historians and economists of how wars have been paid for over the last couple of thousand years or so.
And one of the things that just jumps out at you when you examine these materials is that
The history of war and the history of taxation are virtually one in the same.
I find it hard to think of any innovation in taxation, any new form of taxation, any new way of collecting taxes,
that was not brought into being as part of a government scheme to pay for a war.
Wars put governments to the test, and when governments decide to go to war, unless it's a small war that can be fought out of military inventory,
government is in a position where it has to quite quickly transfer resources from their current uses,
and from the hands of their current possessors and owners
into its own hands for military uses, direct or indirect.
So war requires an abrupt seizure, if you like, of resources by the state.
And that always creates a problem.
The problem, even if the public is generally inclined to favor the war du jour, nonetheless,
each individual tends to disfavor the seizure of his own property. And the more that's seized,
the more people dislike it. Now, governments will always raise regular taxes when they
They go to war in a variety of ways, in major wars.
They will raise old tax rates, adopt new forms of taxation.
But whenever they do that, they're always, as it were, creating tension or having to
deal with the tension that exists between they being the taker and someone else suffering
by being the takee. So there's a kind of a conflict built into every episode of war and its financed by the state.
And the government must find ways to overcome that resistance and proceed if it's going to undertake the war it intends to undertake.
I'm going to focus today on what has been the most common way for government to deal
with this problem or situation it confronts when it goes to war.
And that is to not only create new taxes and raise old tax rates, but to employ the most
Most insidious of all forms of taxation, which is the inflation tax.
So when we look at the history of inflation, again, it's the history of war.
If you looked at a long graph of the general level of prices in the United States over
Over the last 250 years, you'd see, well, for a long time, basically a straight line
with slow ups and downs, and then in the 20th century, a fairly smooth upward sloping line
as the dollar has been progressively diminished in purchasing power, but imposed on those
smooth long-term lines, you would see spikes from time to time.
Every one of those spikes is war.
Every one of them.
It's never been a major inflation comparable to the wartime spikes at any other time in our history.
So we know that death and taxes go together, which means war and inflation go together.
I'm going to show you some of the evidence.
I accumulated on this subject with regard to the two most outstanding episodes in American history, the World Wars.
They were both large-scale affairs in terms of the resources the government seized to carry out the war.
World War I, of course, was by far the smaller of the two, but it was a big deal at the time.
There's a kind of simple rule of thumb, if you want to remember it, about the costs of war in our history.
Go back to the war between the states, which cost something in the neighborhood of $3 billion,
and that was an enormous undertaking at the time and and is still the greatest
war in all of our history in terms of the number of deaths occasioned because
there were more than 600,000 deaths on the two sides in that war and that's a
greater number of deaths than in any of the other US wars but in terms of
of Finances, about three billion dollars for the Civil War, and then just multiply that
by ten, and you get in the neighborhood of thirty billion dollars, that's roughly the
cost of World War I, actually it's a little more, about thirty-three, and then you go
to World War II, multiply it by ten again, so that you get somewhere in the neighborhood
$300 billion for World War II. So it's as if there's an exponential function at work here as we move from one major war to the next that you can multiply the cost by a factor of 10.
And even recently with the relatively small-scale US warfare in Iraq and Afghanistan, the costs have been enormous, considering that the number of men and the amount of material and so forth is nothing like the scale of World War II,
that the government has managed to spend in the neighborhood of a trillion dollars already
with no end in sight and according to some estimates considerably more than that because
some of the costs are, if you put them in present value terms for costs the government
the
future, particularly caring for wounded personnel, then they bulk up very, very large indeed.
But at all events, World War I, which I'll start with, was a big deal at the time. Now
what you can see in this series of numbers, and if you can't see them easily in the back
of the room, I'll tell you what I want you to get from them. First of all, you say that
First of all, you see that the federal outlays in that second column, the federal government before World War I never spent, except during the war between the states, never spent more than a billion dollars.
and so these these figures are in millions of dollars or I'm sorry billions
of dollars here and so you see back here kind of a small-scale federal
government in those days federal spending amounted to something like two
2-3% of the gross domestic product. Now when the U.S. begins to engage in the war, 1917 is an active belligerent, the spending rises hugely, very abruptly, and as you can see, the big year is 1919 when the war is over, because a lot of the costs the government undertook,
to say, purchase ships, airplanes and other things, involve projects that were not complete
at the time the war ended in November 1918 and so the government carried over a lot of
purchases into the following year before it began to cut back.
You'll also notice that when it did cut back, the level of government outlays in the 1920s
was in the neighborhood of around three billion dollars a year then and so it's
roughly three times what it was before the war that's what I call the ratchet
effect or one illustration of the ratchet effect so that even after the
influence of the war had come and gone the government ended up much bigger than
was before and similarly with the level of taxation as you see but if you look
here the government is going to have to get more than 20 times bigger here in a
period of two to three years how does it do that well it raised taxes you can see
The federal taxes went up a great deal. They're, what, six, seven times higher here by the time the war is over than they were before the war.
So there was no doubt the government raised a lot of tax revenue. It did that in a variety of ways.
The Federal Income Tax, you'll remember, was just put into operation in 1913 after ratification of the 16th Amendment.
And so the Income Tax was available now, and when the tax was first discussed before the law was passed in 1913,
Of course, people worried, you know, they said, this is going to turn out to be a way
the government confiscates a lot of income, but its supporters said, no, no, no, not to
worry.
This is just a way of making sure that the rich pay their fair share.
So in fact, the first income tax law in 1913, 14, 15 had rates that ran from 1% of taxable
Income, up to a maximum of 7%. And 7%. Well, maybe if you were J.P. Morgan or Rockefeller,
that was something you didn't sneeze at, but you almost had to be Rockefeller before you
were subject to 7% tax rate for the federal income tax in 1913. And about 98% of the people
The people of the country didn't have to pay any federal income tax. So, it did look like a tax on the rich. But, once the government got into the war, the income tax was pushed down so that it applied to people with much lower incomes and the rates were raised. In fact, they were raised so much that the top rate was pushed from 7% to 77%.
Feller, you took notice. It was nothing to sneeze at, but as you'll see, despite this
substantial increase in federal receipts, which brought in about an additional three billion
a year or more, the government didn't come close to meeting the increase in its outlays.
So it had to borrow a huge amount of money. Now, if you want to go into the bond market
and sell $20 billion worth of debt in 1917-18, you're going to drive the bond price down
real low and the interest rate way up. It's going to cost you a great deal to finance
since that war. So it behooves you to find a way to ease credit conditions. And that's
where the new Federal Reserve system came into play. Also created in 1913, that most
auspicious year, ratification of the 16th Amendment, first federal income tax law of
of the Modern Era, there was a brief one in the Civil War era, and the creation of the Federal Reserve System in December 1913.
So you've got two institutions there without which our history in the past almost 100 years would be unthinkable.
No income tax, no Fed, cannot imagine our history without those two crucial state institutions.
So we've got to ease credit and the way it was done was that the rules were changed for the Fed and the banks.
When the Fed was created, a bank that wanted to borrow from the Fed had to have collateral
And it had to have commercial paper, basically. It had to have some business IOU, short term, usually 90 days or less, a very low risk form of commercial obligation.
And it could put that stuff up and borrow temporary reserves from the Federal Reserve Bank.
But during the war, the government changed the rules so that the banks could use US government bonds.
as Collateral. Well that was handy because the government was trying to sell a lot of U.S. government bonds and so by that measure and by others including by reducing the interest rate, the Federal Reserve Bank's charge to commercial bank borrowers, credit was made very easy and a lot of that new credit that was infused into
to the banking system spilled over into the form of demand for U.S. government debt,
allowing the government to finance its expenditures with much lower interest rates than it would
have otherwise had to pay.
Now the upshot of this is of course that the amount of banking reserves is rising and that
is allowing the banking system to create a greater volume of money and they're doing it and you see that here in this column where the money stock increases between 1915 and 1920 by exactly 100% or almost exactly, close enough for government work.
And when you increase the money stock abruptly like that, you can expect that the general level of prices will be driven up in roughly equal proportion.
And in this case, we have a textbook illustration of the quantity theory of money, because if you look at the GDP deflator,
which is the most general price index, it's the price index for all goods and services
being newly produced. What you see between 1915 and 1920 is precisely 100% increase in
the level of prices. So it's just a perfect fit for the quantity theory of money here
in World War I. You double the money, you double the price level. This is a consumer
price index charted here and what you see is this wartime increase showing up in the
chart here is a doubling of the consumer price level and a little more. And then you see
World War II was a much bigger economic event. There have been some increase in federal receipts and outlays by the time we get to the
The 1940 period, that was the New Deal showing up there, but the New Deal was small potatoes compared to World War II.
And so what the government did here is move its outlays up by a factor of about a hundred in five years' time.
Can you imagine that? Imagine if the government did that today, increased its outlays by a factor of 105 years. Can you imagine that? It's unthinkable.
Well, it was sort of unthinkable then, too. It was hard for people to swallow that that was even possible. But you have to remember what was being done.
The Armed Forces of the United States in 1940, only about 300,000 men, and five years later there's more than 12 million in uniform,
and a larger number than that employed either as civilians by the armed forces or working in war supply industries.
So you reallocated approximately 40% of the entire labor force to war uses in five years' time.
Unbelievable, a huge shift in the use of resources in the American economy.
Never anything like it before or since.
But how do you pay for this?
How do you pay for this?
Well, once again, taxes.
You can raise the tax rates across the board. This time the top individual federal income
tax rate went up to 95%. It makes a millionaire not want to work that last day, doesn't it?
You're going to give 95% of that last million to the state. It takes a lot of the incentive
out of it. So taxes went up enormously. In 1943 the government put into effect the withholding
system to make sure that it got money before people took it home and might not feel like
handing it back to the government later. And that's something we've had ever since is the
the withholding system, another aspect of the ratchet effect, the institutional ratchets
are often more important than the fiscal ratchets by the way, but once again the government
finds that despite enormously increased taxation, its expenditures have gone up much more and
And it has to pay for most of the war cost by borrowing. How is it going to do that without
raising interest rates sky high? And the answer is again, it's going to use the Federal Reserve
system to create expansive credit conditions. And in this case, it not only used the Fed
to lend to the banks and make money so easy that the banking system itself absorbed a
and a huge amount of federal debt, but the Fed directly bought something like $20 billion worth of U.S. government bonds and that's in effect just printing money without even the formality of going through the banking system.
so the Fed enormously increased the money stock if you look over here you see
what happens here by 1945 money stock has gone up by about a hundred excuse me by
about what's it 75 billion dollars so huge increase now you'll notice here in
And the price level I put up, because there was a lot of inflation as a result of this
increase in money, I've left most of these blank. And that's because any prices you purport
to give for the war period are contaminated by the fact that the government put into effect
comprehensive price controls. Now when it did that, of course, it meant that it was
is creating prices so low in almost every market that there was excess demand for these goods and they were no longer being rationed by the market price, they had to be rationed some other way and so the government put into effect a rationing system.
Now I brought with me today a ration book. This one is called Book Four. These are blue
colored ration coupons. You had to have a certain stipulated number of these, plus the
money price when you bought any of the rationed goods. And I have these because I think we
I'm running out of time, but I want to show you just one more display.
This is not, by the way, my creation here, so don't blame this sentence up here on me.
This tells you the items that were rationed in general terms and when they were rationed.
There were a lot of variations and what you'll see is that the rationing system was generally discontinued in 1945 for most of these goods after the war ended.
But the price controls persisted, and they were taken off for a short while in the middle of 1946, put back on again, and then finally after much hemming and hawing and politicking, removed for good, except for a few like rent controls in some cities and price control on sugar, but they lasted for the better part of the war.
of War. They made life very difficult for consumers, by the way, because every time
you had to go to the store, you had to calculate whether you had the right number of ration
coupons and whether you could afford to spend that number at the same time you were calculating
the price and whether you could spend the money price and so forth. So this is just
one of the difficulties. There's a myth that things were great during the war on the home
It's a myth and one of the reasons it's a myth is that this rationing system and the price control system made life very difficult along with many other changes that affected civilians and consumers when the government sucked more than 40% of the national income into making war.
So you don't get something for nothing. The Keynesians have told us that World War II illustrated the Keynesian miracle.
That's baloney. It did nothing of the sort. And the best way to see that is to look at what happened when the government cut back at the end of the war.
The government dropped its expenditures enormously in 1946 and 47.
Every Keynesian theory predicted that would cause a relapse into the Great Depression.
It did nothing of the sort. That should have discredited Keynesian macroeconomics once and for all.
By the very standard of mainstream economics.
Empirical test. There was never a better test of Keynesian theory than that.
It failed and it went on living in academia right up to the present time.
As a very sad commentary on the intellectual honesty of mainstream economics.
and Comics. Thank you very much.