Music Reality captured in user friendly symbols and processed for understanding. Music The Idea Channel The topic I am going to talk about tonight--I had thought it was announced, if not it will come as a surprise to you but I hope not as an unpleasant surprise is the topic of money and inflation. It's not a topic I think there's anybody in this room who is uninterested in, at least the inflation half of it. Most of you are also very interested in the money half, but from a different point of view. Whenever I talk about inflation, I am reminded of a wonderful story about the man who decided to take advantage of the growing science of cryogenics--that's the science of freezing people up so that they can be in deep freeze for a time and then restored to life--and he got himself put into the deep freeze for a twenty-year period. And of course before he went into the deep freeze he left all his securities and his worldly belongings at his broker's with instructions to do the best he could for him. And twenty years later, after the deep freeze had worked, he was unthawed and came out of the deep freeze, and of course the first thing he did was to run to the telephone to call his broker. And his broker said to him, "Well you know, you're a millionaire many times over." "Oh, really?" said the man. "What happened to this stock?" And the broker said it went from here to here; you know... it multiplied ten times... twenty times. "What happened to this stock?" He kept on going. But suddenly, the telephone operator interrupted, the man was just ecstatic the telephone operator interrupted and said, "Sorry, your three minutes are up. That'll be $250,000 for the next three minutes, please." (Laughter) That's real inflation. That's at the moment a story, but it's not a story which does not have some examples in history. Inflation is a disease. It's a dangerous disease for a society. It is sometimes a fatal disease for a society. It's a disease that if allowed to rage unchecked can destroy a society, and we have many such examples. The classic examples, of course, are the extreme examples of Germany, of Austria, of Russia after the First World War when inflation really did reach levels at which the kind of apocryphal story I told you was a literal description of the reality, when inflation reached levels at which employers would pay their workers three times a day--after breakfast, lunch, and dinner--so they could go out and spend the money before it lost all its value. That's the real extreme cases. But you don't have to go to such extreme cases to see the enormous harm which inflation left unchecked can do. You have many examples in South America. Brazil, before 1964, was brought down by an inflation that led to a revolution that toppled the existing government in order to stem the inflation. In the famous case of Chile with Mr. Allende in power, he produced an inflation which was one of the major factors that caused the economic catastrophe that led to the replacement of his government by a military dictatorship. We are nowhere near that stage in the United States, but it behooves us as a nation to pay attention to this disease, to ask ourselves what is the cause of the disease, how do you cure the disease, what are the effects of the cure, what are the side effects of it, and what will happen if we don't cure it? And I propose to discuss the topic tonight under those headings, and then go on to consider in somewhat more specific detail the experience of the United States over the past decade or two, and the present situation that we face. Now the first step toward understanding the cause of inflation is to recognize that it is always and everywhere a monetary phenomenon. It's always and everywhere a result of too much money, of a more rapid increase in the quantity of money than in output. Moreover, in the modern era, the important next step is to recognize that today governments control the quantity of money so that, as a result, inflation in the United States is made in Washington and nowhere else. Of course no government, any more than any one of us, likes to take responsibility for bad things. We are all of us human. If something bad happens, it wasn't our fault. And the government is the same way, so it doesn't accept responsibility for inflation. If you listen to people in Washington talk, they will tell you that inflation is produced by greedy businessmen, or it's produced by grasping unions, or it's produced by spendthrift consumers, or maybe it's those terrible Arab sheiks who are producing it. Now of course businessmen are greedy. Who of us isn't? Trade unions are grasping. Who of us isn't? And there is no doubt that the consumer is a spendthrift. At least every man knows that about his wife. But none of them produces inflation for the very simple reason that neither the businessmen, nor the trade union, nor the housewife has a printing press in their basement on which he or she can turn out those green pieces of paper we call money. Only Washington has that printing press and therefore only Washington can produce inflation. If you listen to the people from the communist world, they will tell you inflation is a capitalist phenomenon. That's not true. If you look at Europe today, one of the most rapid rates of inflation in Europe has been in Yugoslavia which is a communist country. One of the slowest rates of inflation has been in Switzerland which is a capitalist country. So inflation is not a capitalist phenomenon, but neither is it a communist phenomenon. If Switzerland has low inflation, the United Kingdom in recent years has had inflation rates running up to 20-25 percent a year. Italy has inflation rates today of that order of magnitude. Inflation is not a capitalist phenomenon, it is not a communist phenomenon, it is a printing press phenomenon. Now in saying that inflation is a printing press phenomenon, in saying that inflation is always caused by a more rapid increase in the quantity of money than in output, you are only at the beginning of the problem, because you must distinguish the immediate cause from the more ultimate cause. You must ask: why is it that the quantity of money increases too rapidly? But before I go on to that question, I just want to settle for once and for all the point that inflation is a monetary phenomenon. That proposition has been documented over and over again. We have evidence for the United States for over a hundred years, for Great Britain for two hundred years, for Sweden for two hundred years. There has never in history been an inflation that was not accompanied by an extremely rapid increase in the quantity of money. There has never in history been an extremely rapid increase in the quantity of money without an inflation. But in order to persuade you of this quickly and with a minimum waste of time, I have brought a few pictures along to show you that will graphically illustrate the proposition about the relation between money and inflation. And I'd like to, if we can start with the first of those slides now. Maybe you can make out that there are two lines on that chart. That chart is for the United States and it covers the thirteen years from 1964 through 1976. In one of those charts, the solid line is the quantity of money per unit of output and the other line, which is the dashed line, is the consumer price index. Those two lines cross at 1970 because that's the way they are constructed. Both of those series were expressed on 1970 as the base of 100 in order to try to get the two series in the same scale. But there is nothing whatsoever in the arithmetic of it to make those two curves the same elsewhere. And I may say that the quantity of money that's plotted there is the quantity of money for a year ending six months before the price index. So that you are not... there's nothing funny about that and you can see that the two lines are almost indistinguishable. Now I've got a segment of thirteen years up there, but if I had a segment of a hundred years the relationship would be the same way throughout the whole of that period. But, you may say, that's only for the United States, but what about other countries? And so let's have the next slide. The next slide is for Germany for the same period, and again you will see the same story. Now the interesting thing here is that you can see that the quantity of money for a while in the later...in the seventies was running ahead of the price index, but now they are coming back together again, and that's a behavior you very often observe. The quantity of money per unit of output is the major factor that from the immediate sense determines the price index but it doesn't operate instantaneously. Sometimes there are delays of a year or two, but sooner or later they all come back together. Well, the United States and Germany are very similar countries. What about another country? Let's have the third chart. And the third chart there is supposed to be for Japan, and I can't read it. Is that what it says up there? That's for Japan, and you will notice that Japan experienced a much greater price rise than either the United States or Germany did, but Japan has now been coming back. It's done a remarkable job of controlling the quantity of money and, as a result, the rate of price inflation in Japan has come down from close to 30 percent a year to where today, in the period after this chart, it's back down to about 7 percent. But again, you have the same synchronism between the two charts. Now...the next chart... let's have the next chart which is for Great Britain. You can see each one of these shows a little bit more inflation than the preceding one, but in each one of them you again have the same relationship in every case between the quantity of money and prices. Now one of the interesting things about that comparison between Japan and the United Kingdom is you will hear many people telling you that the real reason you have inflation is because of trade unions. If you listen to anybody telling you about Great Britain's plight, they will tell you that the real problem in Great Britain is that you have such strong trade unions- that they push up wages and that causes inflation. Well if that explains this relationship for Britain, what explains the previous chart for Japan where trade unions are not very important, are much weaker than they are in Great Britain? Or what explains the next chart, which is a honey, for Brazil? Can we have the last chart? Now that's an inflation that's really an inflation. That's none of these baby inflations we've been playing with. Of course there are still better ones in Argentina and Chile, but we don't have a big enough room. Now here...if trade unions caused inflation...As you know, Brazil has a military government and trade unions have absolutely nothing to say about anything, except as they are branches of the government apparatus. So that it's clear that you cannot explain in the case of Brazil the inflation by trade unions, but you can see very clearly that you can explain it by changes in the quantity of money. Thank you. We can have the lights back on now. As I say, that's a very small sample of the evidence that is available on the linkage between the quantity of money on the one hand, and prices on the other. That evidence is available for hundreds of years in many countries and there are no exceptions. But that only gets you to first base. The question is: why is it that the quantity of money increases relative to output? If you go back a hundred years ago- and here in California this is very appropriate to go back a little more than a hundred years ago, sometimes the quantity of money increased more rapidly than output because of discoveries of gold or precious metals. As you know you had the Gold Rush in California in the late 1840s, early 1850s, you had the Australian gold discoveries in the same period--in the 1850s, and you had a worldwide inflation as a result. In the 1890s to 1913, you had a worldwide inflation because of the perfection of the cyanide process for extracting gold from low-grade ore which produced an outpouring of gold from South Africa to supplement the gold strikes up in Alaska. But those were the good old days, before the days when government discovered that it could escape from that relic of an earlier time, the discipline of gold, and that it had a much more scientific method of controlling the quantity of money by ending the link to gold and instead turning to government-dominated money, and today you do not have inflations for those reasons. Today you have inflations because governments create a very large quantity of money. The question is: why do governments do that? And today in the main there are fundamentally three reasons, in my opinion, why we have experienced inflation and why it is a threat. The first and by far the most important is: in order to pay for government spending. Of course... I say that government does this; that's wrong. The government doesn't do it. You do it, I do it, we the citizens do it. We tell the people in Washington--we tell out congressmen, and our senators and our representatives: "We want you to spend more money on us, but we don't want you to put any taxes on us, oh no! We don't want you to levy taxes. We want you to spend more but we don't want you to tax more." There is no way you can do the one without the other. The real tax on the American people is what government spends. If the federal government spends $450 billion and only raises $400 billion in taxes, who do you suppose pays that other 50 billion dollars? Do you suppose the tooth fairy does? You pay it and I pay it, and one of the ways we pay it is by the tax which we call inflation. Inflation is from this point of view a form of taxation. If government spends more than it takes in, in the form of things that are called taxes, it has to meet the difference either by printing money or by borrowing from the public at large. Printing money is a very attractive device because inflation, from the point of view of a person sitting in congress or in the senate, is a wonderful tax. He doesn't have to vote for it. Have you ever known of a congressman who got up and said, "I vote to impose a tax in the form of inflation of 10 percent next year"? No sirree. Inflation is a tax which is imposed without representation and which nobody has to vote for. And of course it's a marvelous tax from the point of view of a congressman trying to meet the demands of his constituents for more spending. Inflation yields tax revenue in three different ways. It yields it directly. We think of these pieces of paper we carry in our pocket as money but it would be just as accurate to think of those as receipts for the taxes you've paid. If you pay the government $100 directly in taxes, the government sends you back a receipt, "You paid us $100 in taxes." Well now, the beauty of printing money is that the receipt is right straight with the payment of taxes. What you are getting is not money but tax receipts. And from the point of view of the government, those pieces of paper--and I'm exaggerating, of course; they are not really pieces of paper, that's only the primitive way of doing it. In our modern age we do it in a more sophisticated way through using a bookkeeper's pen or a computer instead of having to turn the printing press. It's in a form called deposits, one of the most misleading terms in the human language. When I think of a deposit, I think I put something there and there it is. But you know, when you go into a bank and deposit money, the people behind the counter run as fast as they can to another part of the bank to pay it out over another counter in the form of loans. It's not deposited there. And similarly, when the government sends a check, it may in effect be doing the equivalent of printing paper money. I won't go into the details of that process. You will get the right answer if you think of it strictly as printing paper money. So when the government gets revenue from inflation directly in the form of these pieces of paper, it can go out and spend without having gotten taxes from anybody. But it also gets revenue in two other ways. In the first place, with the kind of tax system we have, inflation raises other kinds of taxes without anybody having to vote for it. You might think that if prices go up by 10 percent and your income goes up 10 percent you are in the same position as you were before, but you are not. You are pushed up into higher brackets of the income tax and on the average, if prices go up 10 percent and your income goes up 10 percent, your taxes will go up 15 percent. So the congress again is in a marvelous position. It can vote to lower tax rates when in fact taxes are going up. There's a lot of talk in the papers these days and the news these days about the president proposing a tax cut next year. That's pure fiction. Nobody is proposing a tax cut. These much publicized tax cuts of the past few years have not been tax cuts at all. Inflation has raised taxes and the so-called tax cuts have given back a small part of that to the taxpayer, but the actual taxes that taxpayers have paid have gone up as a result of the automatic effects of inflation. In the third place, the government gets revenue from inflation by repudiating its debt. Many people keep worrying about the government debt. That's not something you should worry about because the government debt today is smaller--that is, the announced government debt, the open and above-board government debt, bonds outstanding and the like--is smaller as a percentage of the national income than it was 20-30 years ago. How can that happen? Every year we have deficits. How can the debt be going down? Because those are not real deficits. They are deficits that have been financed by inflation. Anybody who has bought government securities in the past ten years has paid the government for the privilege of lending to it. Anybody who has bought a long-term government bond and then redeemed it has gotten back an amount of money which has less purchasing power, less ability to buy goods and services, than the sum he initially paid for the bond. And to add insult to injury, he has had to pay taxes on what they call interest, and as a result, the debt has gone down in meaningful terms. So inflation is a marvelous resource for a government in all three of these ways. That I think has been the main reason throughout history, not only now but going back for thousands of years. You know you had a great inflation during the time of the Roman Empire when Diocletian was emperor. He did it in a different way. He did it by taking nice, good, full-bodied silver coins and replacing the silver by an alloy that was worthless until there was less and less silver, until one of the history books talks about the ancient denarius which used to be a full-bodied silver coin finally having become in Diocletian's era little more than a copper coin with a wash of silver. Now I happened to come across that quotation the same year in which the American Treasury was replacing our full-bodied silver coin by a copper coin with not even a wash of silver, only of nickel. History does repeat itself. So that's been always throughout history a major reason why you have had creation of money to finance government expenditures. But we've added another reason in these days, and that's allegedly to promote full employment. In the postwar world, after World War II, every country in the West has had a full employment policy which means not that we have had full employment--on the contrary, as you know, we have been having increasing unemployment in recent years--but that every time for quite a period there was a threat of unemployment or unemployment started to rise, there was a strong tendency by government to say, "We've got to do something about this: we have to print more money, we have to spend more money, we have to stimulate the economy," the result of which has been to create an increased quantity of money that in the first instance has had some favorable effects on employment but only temporarily, only so long as you could fool the people. And then when people got on to what was going on, it came out in the form of inflation. In the United States, we have also had, and in most countries, a third less important factor that has contributed to excessive increases in the quantity of money, and that has been mistaken policies by the central bank. Professor Siegan referred to the mistake of the Federal Reserve Bank in the late '20s and early '30s. From 1929 to 1933 the quantity of money in the United States went down by a third, and that was a major factor that produced the catastrophe. That was the great mistake of the Federal Reserve. It learned from that mistake. Government agencies, like people, don't always make the same mistake the next time; they make a different one. And since that period, the central banks have tended to make the mistake in the opposite direction. Their mistake has almost always been caused by confusing their function, by thinking that they had something to do with interest rates instead of recognizing that their real function was to control the quantity of money. Now most of you will be inclined to say, "Well that's all very well, but aren't there some important things you've left out?" Of course the most obvious thing you would have told me I left out was trade union behavior, but I hope I have already persuaded you that that's not a fundamental source of inflation. Trade unions may do a great deal of harm in a great many ways. Trade unions have done Britain enormous harm, but they are not responsible for Britain's inflation. Higher wages are in the main a consequence of inflation and not a cause of it. And as I say, the examples of these charts I gave you before, I hope, will show that anybody who thinks that's a fundamental cause of inflation had better pause for a bit. But there are two other factors that people are inclined to cite. One is to say, "What about international influences?" The government is particularly fond of citing this, to say, "Oh well, you mustn't blame us for inflation. We've imported it from abroad. There's a worldwide inflation and how can you expect the United States to stay clear of inflation if all the rest of the countries of the world are inflating?" That was a valid explanation before 1971 when we had a worldwide system of fixed exchange rates. In that case it is true that inflation in one country would tend to spill over into another because it would influence the quantity of money. In that case it was inflation in the United States that produced inflation in many countries around the world because their currencies were linked through a fixed exchange rate with ours. But today that explanation is not valid. As long as countries have variable floating, flexible exchange rates between their currencies, inflation is a national phenomenon, and not an international phenomenon. And the proof of that is very simple. Inflation is a worldwide phenomenon, but it is not an international phenomenon. You know in every country of the world you have too high taxes, but high taxation is not an international phenomenon. It's just that all the nations of the world do it at the same time. In the same way you have inflation in many countries. But if it were an international phenomenon, how come it's roughly zero to 1 percent in Switzerland, 4 to 5 or 6 percent in Germany, 10 percent in France, 18 percent in Great Britain, maybe higher than that in Italy, and so on down the line? No...inflation is a national phenomenon produced by monetary policy and other policies within the countries. Now the second argument that will be made: "You've left out of this picture productivity." In those charts, what was it that I connected with prices? It was not simply the quantity of money; it was the quantity of money per unit of output. And it's true, anything that increases output will tend to hold down prices. So it's very common for people to say, "Well, the real source of inflation is that our productivity has not been increasing as much as it should," or to say that the real cure for inflation is to increase productivity. Now productivity is an enormously important phenomenon. From the point of view of our standard life, of how well we live, there's nothing that is more important. If we can get a rate of real growth of 3 percent instead of 2 percent, that will make a great difference over a period of time. And I don't doubt that one of our national problems is the fall off in the growth in productivity. But from the point of view of inflation it's the wrong order of magnitude. It would be a tremendous achievement to raise the average rate of growth of real output in this country from 3 percent a year to 4 percent a year. That would be a 33-1/3 percent increase. It would be a dramatic change, but it would reduce the rate of inflation by 1 percentage point a year. And from that point of view, the possible variations in the quantity of money are much greater than the variations in output and productivity. So from the point of view of inflation, productivity is very much of a bit actor on the stage. The lead, the hero or the villain, as you wish it, is not productivity but what happens to the quantity of money. Now...so much for the cause of inflation. It's very easy to say what the cure is. There's no problem how to stop inflation. That's the easiest thing in the world to say: in order to stop inflation you have to have the government spend less and print less. That's the only way you are going to stop inflation. That's the one and only cure. But you know, the real problem isn't to know how to cure inflation; the real problem is to have the political will to do so. If I may go back to my medical analogy, some years ago my physician told me about a young man who was a patient of his who had a debilitating disease as a result of which his fingers were threatening to fall off, his toes were threatening to fall off, and my physician said: "You know, that young man could be cured in no time. The only thing he has to do to be cured is to stop smoking, but I cannot in any way bring him to stop smoking. He refuses to do it." Now the disease was curable in one sense but it was not easy to do it. An analogy that in some ways is much closer to the problem of inflation--it's a very literal analogy but also something of a medical analogy--is alcoholism. The thing about alcoholism is that when you go out on a toot the good effects come first and the bad effects only come the next morning when you have the hangover. That's exactly the way it is with inflation. When you start inflating the good effects come first. After all, the government's printing money, everybody thinks he's richer--he's got all these pieces of paper, and initially it does have that effect. It makes business good, it expands output. It's only after a while, when it has worked its way through to inflation, that the bad effects come later and you then have inflation. Similarly, on the other side, the great problem in curing an alcoholic is that the bad effects come first and the good effects come later when you try to cure it. If a man who has been subject to a craving for alcohol goes off the wagon, it's terrible. He's got a terrible time getting rid of his craving, but if he can once succeed in doing so everything will be fine. It's exactly the same thing with inflation. If you succeed in slowing down inflation, you will initially have some very difficult times. Just as inflating stimulates the economy temporarily, so slowing down inflation slows down the economy temporarily. A more direct reason why it's difficult to apply the cure is because it's not so clear that people want to stop inflation. If I ask people, are you in favor of inflation or not? Everybody is against inflation. But when I explore a little bit further, if I say to people, tell me, have you gained from inflation? "Oh no," they say, "I haven't gained." And yet the fact is that a great many people have gained from inflation. There are many, many people who have benefited. Of course the major gainer from inflation is the Federal Treasury, as I have already said. But almost everybody who has bought a home in the past thirty years has gained from inflation. He was able to borrow on a mortgage which inflation has paid off along with paying off the government debt so that almost all homeowners in this country are beneficiaries from inflation. Indeed, one of the things that makes inflation such a bad social disease is precisely that it tends to be divisive because some people do very well during an inflation period and some people do very badly. And as a result, the population gets split into people who are seemingly in great prosperity and people who are in great distress. When most people say they want to stop inflation, what they mean is that they want the prices of the things they buy to go down and the prices of the things they sell to go up. But since what one man sells is what another man buys, that's a neat trick if you can do it. And as a result, people aren't really serious when they say they want to stop inflation--certainly not in the early stages, not before they fully understand, not before it has gotten to the point where it is really creating serious social problems. Everybody wants to stop inflation at somebody else's expense. Now I've already said that if you start to cure inflation you will get some bad effects first. Let me emphasize that those bad effects are not themselves the cure; they are side effects of a cure. If you have your appendix out, if you go to a doctor and he says, "You have appendicitis. You've got to take your appendix out. But after your appendix is out you'll have to stay in bed. It used to be two weeks, now it's ten minutes, but you'll have to stay in bed for a little bit," and you say to him, "Well, you know, I think I'll just stay in bed and not have the operation." That isn't going to cure you. And in the same way, unemployment is not a cure for inflation. I can tell you a hundred ways to create unemployment that will produce more inflation not less. I may say, that used to be a proposition that people found it difficult to understand, but the experience of the past ten years or so has done a great deal to make people understand that it's perfectly possible to have unemployment and inflation go along simultaneously. In fact we have coined some ugly new words like "stagflation" and "slumpflation" to try to explain this phenomenon--I shouldn't say to explain it, to name it. So unemployment is not a cure for inflation, but it is an almost inevitable side effect of an effective cure. Now why should that be? Why is it that there seems to be no way to cure inflation without going through at least a temporary period of relatively slow growth and relatively high unemployment? The answer is fundamentally because of the time delays between the turning of the printing press and the ultimate effects on output and on prices. Both ways you produce the same result. Look on the upgrade. Suppose the government first prints money and spends it to pay for its expenses. To begin with, the people who find themselves doing better business don't know what the explanation is. Government is paying more money, its employees have better salaries, they are coming to the store and buying more goods, the storekeeper is delighted to sell them at the same prices as before. Each man thinks this is something special happening to him. The shoe manufacturer says, "Ah! Look, I can sell more shoes. The demand for shoes is going up." He doesn't recognize that what's really happening is that demand is going up everywhere and that not only is the demand for shoes going up, but he's going to have to pay more to get labor, he's going to have to pay more to get leather, he's going to have to pay more to produce his products. But when that shows up, when after awhile he finds out that his costs are up, then he suddenly discovers that he has to raise his prices to make both ends meet. And that's why on the average in the United States over the past hundred years an increase in the quantity of money has taken about five or six months to affect people's spending. The first thing that happens is people just have bigger bank accounts. Then it takes them a little while to realize that and they start spending it. And then it's another twelve to eighteen months before that works through into prices. So on the average over the past hundred years, and in Britain it has been for two hundred years--I say a hundred years because that's as far back as our data go in the United States--there has been about a two year interval between a more rapid increase in the quantity of money on the one hand, and the inflationary effects of it on the other. But the same thing happens the other way. If the government slows down its spending, in the first instance people simply experience that as slower demand for their products and they tend to retrench. They tend to say, "Well, my inventories are going up. I'd better cut back production." It's only after a considerable interval that that's reflected in lower prices or in a slower rate of increase in prices and works its way through. So there is no way that I know to avoid the interim effect of slowing down inflation. In the long run there is no relation between inflation and unemployment. On the average, suppose a country gets accustomed to 10 percent inflation. That's perfectly livable, that's something people can get along with. What will happen? Everybody will know that it's going on. All wages will automatically tend to go up by 10 percent more a year than they otherwise would. All prices will tend to go up by 10 percent more. Instead of interest rates being 5 percent, they will be 15 percent. Everything will get adjusted to it. We have a great deal of evidence that the average rate of inflation over a period of time has no relationship at all to the average rate of growth or the average level of unemployment. The thing is that only surprises matter. It isn't inflation that produces a stimulus; it's only higher inflation than you expected. It's only the surprise. If you get adjusted to it, it doesn't do any good. It's just like again alcoholism and drug addiction. When a fellow first gets started on drinking, all it takes is one drink to make him happy. But after his body gets adjusted to that, it takes a little more, and pretty soon he's taking a half a bottle. Similarly with drugs. It takes bigger and bigger doses to have the same effect. And similarly with inflation. As a country gets accustomed to higher and higher rates of inflation, it needs a bigger dose to have any stimulating effect. So in the long run there is no relation, but in the short run there certainly is. There is no way to avoid these side effects, but those side effects can be minimized by trying to take the cure gradually instead of overnight. Here we are in this nation with a base rate of inflation at the moment somewhere around 7 percent. It would be a mistake to try to bring that down to zero next year. We ought to do it over a three or four year period to give people a chance to adjust. We can also minimize the side effects of inflation in my opinion by adopting a widespread program of escalator clauses, particularly with respect to government obligations, particularly with respect to taxes. I think it is a disgrace and a scandal that we have not had legislation which has adjusted the income tax system so that inflation does not automatically raise rates. Congress has been very quick to index its own salaries. Congress has been very quick to index the salaries of government employees, but it has been very reluctant to apply the same principle to the taxes that it imposes on the citizen. I must say myself I would go the other way. I would like to see the taxes indexed and with respect to the salaries of congress and of government officials, I would index them perversely; every 5 percent inflation is a 5 percent reduction in their salaries. And I assure you, if you did that you'd cure inflation real fast. One more general point. What if we don't cure inflation? We have no good choices. If we don't cure inflation, if we continue at high rates of inflation, we'll also have high unemployment. One of the main reasons is because of the false cures that will be attempted. In every country that has had great inflation the governments have resorted sooner or later to wage and price controls, supposedly as an attempt to cure inflation. We did that in this country in 1971 with disastrous results. Wage and price controls are not a cure for inflation. In fact, wage and price controls, you will find are imposed by governments that want to inflate but want to conceal it from the populace. Governments want to get a short-term benefit by pumping up the economy, but they want the populace to think they're doing something about inflation, so they announce with great fanfare that they are fixing prices and wages. But the result is only to hold down, to conceal the inflation for a year or two and then have it blow up, which is of course exactly what happened after 1971. In light of this background, I come to the final point I want to make. I think it's very instructive to look at recent U.S. history. Our inflation really started in the postwar period in the 1950s. In the 1950s, we first had a very substantial inflation during the Korean War and then after that was over we had a creeping inflation. It was an accident that that 1950s inflation didn't continue and grow from that point on, but we had a political accident. We had a nonpolitical president who was willing to risk the election of his vice president in order to stop the inflation. Mr. Eisenhower was willing to take the unpopular measures that stopped inflation, that put us back on a noninflationary course, by approving measures that led to a series of recessions in 1958 and then in 1960, by holding down government spending, holding down government money creation, so that from an inflation rate--which at that time was regarded as terrible--of 3 to 3-1/2 percent it was brought back to essentially zero. Our real inflation started in the early 1960s when John F. Kennedy inherited this windfall of a noninflationary environment as a result of President Eisenhower's policies. And from 1960 on we have been on a roller coaster. We have been going up in inflation, we have been coming down, we have been going up and we have been coming down. Every time we go up there is a great outcry that we have to do something about stopping inflation, and so we tend to step on the brakes. That tends to produce a down turn. But the moment unemployment starts going up, there is an even bigger outcry, "We have to do something about the unemployment." So we reverse and step on the accelerator instead of the brakes, and we're off again. But this roller coaster is around an upward level. It has not been on the level. Each peak has been higher than the preceding peak. Each trough has been higher than the preceding trough. In 1961 the lowest rate of inflation at that time was 1 percent. In 1967, the next trough, the lowest rate of inflation was 2-1/2 percent. In 1971, before Mr. Nixon introduced price controls in order to control what was then supposed to be the horrendous rate of inflation of 4-1/2 percent, in that period the lowest rate was about 4 percent. In 1976, last year, when again we went through a recession to stop the inflation, the lowest rate was 5 percent. So each bottom rate has been higher than the preceding one. Similarly, each top rate has been higher than the preceding. In 1966 we reached 4 percent. In 1969 we reached 6 percent. In 1974 we reached 12 percent. In 1979 we will reach--you fill in the numbers. It's not a pleasant prospect. So we've been on a roller coaster, going up and up and up, and we have been on that roller coaster because of the problem that I have mentioned that we get accustomed to our addiction and we need bigger doses to get another high. If we look at the most recent period, we've had the same situation again. From January 1974 to January 1975 the quantity of money defined to include the currency in your pockets and all deposits at commercial banks, demand and time, what has come in the jargon of the literature to be known as M2--I apologize for having given it that unlovely name-but M2 grew in that year at 6.8 percent a year. That was a relatively low rate and it was that that was responsible for the tapering off of inflation so that by the end of '76 it was down to about 5 percent on a year to year basis. But in the period from January '75 to now, the money supply has been running at the annual rate of 10 percent a year--M2, this quantity of money--and that portends an increase in the inflation rate. We are now... have hit the bottom and we are now on the way up. We had a temporary bulge in January-February as a result of the very hard winter, but the more fundamental phenomenon is that we are now on an upgrade, we will probably hit 7 to 9 percent next year or something like that, and the base rate of inflation today is somewhere in that level. The tragedy of this whole history is that we have time and again--four times now--paid the price of stopping an inflation and not gotten the benefit. We stepped on the brakes, we have slowed down the monetary expansion, we've taken a recession, we've had unemployment, and then just as inflation is starting to taper off we throw the whole ballgame away by going to the races again with the printing press. Unfortunately, given these mistakes, at the present time the options open to this country are only bad options. We don't have good options. If you were sitting in at the Federal Reserve Board and deciding on monetary policy, you mustn't suppose you would have anything good you could do. Whatever you do is bad. Given the amount of money that has now been pumped into the economy, you have only two bad choices. If you slow down drastically in order to try to hold back inflation, the economy will experience a recession in late '78 or early '79 and it may be a fairly severe recession. Alternatively, you can say, "Well we can't do that. We've got to step on the gas, keep doing what we are doing now." Then you are condemning the economy to going into another period of double-digit inflation. Two years ago there was a choice. Having paid the price for slowing down the inflation, we should have continued on a relatively slow rate of monetary growth and then we would by now be well on the way to a cure for our inflation. But we have not done so. And as I say, I don't really blame the people who are doing it. The real blame has to be put on us, the citizens, the voters of this country, for not telling our government what we want them to do. And I am afraid that we shall have to go through several more of these swings in the roller coaster before the American people decide that they have had enough of it and that it's time to bring it to an end, that it's time to send an unmistakable message to Washington, "We want you to stop the roller coaster." When we do, there is no technical difficulty about stopping it. Let me emphasize it will not be costless to stop it, but it will not be costless to continue what we are doing. If I may conclude with my medical analogy: if you are sick, it's very, very seldom that a doctor can give you a cure which will enable you to rise from your bed the next day a whole person completely unaffected by your illness. We have a disease called inflation. Fortunately our basic constitution is strong. This is a strong, healthy country although we have been doing our best to make it unhealthy. We have been doing our best to take measures that will reduce our productivity, but nonetheless we are still a pretty strong, healthy country. There is nothing basically wrong with us, but we have been suffering from a self-imposed disease of inflation. Sooner or later, I am sure we shall get up the will to cure it, but we shall not cure it, or continue it, without paying a price either way. Thank you. Dr. Friedman, if you were advising President Carter, would you advise him to work through the Federal Reserve or through congress to implement your recommendations? I'm not sure those are different and I'm not sure it's really President Carter who'd work through them. You know, the president has a lot of influence but very little power. The president does not pass the appropriation bills; the president has no direct control over the Federal Reserve printing press. The real sources of power in this respect are the congress and the Federal Reserve, together and jointly, and I believe that's where the public at large has to bring political pressure to bear to produce the right kind of policy. We need to change congress to get off the treadmill? No, we don't need to change congress, excuse me. You know, people have a great misunderstanding about this. People in congress are in a business, they're trying to buy votes, they're in the business of competing with one another to get elected. The same congressman will vote for a different thing if he thinks that's politically profitable. You don't have to change congress. People have a great misconception in this way. They think the way you solve things is by electing the right people. It's nice to elect the right people, but that isn't the way you solve things. The way you solve things is by making it politically profitable for the wrong people to do the right things. (Laughter and applause) You said, rather optimistically I think- that you have detected a trend wherein the public will accept a slowing down of the rolling of the printing presses. I confess that that trend is invisible to me, and I wondered what evidence of it you have seen. I was really not referring directly to a trend to slow the printing presses, but a more fundamental trend in people's ideas and attitudes toward the role of government. Ten years ago, twenty years ago, it was widely taken for granted that there was hardly any problem the solution of which did not reside in Washington, did not reside in throwing more money at the problem. Very few people believe that anymore today. People are greatly disillusioned about what government can accomplish. In the more particular area you are describing, worldwide and not merely in this country the public at large has shifted its major emphasis from unemployment to inflation. It is not any longer politically popular to reduce unemployment by creating inflation. If you take a case like Great Britain, which has in some ways been in the forefront of this, ten...twenty years ago it would have been said that it was absolutely politically intolerable to have had rates of unemployment of the kind that Britain has had. But today the Labour government in Britain finds it popular, politically popular, politically profitable, to put its emphasis on reducing the rate of inflation. In Britain, last September at the Labour Party Conference, Prime Minister Callaghan found it politically profitable to say, we used to think that if you had unemployment and a recession, the way to get out of it was by spending more money or cutting taxes, but if that was once a solution it is no longer an option open to us. I'm not quoting precisely, but the sense of it. He said, because we have learned that that only works temporarily but the ultimate result is more inflation. So you have in Britain, and in other countries around the world, a willingness on the part of the population at large to stand for measures directed at reducing inflation. The same thing is true in this country. Every public opinion poll has shown that inflation is a problem that the public at large is more concerned about than the problem of unemployment. It will not be...you see I think President Carter faces a real dilemma at the moment with respect to his own election prospects in 1980. He cannot control...I said before that he has much influence but little power. He cannot really control it but suppose he could, what should he do? He's facing a dilemma. Ten years ago the answer would have been obvious: step on the gas, print money, create a great period of prosperity by 1980--but with double-digit inflation. The double-digit inflation will do him more political harm than the boom will do him good. So I think there is a very strongly detectable change in the attitudes of the public at large. On the one hand they are more inclined to attribute the responsibility for inflation to government and to be more conscious of it. And on the other, they have less rosy views about the power of government to cure all ills. Thank you very much. Let's have some more people come up to increase our inventory. Professor Friedman, for the federal government's ability and willingness to produce unlimited amounts of money, what are the implications for the concept of a vital local and state government and...the broader question, implications for the concept of federalism? Well, obviously one of the trends that has been reducing the viability of local and state government has been a trend toward centralization, a trend toward enhancing the power and the strength of Washington at the expense of the state house and of city hall. And no doubt, the fact that Washington possesses a printing press, and the city hall and the state house do not, has been a factor that has been contributing to that. But again, we come back to the same question that has come up before: will that continue, is that necessary? Is it inevitable that the federal government will grow in power? If it is, if it does, then I agree with you that we would be headed toward a unified centralized country. I think one of our great strengths as a country is precisely the federal system; precisely that we have a distribution of power, that we do have states which attach loyalties to themselves, which have independent powers. So I think there is a trend in your direction, but I don't think it necessarily needs to continue or necessarily will continue. As a member of a government agency, do we do ourselves a disservice by quickly pursuing federal grants and funding to meet our needs when often those grants are not our priorities but just where we can get matching money? Well, you have a dilemma there. Given the program, given that there is a federal program, I can't blame you for trying to go get it. And yet, I think sooner or later the public will wake up to the idea that they really aren't doing themselves any favor by sending a dollar to Washington, and getting 80 cents back. That's been the experience. What we have had...it's a great defect of the centralization and it's very hard to understand why people allow themselves to be fooled, but somehow they have the impression that if the money comes from Washington, somebody else is going to pay for it. But of course it's a two-way trip and there is a discount taken off in Washington as it turns around. I don't know if I can ask one more question but since I deal with high school students and I am concerned about economic education in our schools, what is your barometer as you talk to young people? What is their projection of the business economy? I deal with many young people who go into government thinking that that's where the jobs are, and that concerns me. What is your forecast? Again that is not preordained. We're masters of our own destiny; that depends what we as a people decide. If we as a people decide we want to continue on the path we've been going on, which I hope we won't, but if we do, why then your youngsters are better off going in to Washington; they will get better salaries. Do you people know what the highest average income county in the United States is? It's not San Diego County; it's not even Marin County; it's not Westchester; it's not any of those fancy Connecticut counties; it's Fairfax County in Virginia, the bedroom of the Washington civil servants. That's the highest average income county in the country. So you would be telling the students right if you said to them, "If you want to make an income, go to work for Washington." But it's up to us as citizens to make that no longer true. Thank you. Recently we've heard that the inflation currently experienced in this country won't respond to monetary restraint because it's cost-push inflation and not demand-pull. What response would you have to that analysis, if any? It's another example of the people who produce the inflation trying to find scapegoats for their own deficiencies. Of course the inflation will respond to monetary restraint. There is no such thing as cost-push inflation except in the form of the delayed effect of monetary inflation. If you have a monetary inflation that starts to push up prices it tends to hit retail and wholesale prices first, the prices you and I pay. It's only later that it works its way through costs, but then costs fall behind prices and there is a make-up period, and during that period you have what looks like cost-push inflation. But there has never been an inflation in history that didn't respond to monetary restraint. If you look at American experience it responded to monetary restraint. If you take that roller coaster I was telling you about, on each occasion the slow-down in the rate of inflation was preceded by a slower rate of monetary growth, and you have much more dramatic examples of that. The most dramatic example from American history of how inflation responds to monetary restraint was one that was once dug up by a student of mine when he was writing his dissertation on inflation in the Confederacy during the Civil War. And in the later parts of that war, you know the South financed the war almost entirely by printing press money and the rate of inflation during the Civil War in the South...I don't know... got up to something like 4 or 5 percent a month or more. But at one point in the later part of the war the Northern army overran the place in the South where they were printing money and for two weeks the printing presses couldn't operate. And lo and behold, within two weeks the inflation stopped. (Laughter) And you've got many, many examples like that, so that what you can say to people is they are kidding themselves. Yes sir? I have been re-reading James Buchanan on the monetization of the debt and his conclusion that we can't possibly reduce the debt because of the depression effects that would result; in other words, we're stuck with it forever. What's your opinion on that? Which debt are you speaking of now? Are you speaking of the funded debt, the bonds? The funded debt. The funded debt--we've been reducing it every year. It's much smaller now in real terms, i.e., divided by prices or divided by income, than it was right after World War II. And how have we been reducing the debt? By monetizing it, by paying it off through inflation. Now when you come to the unfunded debt, this three trillion or more of obligations under Social Security and other programs, that's a much more difficult task. I think I may say, if you'll pardon me for a digression here for a moment- that those fiscal conservatives who keep their eye on balancing the budget and on the debt are making a great mistake and in fact that they have been the handmaidens of the big spenders. What has happened over and over again is that the big spenders get off and start spending money; this produces a deficit. The fiscal conservatives scratch their heads and say, "My God, we've got to do something about that deficit." So they go to work and raise the taxes to pay for the deficit, and as soon as they get the budget balanced again the big spenders are off to the next lap. And the so-called fiscal conservatives are turned out to do the dirty work for the big spenders. As I said before, keep your eye on one thing and one thing only, how much government is spending, because that's the true tax. Every budget is balanced. There is no such thing as an unbalanced federal budget. You're paying for it. If you're not paying for it in the form of explicit taxes, you're paying for it indirectly in the form of inflation or in the form of borrowing. The thing you should keep your eye on is what government spends, and the real problem is to hold down government spending as a fraction of our income. And if you do that, you can stop worrying about the debt. I have two very different questions but first I wonder if you would comment on an assertion with regard to your theory on the political process. It seems to me that the incumbents who disagree with you and with me are one step ahead of us and are so carefully insulating themselves in the political process by giving themselves vast perquisites and benefits of incumbency so we have people voting for their re-election not on the basis of their policies or their issue positions or their votes, but whether or not they are being serviced in their district, which is a vastly different situation than it was years ago. Well that may well be true. I agree with you that incumbency is an enormous advantage these days, that the drive of course for governmental financing of elections is really a drive to strengthen the power of incumbents and make it more difficult for anybody to challenge them, that the bill that was passed about campaign financing limiting private funds was also a major step toward increasing the advantages of incumbents. But I nonetheless believe that if the public at large feels strongly enough about a subject, congress will listen and act in accordance with it. Aren't some of the same people who feel strongly about this the same people who are so cynical and skeptical of the political process, therefore taking themselves out of the voting process? I'm not sure whom you are referring to at this stage--the people who don't vote? Well I'm talking about...we see more and more people becoming disenchanted who believe strongly in the free market, who are just giving up and saying, "No matter whom I vote for, the policies continue," and as they take themselves out of the political process we're left with a proportionally large percentage of the others. But there is more than one way to make themselves effective. I understand your point. And I would say that the most encouraging move I've seen around is one which started in this state, and that is a move to take the total budget out of hands of the elected representatives and determine it through a constitutional amendment. That was the Proposition 1 fight that was started here five years ago...unfortunately was defeated. But I am very much encouraged by the strength which the movement for such amendments around the country and at the federal level is gaining. As you know, last year Michigan had a similar proposition on its ballot and it was defeated, too. It's very interesting to compare the propaganda that was put out in California and Michigan five years apart on the same proposition. It was the same propaganda financed and fostered by the same groups, primarily the state education association, making the same kind of misstatements about the proposition, and in both cases with considerable success. But in both of those states and in a considerable number of others there is a grass roots movement that is growing, and I think we're going to see in the next four or five years at least a half dozen states adopt tax limitation or spending limitation amendments of that kind. In addition, on the federal level the Southern Governors' Conference a few years ago had a task force which drew up a federal amendment to limit federal spending. That task force was headed by Governor James Edwards of South Carolina. Unless I am mistaken, the Southern Governors' Conference has endorsed that proposal. There are various congressmen and senators who have introduced similar budget limitation amendments in congress. So I think that there is a strong chance that we have a movement underway which will give people something to vote for that they think will be effective over and beyond voting for particular individuals. Dr. Friedman, part of the twofold cure you suggested tonight would be a reduction of government spending. What areas of government spending would you suggest are most amenable to reduction? Every area...I think that the only way to reduce government spending is across the board, cut every single appropriation first year by 10 percent, the next year by 20 percent, and just keep going. Why do you want to choose? The reason I asked that is because it seems to me that higher unemployment is a short-term side effect of your inflation cure. Then welfare costs are going to go up as a result. Well that depends, you see the problem you are raising is the following one. Every one of us would like to reform a program but if you try to achieve a reduction in spending via reform you won't get it. But if you first achieve a reduction in spending through across the board cuts- that will force you to engage in the kind of reform you're talking about. And I quite agree with you. I don't think we need to spend more money on welfare, not at all. If we had a more sensible welfare system we would spend less and yet give help where it's really needed. The welfare system today does not help the people who really need it. If you take the total amount of money which the government is now spending on programs labeled as poverty programs to help the poor and count how much that amounts to for each person who is designated as poor, it turns out that if they were getting it they would be among the rich people in this country. But of course they aren't getting it; it's going to lots of other people. So I agree with you that a temporary increase in unemployment in the process of curing inflation might very well cause an increase in some kinds of expenditures on the welfare side, but I think that is not inconsistent with cutting expenditures in general. Also, what is your opinion of consumer protection legislation as it affects economic freedom? Well, most consumer protection legislation is not consumer protection legislation. It's the enacting into the laws of the prejudices of a small group of people who have organized themselves into an effective lobbying group. Is the consumer really being protected, by having somebody else decide for him whether he may use saccharin or not? He's not being protected; he's being hurt. The most anti-consumer measures on the books that have been taken in recent months have been the imposition of quotas or their equivalent, voluntary restraints, on the imports of TVs from Japan and of shoes from I think it was Taiwan. Did you hear any of these consumer protection agencies get up and protest about that? Where were they when we really needed them? I think the most effective protection the consumer can get is free competition. If you really want to have a pro-consumer protection move, then you ought to join yourself with other people in promoting free trade. (Applause) I have two questions. The first is: how detrimental do you believe the significant increase in petroleum products has been to the rates of inflation throughout the world? Not at all. The increase in petroleum products has been a negligible cause of higher rates of inflation. It's been an excuse for governments that have produced the inflation. After all, if petroleum prices are the basic cause of inflation, how can you explain the very different impacts on different countries? Here are Japan and Germany; they both import almost all of their oil. It should hit them alike. Germany went through with a maximum rate of inflation around 6 percent; Japan got up to 30 percent. What happened is that not the increase in petroleum prices but the OPEC cartel and the reduction in availability of petroleum has produced a transfer of wealth from the rest of the world to the Arab countries; it's made us poorer. To a very small extent, insofar as it has made us poorer, it's had a slight effect on making prices higher. But it has had a very trivial effect on the rates of inflation. The second question is: what do you believe the probability might be of the removal of the capital gains tax as well as the removal of the double taxation on dividends? Well I think there is a possibility that you will move in both those directions but I think it's very dubious that you will go all the way in either case. I may say I think the more important point about capital gains is not so much about whether it's removed, but about whether the base for calculating capital gains is indexed. That's the really important question. It would be well worth paying the price of getting rid of the special treatment of capital gains if you could get the base of capital gains indexed, because the problem with capital gains taxation now is you are not taxing real capital gains. You are taxing purely paper gains which simply reflect inflation. That's part of the whole problem of tax indexation. Dr. Friedman, one more question about tax reform... And one more question is right, because we're coming to the end of our time. We've got one more gentleman there and we will try to handle both of these if we can. Congressman Kemp of New York has a proposal for a permanent tax cut--I don't know of how much--partially in emulation of President Kennedy in 1963, I believe, the idea being that if you cut taxes in times of a slowdown you will pick up the economy and perhaps even produce more revenue for the government. Now given your skepticism about tax reform, is this perhaps one proposal you might endorse? Well, I have long ago concluded that I am in favor of reducing taxes at any time under any circumstances for any excuse, that that's the only effective way to exert pressure on government spending. Congress will spend whatever the tax system will yield plus a good deal more, but that plus a good deal more is not infinitely elastic. There is some pressure on them when it gets large, and therefore the only effective way in my opinion, other than these kinds of constitutional amendments I was talking about before, of bringing down spending is to reduce taxes. So as I say I don't go along with Mr. Kemp's reasons, but I'm in favor of cutting taxes. I'm associated with the banking system, and I do... I won't hold that against you. ... I do have a line of credit and this relates to M2. I go in tomorrow and sign a piece of paper; the bank will write out a deposit ticket thereby the money supply is increased. How do you stop that? Oh no, the bank will only be able to do that if it can find the reserves and for the banking system as a whole, one bank can always get reserves from another bank. But the great mistake that everybody makes about many different items--it's not only this--is to confuse what's true for the individual with what's true for the society as a whole. The most fascinating thing about economics--you know in a way it's always an interesting thing about economics--is it's the most trivial subject in the world and yet so many people misunderstand it, and it is so hard for people to understand it. Why? I believe a major reason is because almost every interesting economic proposition has the following characteristic: what's true for the individual is the opposite of what's true for everybody together. It looks to you as if you can decide how many pieces of paper you carry in your pocket and how much cash you have. It looks to you as if you can decide how many deposits you have. It's true you can, but to everybody together it's a game of musical chairs. The Federal Reserve determines the total quantity of money and then it is shared out among the people. Your bank can increase its deposits by attracting reserves away from another bank, but that puts pressure on another bank to contract. The total amount of reserves will set a limit to it. Let me give you some other examples. It looks to you when you go to the store and you see an object offered for sale as if the price is fixed and the amount available for you to buy is indefinite. If you want to buy two pairs of shoes at that price, you can buy two pairs; three pairs, you can buy three pairs. To the whole country together there are a certain number of pairs of shoes available at the moment, and the price is what's free to move up or down to equate the number of pairs of shoes people want to buy to the pairs available. You try this out: on almost every proposition, what's true for the country as a whole is the opposite of what's true for the individual. And that's equally true with the proposition you are presenting. It sort of depends on who gets there first, then. Yes, it does. It does very much so. Thank you.
Though I am not an investor in any crypto currency, I find that this community is the only one talking about effects of inflation. I think this sub will appreciate this talk a lot.
the world would be better with more like him
at min 24 they laugh, these days that is the normal cases with zero interest rates. ha!