Sunday, July 7, 2013

Monetary Policy and Philippine Economy Part 3 - Mises' Lecture

This is my summary of Mises' lecture on inflation with some insertion of content from articles in this blog. I am using the word "inflation" here in its primary sense. You will recall that I already made a distinction in the early part of this series. This distinction is taken from Mises' lecture.

In this summary, I want to share 5 subsidiary topics under inflation: 

1. Two Ways to Solve the Financial Problems of the Government

After Mises clarified the distinction, he shared about two ways the government solves its financial problems. The legitimate way to do it is by taxing the citizens. But since taxing the people is considered not good for political career, another way of addressing the government's financial difficulties was made. This time it is by simply printing paper money.

In directly taxing the people, at least the people are aware about the deduction in their salary and they can adjust their expenses to a new financial situation brought about by new taxes. And another advantage of direct tax compared to simply printing paper money is that the price of goods and services is not affected. The only negative repercussion of such an act is the increase in buying power for the government and less on the part of private citizens. 

But this is not the case when government decides to print paper money to solve its financial trouble. It is also a tax, but people do not see it for it is done indirectly. And it also does not affect anyone's political career. 

What's detrimental in this form of indirect tax is that since people do not see any reduction in their income, they think that they can still buy the same amount of goods that they previously buy when the quantity of money is not yed increased. They do not realize that the purchasing power of their money has been reduced since the certain consequence of printing more money is price increase. And since prices of goods and services have already increased as a result of additional money, those who receive the same amount of salary when the new money was not yet introduced will suffer. And since most people do not know how their money lost its value, they simply consider it as something natural.

2. The Most Affected Sector in Inflation

The fact is, price increase and the lost of purchasing power are not natural. It is an inescapable outcome of government's act of printing money to address its financial problems. So the financial burden is transferred from the government to the citizens without them knowing it. 

Mises was questioning not how the money is spent but how the money is obtained by the government. Due to the preference of the government to use printed money rather than direct tax, some people will have greater advantage than others. Those who receive the new money earlier are in a better position than those who receive it late. Ron Paul identified the early beneficiaries as the “speculators, bureaucrats, and the special interests favored by the government” (Pillars of Prosperity, 2008, p.110). The sufferers are the laborers and savers. Among them are the teachers and ministers. Mises clearly identified teachers and ministers as the people who would suffer the greatest disadvantages from the increase in money supply. He explained why this is so: 

"As you know, a minister is a very modest person who serves God and must not talk too much about money. Teachers, likewise, are dedicated persons who are supposed to think more about educating the young than about their salaries. Consequently, the teachers and ministers were among those who were most penalized by inflation, for the various schools and churches were the last to realize that they must raise salaries. When the church elders and the school corporations finally discovered that, after all, one should also raise the salaries of those dedicated people, the earlier losses they had suffered still remained" (Economic Policy, 1979, p.61).

Since there are groups who benefit from new printed money, for them, this kind of monetary policy is good. I think this explains why there are people who insist that there's nothing harmful about increasing the money supply. On the other hand, those who are harmed by this policy do not know the connection of the government's action to their financial situation. And besides, the technicalities surrounding this matter is so complicated, as if, it was really made intentional in the first place to hide it from average citizens. 

3. How long shall inflation last? 

The basic flaw of this kind of monetary policy is that it cannot last. The Roman Empire, Han Dynasty, and Germany are used as typical examples to demonstrate the catasthropic end of continually increasing the supply of money. Mises described the situation of Germany in 1923. He stated, "On August 1, 1914, the value of the dollar was four marks...Nine years and three months later, in November 1923, the dollar was pegged at 4.2 trillion marks" (ibid., p.63). In short, German currency collapsed. 

The question is, until when will the government continue this monetary policy? Mises answered: "Probably as long as people are convinced that the government, sooner or later,...will stop printing money..." (ibid. pp.63-64). When people do not believe this anymore, then they will realize that prices will continue to increase. As a response, they will start "buying at any price, causing prices to go up to such heights that the monetary system breaks down" (ibid. p. 64). 

Under inflationary monetary system, becoming a debtor is considered wise. Anyone who understands the system could take advantage of it and could utilize it to attain easy wealth. Another feature of inflationary policy is the perception about the government's power. It is looked upon by the people as all-powerful. People ask the government to take care of them for with an unlimited supply of money, the government can do anything. This kind of government perception is a clear break-away from the past for then it was considered the citizens' duty to support the government, not the other way around. US President Grover Cleveland said, "While it is the duty of the citizens to support the government, it is not the duty of the government to support the citizens" (p.66).

In order to correct the wasteful spending of the government, Mises believed that only a return to the gold standard can do it. He argued that the gold standard is a form of protection from extravagant government. One great advantage of it is that "the quantity of money under the gold standard is independent of the policies of governments and political parties" (p.65). 

4. Labor Unions

After explaining the advantage of gold standard, Mises turned to the labor unions. He considered it as the second power next to the government who influence wage rates. The problem with the wage rate demanded by unions is that it is above the level of wage in free market. As a result laborers are only employed by industries prepared to suffer loss. When businesses can no longer afford losses, they shut down resulting to more unemployment.

Currency devaluation has been the usual response of governments to unemployment. But as both workers and unions realized through time that currency devaluation had reduced the purchasing power of their demanded wages, they made additional demand: wages must go up with price increase. This is known as "indexing"(p.69) and so the unions became index conscious that made currency debasement as solution to unemployment inapplicable.

5. Full Employment

John Maynard Keynes was a strong advocate of currency debasement. In his 1936 book, "General Theory of Employment, Interest and Money", he argued that unemployment is bad and that the only way to solve it is by inflating the currency. Mises described Keynes' strategy as "cheating the workers" (p.70) and this is considered necessary in order to attain full employment. 

For Mises, there is no need to resort to inflating the money supply to achieve full employment. The market should be allowed to operate freely without the interference coming from both the governments and the labor unions. This is the only way to achieve full employment. Mises explained this further:

"...wage rates for every type of labor tend to reach a point at which everybody who wants a job can get one and every employer can hire as many workers as he needs. If there is an increase in the demand for labor, the wage rate will tend to be greater, and if fewer workers are needed, the wage rate will tend to fall" (pp.70-71). 

So the choice should not be between inflating the money supply or unemployment. Full employment can be achieved without increasing the money supply. 


Mises concluded his lecture by emphasizing that inflation is a monetary policy and it can be changed. And the only way to change it is for the intellectuals to do their role in shaping public opinion. Once the public are informed about the disastrous results of inflation, Mises was confident that politicians will abandon this monetary policy.

Part 1 - Dr. Nye's Lecture

Part 2 - Summaries of 6 Related Articles

Part 4 - Biblical Critique of Inflation

Source: Mises, Ludwig von. (1979). Economic Policy: Thoughts for Today and Tomorrow. Chicago: Regnery/Gateway, Inc.