III
THE
COMING CRISIS
THE
THREATENING INFLATION CHAOS AND HOW TO AVERT IT
After
12 years of sewing the seeds of inflation, we must now reap the
harvest. By examining the causes and effects of inflation we shall be
able to meet the coming crisis with the minimum of hardship.
Inflation
means the creation of money units without commensurate creation of
wealth. The release of inflation, i.e., the affect of inflation, is
to raise prices when the expanded money supply meets the goods supply
in the market. We have been creating inflation for 12 years by
increasing money supply out of ratio to goods supply; and during the
past three years we have even diminished civilian goods supply while
accelerating the increase of money supply. We have, however, as yet,
released very little inflation, i.e., very little of the excess money
supply has gotten into the market place. This means that we have been
restraining and storing it, thus creating an explosive situation.
To
understand the present political inflation, we must distinguish it
from so-called bank credit inflation. When, as has been pointed out,
substitute dollars are created through the banks, it is not the banks
but the borrowers who create them. The borrowers in writing checks,
create bank or substitute dollars; and, on the presumption that they
receive full value therefore, do not create inflation, since these
dollars are backed by actual wealth. All the purchases resulting from
the loan are bought with bank dollars, save one. The loan provides
for the purchase of everything but the banker's "service" -
the interest charge; this cannot be paid, with bank-created dollars.
Thus,
what we call a bank inflation is merely a boom caused by releasing
exchange power which in turn releases productive power, but creates a
potential absorption of government dollars by reason of the
necessity, at some later date, of taking from the supply of
government dollars a sum to meet the banker's interest charge. This
interest charge has created nothing; and is, therefore, unbacked by
wealth. When, by the calling of loans, government dollars are
extracted by the creditors from the total money supply, a deflation
of money supply occurs and there appears a surplus of unsaleable
goods.
Thus
we see that the bank-loan-interest system always creates unbalance
between money supply and goods supply; and that what we call the
depression phase of the business cycle is but the flower of the seed
that was planted in the boom phase. Interest increment is in fact
money decrement. This is the termite that feeds quietly and
insidiously upon the circulatory system and depletes the money
supply, thus diminishing consumption and production, producing
depression.
The
depression or deflation phase of the business cycle always follows
the boom phase by reason of ultimate loss of confidence by the
creditors; and thus there is an automatic reaction and termination to
bank credit inflation. Not so with political inflation.
Since
the peculiar position and function of the banker in the scheme of our
economy is so universally misunderstood, and even by the banker
himself, a few more words devoted to clearing up the mystery may not
be amiss.
The
banker is the holder of a government license to speculate in money.
As has been stated, he neither creates nor loans money. He permits
businessmen, for a fee, to create substitute money by a "loaning"
process in which he takes this position toward his "borrower":
"If you will pay me a fee I will establish a credit on my books
that will enable you, by drawing checks, to create businessman's
money. I will take the position, with all my depositors, that they
may draw either businessman's money by means of checks payable to
some one else through a credit on the books of some bank, or I will
deliver Uncle Sam's money on demand."
The
banker's pledge is a legal fraud because it professes that all book
credits established by the "borrowing" process are
warehouse receipts for currency, which is true only to the extent of
currency actually held or available. Thus banking has merely evolved
from the original goldsmith-banker's false representation of holding
gold to back all his outstanding promises to the modern method of
professing to 100% currency backing.
Under
this system it follows that as businessmen's money expands through
"loans" and the sum of Uncle Sam's money remains the same
or diminishes or expands but slightly, the banker's undertaking grows
more hazardous and in due course it becomes so manifestly impossible
of fulfillment that a scramble begins for currency by banks and
depositors, resulting in a money panic and depression.
To
distinguish this condition from a political inflation, substitute
Uncle Sam as the "borrower." Since Uncle Sam can deliver an
unlimited sum of Uncle Sam's money, it is obvious that the banker has
nothing to worry about and can "loan" an endless amount of
money and instead of producing ultimately a panic for money, the
effect is to produce a panic for goods to exchange for the plethora
of money.
A
political inflation can be arrested or reversed solely by government
action. Here the debtor - the government - controls the situation,
because, unlike a private debtor who promises to deliver more than he
can create, the government can make good its promise to deliver any
number of dollars. These dollars, however, grow progressively
smaller, but nevertheless fulfill the government's loan obligations
which are written in the simple word, dollar, without specification
of power. A dollar is whatever the government issues as a dollar - it
has no fixity.
A
political inflation, therefore, has no automatic corrective; it is
speeded, retarded or reversed entirely by government action. Action
to arrest or reverse may take one or both of two forms, namely,
repudiation of promises, or budgetary action to balance or create a
surplus from which to retire obligations. To balance the budget means
to retrieve as many dollars as put out, thus ceasing to feed the
inflation further. A surplus budget means retrieving more dollars
than put out, thus deflating the money supply.
GOVERNMENT
TAKES OVER
We
are at present in a political inflationary movement which during its
life, and probably forever, has ended the menace of bank credit
inflations and deflations. This is due to a radical change in
political policy, adopted in 1933 after the depression beginning in
1929. In previous bank credit deflations the government did not
intervene but allowed the depression to run its course and the cycle
to renew itself. In this instance, however, the government took over
the banking function by expanding the money supply. There is now no
way by which the banks can recapture their function because there is
no way by which the government can let go of it. The banks are now
mere pensioners on the government's hands; and, as previously
explained, it is politically expedient to keep them alive by the sham
process whereby the government professes to borrow from them. As an
example of their reduced position, we may compare the average
interest rate of 4 1/2%, paid by the government for financing the
last war, with the average rate of 1 3/4% at which this war is being
financed.
Another
index that points the same trend is the fact that total private debt
- corporate, farm mortgage, urban real estate mortgage and state and
local government - rose from $72.4 bns in 1916 to $90.8 bns in 1919,
an increase of 25.5% while in this war there has been a rise in the
same brackets from $125.3 bns in 1939 to $129.2 bns in 1942, or only
3%. On the other hand, the Federal debt rose from $1.2 bns in 1916 to
$25.6 bns in 1919 and then declined, while in this war it rose from
$47. bns in 1939 to $112.5 bns in 1942, and rose to $171.2 bns in
1943. At the end of the last war (1918) the Federal debt was only 19%
of the combined private and public debt, whereas, today, in the
middle of the war, it is above 60%. Since private and state and local
debt are practically standing still, and public Federal debt is
rapidly expanding, the relative positions of the two classes of debt
will undoubtedly be reversed, with Federal debt being 80% of the
combined total of private and public debt, instead of 19% at the end
of the last war.
Banks
no longer have any influence upon monetary matters; the government
now controls the situation completely; and in forecasting we have to
consider, therefore, only political expediency and political action.
This is an entirely new condition in America, and we therefore have
no precedent to guide us. Many persons will be misled by using old
guides and therefore expecting deflation to follow this inflation as
deflation has always followed previous inflations. This is total
inflation; there will be no deflation.
The
banking system is being used now, not to create substitute or bank
dollars, but to create government dollars, because the government is
the borrower-creator. The supply of government dollars is now so
great that the admixture of substitute dollars offers no hazard
whatever, and the day of bank panics is past. Banks will no longer
fail; they may, however, liquidate and retire from business. This
depends upon whether the increase in their expenses, due to the
inflation, will be counterbalanced by increased income from
government loans. Such increased income will probably come
automatically without a rise in the interest rate. Banks are now
taking about 40% of the government's securities and private
investors, 60%. As the inflation progresses this latter percentage
will diminish and the former will correspondingly expand. Private
investors will show increasing resistance to bond selling, and the
banks will absorb what the public doesn't take. Thus increased volume
of loans will produce increased income for the banks, without
increase in the interest rate.
GOVERNMENT
DEBT EXAMINED
So
much misconception exists on the meaning of the so-called government
debt that it needs to be analyzed. It is not properly called
government debt; it is a taxpayers' debt. It arises solely out of a
postponement of tax levies to balance the budget. It means that the
citizen has been getting government service and disservice at a cost
that in part has been on the cuff. By the borrowing process the
government has been inducing its security holders to advance the
unpaid cost to the taxpayer; and, for his thus "holding the
bag," government pays the security holder an interest which is
added to the taxpayers' obligation. The government is only a
middleman between the creditors and the taxpayer-debtors. How it will
serve their respective interests depends upon political expediency
and the reactions of both classes. To be sure, the security holder
and the taxpayer are often the same person, but not always - and
rarely in the same degree. Also the taxpayer consciousness may be
keener than the creditor consciousness or vice versa. We shall speak
of the two as investor interest and taxpayer interest.
There
are two ways that the taxpayer interest can be made to pay its debt
to the investor interest. One is the bald and bold way of levying
taxes to create a budgetary surplus out of which to pay the security
holder. The other is to pay the security holder on demand while
continuing a deficit policy. The latter is undoubtedly the way it
will be paid as the former is politically a dangerous method. This
latter course means of course, releasing funds from Government
securities and increasing the pressure of liquid funds on the
diminished goods supply.
What
are the retards and the inducements to this process of liquidation?
We have price ceilings and rationing. These are restraints to price
rises but they are effective only as long as the people remain under
the illusion that non-spending means savings. The price rises have as
yet (May 1944) not been large enough, and the continuity of the rise
has not been long enough, to destroy this illusion. Some people are
already aware that money saved, declines more in principal than it
accrues in interest; but they have another illusion, namely, that
there will be a deflation as has been the case with every drastic
price rise before in our history. On the other hand the inducement to
the security holder to liquidate is the persistent and henceforth
accelerating price rise - forcing some to sell to meet current
expenses, and causing others to become panicky.
What
are the indices that the liquidation trend is approaching? One is
that shown in the increasing amount of refunding that becomes
necessary; and the best example of this is Series E Savings Bonds. In
January 1942 the redemption as compared to sales was less than 1/2%.
This has risen until in December 1943 it was 25% and in March 1944 it
was 42%. Another index is the comparative percentage of securities
held by banks to the total. Comparing July 1942 with December 1943,
we find the former date showed 38% held by banks and the latter 43%.
As private individuals and corporations take less, the banks must
take more and thus the increasing percentage of bank holdings is a
reflex of the increasing public sales resistance.
There
is no power that can reverse this trend toward liquidation except a
drastic increase in taxes; and the government, having lacked the
courage to adopt this policy thus far, will of course not regard it
as politically expedient in this critical stage of the war and an
election year, nor will the next administration whether Democratic or
Republican be super-human. Rather, the incumbent administration will
beat its breast, make many demagogic pronouncements of its faithful
effort to protect the consumer and many denouncements of
"profiteers," "black markets," "chislers,"
"racketeers," and 'bootleggers;" and this will in
large measure deflect criticism from itself to defenseless tradesmen
who will be the objects of the thus aroused public wrath. If we have
a Republican administration next year, it will blame its predecessor.
What
are the evolutions and culmination of the above stated liquidation
trend? As more security holders, for various reasons, convert into
cash it will, of course, be for the purpose of buying. This, with the
greater spending of the cash and bank deposits already available,
will force prices up with increasing speed - and this, in turn, will
force greater liquidation and greater price rises. Thus, by the
diminishment of the power of their dollars, the taxpayer interest
will pay against its tax delinquency and the investor interest will
take a loss. The debt claim will be paid in full, dollar for dollar,
but the dollars will buy less and less.
The
process of liquidation implies that the public holding of securities
will diminish and bank holdings will expand not only commensurately
but plus because the government will be obliged to issue not only
refunding securities but additional amounts to cover its current
deficits which will expand as prices rise. To illustrate; the public
now (May 1944) holds about $110 bns of government securities. Assume
that the saturation point is $150 bns after which public holdings
will decline through liquidation. Such liquidation implies more money
in the market places, with consequent price rises. The government
must therefore, make added appropriations to cover its scheduled
purchases. Assume the price rise during a year averages 50% while the
government's expenditure is planned to be $100 bns. By the price
rises, the total expenditures would be upped to $150 bns and if the
tax receipts were 40 bns, the deficit would be $110 bns; and this
sum, plus the refunding of say $50 bns of the public's liquidated
holdings, would mean that $160 bns would be thrown upon the banks.
Assuming that they already held $75 bns, their total would then be
$235 bns.
THE
RUNAWAY PHASE
At
this point the inflation would have gained its momentum and we will
assume that in the next year the public would liquidate its remaining
$100 bns, and the price rise may be estimated at 1,000%. If the
government's expenditure is planned at $150 bns it would thus be
boosted to $1 1/2 trillions. Its income might be planned at $75 bns
and rise to say $225 bns making a deficit of 1 trillion, 275 bns
which would have to be absorbed by the banks - bringing their total
to 1 trillion, 500 bns, which would be the total of all securities
outstanding. There would then be approximately this sum of money in
private hands, either as bank deposits or currency in circulation.
These figures would continue to mount until the end.
While
this fanciful outline is only a skeleton, it is not overdrawn for a
total inflation such as we anticipate. It is not irrational to up the
government's planned expenditures by 10 to 1 while estimating an
increase in its planned income by 3 to 1 because there is a lag in
the income tax which is the main tax levy. The irony of the tax
measure against inflation is that it is a preventative and not a
cure, since it cannot overtake the inflation once it gets its
momentum. In the insipiency of an inflation statesmen do not lay
sufficient taxes and in the flood they cannot. The picture also does
not ignore the fact that about 20% of all securities privately held
are held by insurance companies which are not so apt to liquidate as
individuals and other corporations. They will however, be obliged to
pay out vast sums for loans and cash surrenders, especially to the
white collar workers whose income will not keep up with the price
rises. Thus these companies will be compelled to liquidate to some
extent and will choose to some extent to do so for investment in real
estate to preserve their reserves. Their new business will also
virtually disappear and their current income will fall short of
current outgo.
The
astronomical increase in bank loans as shown is not unlikely – for
it must be remembered that so-called loans to the government are not
like private loans, and have no limit of safety. A loan to the
government means merely placing two figures on the books of a bank,
each offsetting the other and each being of the same quality, and
varying equally in weight. As we have pointed out, the process is but
an empty gesture whereby the government subsidizes the banks through
the interest payment. Whether the government orders the bank to mark
on its books a million or a billion or a trillion is but a matter of
adding cyphers; but these added cyphers are very welcome to the bank,
since each is an egg that hatches more interest income for the bank.
It is quite possible that in the general demoralization of runaway
inflation, the banks may even recklessly extend private loans, seeing
that there would be no hazard in spewing some substitute dollars in
the flood of government dollars. The base of government dollars is
now so broad that there is no danger in adding a structure of
substitute dollars.
What
is the end? The end is what is called stabilization or official
ending of the inflation. This will be accomplished by exchanging a
new unit for the existing dollar at a ratio of one new for some
multiple of the old. This multiple may be from 100 to 1,000 depending
on when the government chooses to end the agony without probability
of the malady carrying over into the new unit. If the total bank
deposits and currency outstanding prior to the stabilization were,
say, $2 trillions and the conversion under the stabilization were at
the rate of 1 to 200, the total money outstanding after the
stabilization would be 10 bns of the new unit and prices would come
back to about 1/200 of the pre-stabilization level. The slate would
be wiped clean. Nobody would owe anybody because all public debt and
all private debt would be wiped out.
The
public will have sold all securities back to the government and the
$2 trillion mentioned in the hypothesis would be the aggregate of
bank deposits and currency. Only the banks would hold government
securities and all would be equivalent to cash and would be wiped out
with the currency by the stabilization decree. Thus the government
would begin a new fiscal era without a dollar of debt, and the
taxpayer obligation and the security holder claim would be
liquidated. The complete obliteration of debt with a complete new
shuffling of the cards is a consummation that may have a popular
appeal and therefore make total inflation welcome to a large number
of our people.
THE
HUMAN SIDE
This
is a cold mathematical picture of a coming collapse. It lacks all the
colorings of human reactions of reason and emotion but in reality the
experience will be anything but cold; it will be wrought and fraught
with passions. Men cannot calmly watch their fortunes fade -
especially when others are profiting by the fade-out - and broadly
speaking, the entire debtor class will benefit by the depreciation of
their debts and many men, foreseeing this, will pile up debt as a
means of thus acquiring property cheaply. Trust funds visualized by
their testators as permanent, will be wiped out; and not only private
individuals dependent thereon but educational institutions, hospitals
and charity institutions will find themselves bankrupted. Insurance
companies may weather the storm, but their benefit payments will
decline to a small fraction of what the insured paid in and the
companies will emerge emaciated and shrunken, if indeed they survive.
Government's entire social security benefits, with soldier bonuses,
will likewise be reduced to the vanishing point unless the government
sees fit to increase payments as the dollar declines, thus feeding
the already raging flames of inflation.
Many
businesses, following the normal markup on costs without anticipating
replacement costs, will be wiped out and their owners added to the
unemployed. Social unrest will intensify race problems. Drinking,
dissipation and immorality will increase. The climate will be
riotous, rebellious and dissolute. America will be tried as she never
has been tried before - but the whole experience will be bearable if
we prevent exchange from breaking down. If we fail in this we will
not only paralyze production and consumption at home but will also be
obliged to withdraw from the war if peace has not been previously
signed. The end of the war may precipitate the runaway phase of
inflation; but inflation may force the end of the war. The one will
not necessarily wait upon the other.
The
first crisis will come when the rapid rise in prices will make it
impossible for our credit practice to continue. The seller will not
be able to bill goods on credit terms when the dollar on payment date
will be worth an uncertain amount less; and when it will be to the
advantage of the debtor to delay payment to take advantage of further
decline. This breakdown of our credit practice will be a serious
inconvenience - more so than in any other country that has gone
through or will go through inflation, because credit practice exists
hereto a much greater degree than elsewhere. We will be forced to a
cash basis, which does not mean a currency basis. We will continue to
use our checking system, but there will be a great increase in
currency.
The
Supreme test of whether we can avert the decline to barter – and
possible riot, rebellion and revolution - lies in our ability to
provide a stable money unit and thus preserve our money exchange. The
time will come when the dollar will decline so rapidly that it will
no longer be feasible to conduct trade in terms of it - with barter
the only visible alternative. Simple barter is extremely difficult
for a society that has been as highly specialized as ours is, and
that has grown away from the soil. Farmers will not ship food to the
cities if, before they can buy with the money they receive, it has
declined to some uncertain or perhaps vanishing point. On the other
hand, while they would barter, they are so far removed from the city
dweller that contact is impossible without transportation. But
railroads could not operate on a barter basis; they must stop rolling
when the dollar stops rolling. With transportation broken down, city
people will face starvation and with such a threat, order cannot be
maintained and violence may take any course.
PREVENT
CHAOS
If
total inflation, as outlined, cannot be seen as a probability, it
should be contemplated as a possibility and a preventative of chaos
adopted. The solution of the problem lies in switching business from
the unstable dollar to a new unit that will remain stable regardless
of the decline of the dollar to the vanishing point. This would not
save past dollar contracts from going through the inflationary
process, but it would permit new contracts to be made covering the
current business of life in terms of the new unit. If we can keep
money exchange operating we can avert all the chaos of decline to
barter which for us would be virtually impossible. Under such
conditions the inflation could run its full course without destroying
orderly life. No country that has gone through total inflation has
had the opportunity of utilizing this unique escape from the chaotic
phase.
The
valun concept is the result of studies begun 10 years ago and is not
presented as a mere emergency measure. It is presented as a true
money system, to serve in place of the existing political money
system at all times and places. It happens, however, to come now as a
salvation from chaos in the impending crisis. The valun can step into
the breach and save the American people from severe misery and
bloodshed; and, after the crisis can remain to assure equitable and
stable exchange - and preclude all future inflations, deflations and
other evils that beset us under the existing money system.
Disastrous
inflations as the result of political efforts to subsidize the
economy by means of deficit financing are common in history –
always followed by continuation of the political money system which
breeds the malady. The American people have now the opportunity to
demonstrate to the world that America's first political inflation
shall be its last, and may also be the last in the world if other
peoples follow our leadership in setting up the private enterprise
money system. In the second half of this course of studies the valun
and the valun system - the proposed private enterprise system - are
described in detail. The purpose of this study is to point out the
seriousness of our present monetary situation and the urgent need for
the adoption of the valun system now to avert untold miseries.
ADDENDA
As
an example of a stabilized bond and in contrast to those now
prevailing, we have been privileged to copy from the private
collection of Mr. Farran Zerbe, the following indenture of a bond of
the revolutionary era:
STATE
of MASSACHUSETTS BAY
No.
6025
£373-3-9
The First Day of January A.D. 1780
In
Behalf of the State of Massachusetts-Bay, I the Subscriber do hereby
promise and oblige Myself and Successors in the Office of Treasurer
of said State, to pay unto Charles Steward or his Order, the Sum of
Three Hundred and seventy three Pounds 3/9 on or before the First Day
of March, in the Year of our Lord One Thousand Seven Hundred and
Eighty one with interest at Six per cent per Annum: Both Principal
and Interest to be paid in the then current Money of said State, in a
greater or less Sum, according as Five Bushels of Corn, Sixty-eight
Pounds and four-seventh parts of Beef, Ten Pounds of Sheeps Wool, and
Sixteen Pounds of Sole Leather shall then cost, more or less than One
Hundred and Thirty Pounds current Money, at the then current Prices
of said Articles - This Sum being Thirty-Two Times and an Half what
the same Quantities of the same Articles would cost at the Prices
affixed to them in a Law of this State made in the year of our Lord
One Thousand Seven Hundred and Seventy-seven, intitled, "An Act
to prevent Monopoly and Oppression." The current Prices of said
Articles, and the consequent Value of every Pound of the Sum herein
promised, to be determined agreeable to a LAW of this State,
intitled, "An Act to provide for the Security and Payment of the
Balances that may appear to be due by Virtue of a Resolution of the
General Assembly of the Sixth of February One Thousand Seven Hundred
and Seventy-nine, to this State's Quota of the CONTINENTAL ARMY,
agreeable to the Recommendation of CONGRESS, and for Supplying the
Treasury with a Sum of Money for that Purpose."
M.
S. Dawes Witness my Hand
Committee
R.
Cranch H. Gardner, Treasurer
Observe
the fidelity of this bond. It is payable in "the then current
Money of said State" regardless of whether that be the English
pound or revolutionary money, provided, however, that the holder
should receive either more or less as may be required to purchase the
commodities in the quantities named. (The reason the second sum
stated is different from the first is because the latter was a fixed
unit printed in the bond as the basis for computation, while the
first amount is the actual loan and is written in by pen.) Another
interesting revelation is that at the time the bond was issued,
inflation had carried prices 32 1/2 times the level fixed by a futile
price control law, ("An Act to prevent Monopoly and Oppression")
passed just three years before.
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