Inflation Is Already Here


By WILLIAM TRUFANT FOSTER, Economist and Author. Director, Pollak Foundation for Economic Research

Delivered at Convention of the American Hardware Manufacturers' Association, Atlantic City, October 16, 1940

Vital Speeches of the Day, Vol VII, pp. 106-107

IN the confusion of the present turmoil, at home and abroad, businessmen are concerned even more than usual with the immediate prospects of markets. They are asking what will happen during the next twelve months to the volume of business, and to the movements of prices and of wage rates. They see evidence on every hand of increased orders and increased prices. What, they ask, is the Government likely to do to stop a rapid rise in prices once it is started?

These questions call for statistics and for prophecies, but no businessman need apologize for being either a statistician or a prophet. If he is in business at all, he is in the business of forecasting; and if he forecasts on the basis of evidence, he forecasts on the basis of statistics. He may be a poor forecaster or a good one, but some kind of forecaster he must be, or never make another decision.

In forecasting what degree of inflation is likely to come in the next twelve months, his best guide is the flow of purchasing power in relation to the flow of goods. Inflation, as I use the term, is nothing but a flow of currency and credit into the hands of those who wish to spend it, in excess of the flow of goods which are offered for sale. Inflation, so defined, is already here.

Forewarnings are plain. Construction contracts awarded and dollar sales of department stores both are at the highest level for ten years. This year, both steel production and electric power production will make new all-time high records. Rail shipments of manufactured goods have increased abnormally, as has consumption of cotton and wool. Industrial activity as a whole by a dozen different indexes shows a recent sharp rise.

In attempting to forecast the future course of inflation, we can do no better than consider the conditions which have paved the way for inflation all over the world, for the past century. The first of these is an excess of Government expenditures over receipts. In the United States, in the decade 1921 to 1930, there was a surplus of receipts every year; but in the decade 1931 to 1940, there was a deficit every year. Thus we have established the first condition which in the past usually has led to inflation.

The second condition is mounting Government debts.

The Federal debt has risen rapidly from 18 billion to 44 billion. The reason why such huge debts lead to inflation is that, as tax rates rise, the point is sure to come when higher tax rates yield no higher returns. Payments of the debt on the prevailing price level thus becomes impossible. Then the easiest way for the Government to lighten its burden of debt is depreciation of the dollar. In this way the Government can pay its debts, legally, with fifty cent dollars, or even with ten cent dollars. This is clandestine taxation.

The third condition which, under our Federal Reserve System, permits at least a ten-fold expansion of credit for every unit of gold, is a piling up of unused stocks of monetary gold. In fact, the only monetary system we have is one under which bank credit expands automatically and riotously precisely when expansion is most dangerous, and contracts with equal certainty and celerity precisely when expansion is needed. During the past ten years, as everybody knows, we have more than doubled our gold resources until, with 18 billions of gold, we have the greater part of the monetary gold supplies of the world. The performance has all the features of a comic opera. It makes old King Midas look like a piker. If these hordes were used even to the extent which the present law permits, they could produce far more disastrous inflation than we have hitherto suffered.

There is, moreover, a fourth potential source of inflation: lately the idle demand deposits in the banks awaiting use have increased from 13 billions to 26 billions. And a fifth source; the excess bank reserves have risen from one billion to five billions.

These five conditions, which often in peace time have led to inflation, were created before we began to prepare for war. Now, with war hysteria and war expenditures added, we have the one agency for using inflation resources which, in the history of the world, has always been the most effective. Last month Government actual war expenditures rose to a new high of 200 millions, and they are likely to grow rapidly until, by the end of the fiscal year, we shall have spent four or five billion dollars.

These expenditures, directly and indirectly, will flowchiefly into pay-rolls; and over 90 per cent of the pay-rolls will be spent within two weeks after they are received. The immediate and inevitable result will be higher prices. This movement will gain much impetus during the next twelve months because the billions which the Government spends for defense will create virtually nothing which is offered for sale; whereas these same billions, flowing into pay-rolls, will be offered promptly in consumer markets for goods which cannot be produced fast enough to keep up with the pay-rolls. Under these conditions, inflation results, dollar for dollar, from expanded pay-rolls.

Object, if you like, that the new money is not real money; that it is merely the result of credits written on bank books; that it is based on the unsound creation of Government debt. The fact remains that once a new dollar gets into circulation, it cannot remember how it got started. It has the same effect on prices as any other dollar. Prices rise.

Rising prices, moreover, mean rising costs of living, and higher costs of living always mean demands for higher wages. Already labor unions are listing the concerns which have received the largest Government orders. There will be prompt demands for higher wages wherever the prospects seem best. Higher wages, however, promptly lead to still higher prices. Thus is started the familiar vicious spiral of inflation.

Initial results of this process are already here. During the current year, production of durable goods is likely to show a 30 per cent increase over the 1935-1939 average. Thus we shall have restored one of the prerequisites of prosperity which has caused so much concern to economists for several years. Industrial production as a whole willmake new high records; but, to repeat, a large part of this will not create ordinary market supplies.

It is true that these conditions have not yet produced results comparable to the underlying forces. That, however is to be expected. In the first six months of the first World War, production in this country actually fell. It declined from nine per cent above computed normal to five per cent below. It was not until two years later than production rose to 14 per cent above normal; but by that time we were producing 55 per cent more per capita than we produced twenty years later.

We are told, however, that the Government is taking steps to control prices. We hear that the Retailers' Advisory Committee, chosen by the Consumer Division of the National Defense Advisory Commission, is endeavoring to prevent a rise in prices. All we can say in this connection is that if the Government succeeds in controlling prices under these conditions, it will be the first success in the history of this country, or any other country. Governments the world over have undertaken to control the price of copper, zinc, tin, sugar, coffee, raw silk, cotton, wheat and rubber, to mention only a few of innumerable attempts. These attempts have only one thing in common: all, without exception, have failed.

They have failed because they ignore the function of price. The function of price is to move goods. When there are no arbitrary interferences, goods are moved. The fact that the goods are moved shows that prices are right. Price is the sign of trouble: not the cause of trouble. To attack prices gives no more promise of relief than to smash the thermometer because the temperature is too high.