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Listening to the news, you might have the impression that its Christmas and the government is Santa Claus. Under legislation recently introduced in Congress, Americans over the age of sixteen would receive $2,000 per month for at least six months. This follows the government’s $1200 giveaway in progress. Milton Friedman, the creator of the term “helicopter money,” warned that the helicopter was unlikely to fly only once. The current government policy is to keep the rotor blades from powering down.
The USA also approved $2 trillion in additional spending without any real discussion or even concern over how to pay for it. This is not surprising. Every year we talk about fiscal cliffs or budget deficits, and every year these grow larger.
How does this keep going on? The lack of obvious inflationary pain for ordinary people has been made possible by the amazing gains in capital formation and productivity that have taken place over the past century. So long as this continues, the effects of money supply inflation will be manageable.
Moreover, without pain or serious voter anger, governments will never take serious actions to reduce them. Nothing will change if politicians do not fear the loss of their jobs due to inaction.
The Effects of Government Borrowing
Central banking is a key factor enabling governments to borrow at levels far beyond what they would be able to get away with in an unhampered market.
After all, in a world of sound money (without fractional reserve banking and central banks), this pain comes from higher interest rates, which government borrowers must pay. Interest rates are determined by the supply and demand for loanable funds. The supply comes from slow-moving savings. In this world, as the government borrowed more, the demand for loanable funds would increase, raising the interest rates. Soon, businesses would complain about the high costs of renewing equipment or purchasing new capital, while individuals would find it harder and harder to afford a new car or own a home.
But in our current world of unsound money, the central banks can easily increase the supply of money or loanable funds, keeping interest rates lower than they otherwise would be. The pain will only come as a slow ratcheting up of asset or consumer goods prices.
Why Productivity Gains Have Made Our Debt System Manageable
We are already in the ratcheting-up phase, and have been for a long time. Yet a market phenomenon over the last one hundred years has postponed the inevitable next stages by keeping most prices from rising too swiftly and therefore allowing politicians to avoid voter retribution. A simple example will make this clearer. Suppose you have ten pencils and ten dollars. Supply and demand will ensure that the price of the pencil will be $1 each. If the price were $2, we would have unsold pencils driving the price down. If the price were only fifty cents, people would have $5 looking for pencils to buy, driving the price up.
Now, suppose we increased the number of pencils to one hundred. Prices would normally fall to ten cents. This would reflect a massive improvement in the standard of living of the average person. Lower prices and deflation reflect a victory against scarcity—something that should be hailed instead of scorned.
If, however, this gain in production were accompanied with more money creation, we would not see this drop in price. The price of pencils in this case could even remain $1 in spite of years of increasing output. Many of the gains that should have gone to consumers will have instead gone to governments, central banks, and other recipients of newly created money such as commercial banks.
The incredible increase in the production of goods and services in the last two centuries has come from gains in the division of labor and the massive increase in the capital base.
Thanks to these immense gains in productivity, average people have not noticed sizable increases in consumer prices, although money creation has been substantial As Keynes said,
The process [inflation] engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
Although this system may be entail an unjust transfer of wealth, the fact is that decades of productivity growth have made the situation manageable. The pain of money supply inflation has been “acceptable.” When the pain finally does become obvious to most, that will likely signal stagnation in production, and that will mean we’re in real trouble.