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The Effects of Inflation (Editor's note: As most of you might have noticed, we frequently post articles in "the Fed " forum that are concerned with the decimation of our liberty and, as a result, our standard of life. I would say the following might be considered a paramount issue. "The Effects of Inflation " is the fourth chapter of a book by Mr. Pugsley entitled "The Alpha Strategy", written fifteen years ago. We intend to post a chapter each week. -JSB)
The Misallocation of Capital Resources are limited and change is costly. These facts go a long way toward explaining why the growth of government is destructive as well as so hard to contain. When you create a product and exchange it for money, you assume control of how that money will be spent. You will spend it according to your values, trading it for the things you value the most at that moment. If you earn $100 by baking bread and choose to spend it on a suit, the tailor will benefit. he will make a profit and that profit will encourage him to invest more capital in training and equipment to enable him to make more suits. Your spending encourages capital investment in the production of things you value. Suppose the government hits you with a $100 tax. They now have your money, and you can no longer buy the suit. The government chooses to spend the money on a sign for the subway system in Washington, D.C. Now, the businessman who makes those signs for the government is encouraged to expand his capital investment, just as the tailor would have. The government has reallocated capital. Instead of your money encouraging the production of goods you value most, it now encourages the production of goods that some bureaucrat in Washington values most. Not only does government spending cause capital to be reallocated away from consumer demands, it also encourages waste by not rewarding the most efficient producers. You work hard for your money and, therefore, are careful to shop for full value. You try to pick a tailor who will give you the best buy for your money. The bureaucrat, on the other hand, does not work at all for the money. He spends someone else's money, someone he does not even know. Getting the most value from the money he has taken from you cannot be as important to him as getting value for the money would have been to you. While production is encouraged by government expenditure, it is not necessarily the efficient producer who gains. More importance is placed on giving contracts to companies that offer some political benefit to the bureaucrat than to those companies offering the best products for the lowest price. Government spending is naturally wasteful. The government reallocates capital, and does so inefficiently, but a further problem occurs when any attempt is made to slow government spending. If the government were suddenly to disappear, all those individuals and businesses dependent on government support suddenly would have to satisfy consumers in the open market. They would have to abandon much of the capital investment they had in their current products and invest time and energy to gear up for making the products demanded by consumers. Nor would consumers be willing to pamper them or subsidize them. Those producers who successfully sold products to an uncritical government bureaucrat would find a cold reception among consumers unless they could compete with businesses already meeting consumer demands. The transition would be painful for all these individuals and companies, and fatal to many. This same effect happens in a small way whenever the government cuts back on any of its programs. Cutbacks in any area are always met with cries of anguish and vigorous political lobbying from those affected. In summary, when the government spends your money rather than letting you spend it, it misallocates productive resources, causing human energy and capital to be directed toward the production of goods that are not the choices of consumers. Once it begins doing this, change is difficult because of the reluctance of individuals to abandon previous investments. The result is a continuing growth of the bureaucracy, and an increasing misallocation of resources. Unfortunately, the problems of government spending do not stop here. The Business Cycle When the people who run the Fed decide to expand the money supply, an order goes out to buy T-bills. At that instant the demand for T-bills has risen, and this affects the entire market for debt securities. It means that new buying power is making a demand on the bond market, and prices for bonds will begin to rise. Interest rates are inversely related to bond prices. When bond prices rise, interest rates begin to fall. Another way to see this is to view the interest rate as the price of lendable funds. A greater supply of lendable funds means a lower price for those funds. The marketplace gets a signal that interest rates are softening. Those investors who watch the stock market will notice this trend and will assume that it's a good time to buy stocks, since business profits tend to improve during periods of falling interest rates. Investors will also find that money for stock purchases is more available, just as business men will find that it is easier to borrow money. The new money issued by the Fed is at work, percolating down from the securities dealer, who received it first, to the banking system that is eager to expand its deposits and loans. Interest rates fall, bond prices and stock prices rise, and business activity picks up. The fresh money eventually reaches down to the consumer, who can now feel the effects as unemployment rates fall and consumer loans become easier to get. We are told that the economy is entering a period of prosperity. It will not be long, however, before the new money added to the system begins to create a pressure for individuals to raise their prices. This pressure is not immediate, but may begin to be felt anywhere from one to three years after the Fed's initial purchase of securities. One after another, prices are raised to meet increasing costs, and soon the price level has ratcheted a notch higher. The increase in the money supply has been offset by an overall increase in the price level, and the economy is now in trouble. Firms that geared up to produce more goods during the boom now find themselves without customers, and soon a recession appears. To visualize this, assume you are manufacturing shirts. Pretend your customers have a total of $100 a day to spend on shirts, and your shirts sell for $10 each. You thus sell ten shirts per day. Suddenly the government hands your customers an extra $100 per day and directs them to spend it on shirts. Faced with orders for twenty shirts per day, you scurry to equip yourself to meet the demand. You buy new sewing machines and hire new seamstresses. Things go well for a few weeks, but when you order more cloth, you find the cost has risen. Next your workers complain that they cannot get along on the wages you are paying and demand a raise. You reluctantly inform your customers that you must raise the price of your shirts to $20. Since they have a total of $200 per day to spend, they now cut their orders back to ten shirts per day. You are back where you started. Only now you have too many machines and too many workers. Your only choice is to cut back production, lay off the workers you hired, and sell your surplus machines at a discount. Thus, expanding the money supply causes a temporary business boom. Soon the money causes higher prices. At the new higher prices, there is no longer enough purchasing power around to buy all of the products that the businessmen geared up to produce when they were first hit by the fresh money, and they are faced with cutting back to old levels of production. This means layoffs, cancellation of orders for raw materials, and curtailment of production. The cycle has been completed, and the country faces recession once more. There is one more distortion to add to the picture. When the Fed created the new money, that money acted as a demand on certain products. The money first makes a demand on bonds, then stocks, then production goods, and then consumer goods, in that order. The money creates a chain of false prosperity that wends its way down to the consumer. Each person who receives the money thinks himself richer, and shifts his value scale around a bit. He decides he can afford some additional goods that had formerly been out of reach - some luxury item, for example. New money tends to create a demand for luxury goods. Since we know that the investment of capital in production of one thing means that capital is withdrawn from investment in something else (since resources are limited), expansion of the luxury industries must come at the expense of other industries. Once prices rise, and a recession sets in again, those industries producing these luxuries usually find their sales falling. If their sales continue, the money they receive is drawn away from the producers of non-luxury goods, and those producers are hurt. The expansion of the money supply by the Fed causes a chain reaction: first, a business boom, then rising prices, and finally recession. Simultaneously, the capital structure of the nation is distorted. During the cycle's initial stages, capital is allocated to the production of goods that consumers would not have purchased without the additional money. During the later stages, industries must change back again, and the adjustment hurts everyone. A Climate for Plunder Earlier, I said that rising prices are the reality of the future. Now I think you can see why prices themselves are not your only concern. The business cycle discussed above is far more destructive to your well-being than rising prices alone. Nor is it just the lower production - which results from the difficulties businessmen have in meeting fluctuating demand - that saps your standard of living. Business turmoil feeds back into the political arena as people become increasingly frustrated by the vacillating economy. Where do they turn? They demand that politicians do something. but the only thing politicians can do is to interfere even more in the economy. Individuals cry for immediate relief from the symptoms of inflation - rising prices, recessions, unemployment - and politicians respond with more government spending and a series of controls. Rising wages by wage controls. Business losses by subsidies. And then there are the antitrust laws, the labor laws, tariffs, export controls, and on and on. Why do these laws follow so quickly? Because economic turmoil creates rich opportunities for some individuals to tap government power and use it to profit at your expense. Recession and inflation create a perfect climate for the sting, and out of the woodwork come hordes of con men and swindlers. Let us see just how they use your economic travail to pick your pocket. Price Controls Everyone resents rising prices. When prices rise rapidly, individuals support politicians who will take action to stop the rise. Since most people believe the person raising the price is responsible, the most obvious political action to be taken is to pass laws fixing prices or limiting profits. Price controls are not bureaucratic solutions, they are a political demand made by voters. Mandatory, across-the-board price controls have instituted thousands of times in the history of nations (three times right here in the United States in the last forty years), and voluntary guidelines have been even more frequent. Not once in their three-thousand-year history have controls or guidelines had any real effect on rising prices. The only excuse offered for this dismal history of failure has been that the controls were not strong enough or were improperly administered. Even those who are adamantly opposed to controls ("free-enterprise" businessmen, for example) defend this philosophical position on the basis that controls fail because they are too hard to administer. In other words, they really believe that controls could work if an effective way could be found to force producers to comply. Only a tiny handful of economists, mostly unnoticed, have used the correct argument against controls: they cannot possibly work, no matter how they are administered, because the individual prices at which people sell their products have nothing to do with inflation. Since people believe producers - manufacturers, retailers, laborers, and middlemen - are responsible for inflation, price controls will be tried over and over again, and each time the public will demand that politicians develop more efficient methods of enforcing them. Since it is unlikely that the public can be educated to the fact that such controls cannot work under any circumstances, the future is clear: we will have price controls over and over again whenever we have inflation. Price controls will not stop inflation. Instead, they reduce production. Remember Economic Law 2: When work is not rewarded, production falls. If the profit is removed, the reason for making the effort _vanishes. Price controls remove profit and drive the producer out of work. Forced to quit producing the price-controlled product, the individual is driven into some other line of work for which he is not as well qualified; this results in less production. Price controls always result in shortages of controlled products. When controls limited prices during World War II, the Korean War, and during the Nixon administration, shortages were widespread. The gasoline and heating oil shortages of recent years are further examples. A complex network of controls made it unprofitable for the producers to expand production to meet demand and scarcity was the result. Price controls on apartments (rent controls) have a clear history of creating apartment shortages wherever they have been used. Products that are price controlled disappear from the shelves and show up on the black market where they are priced even higher than they were on the free market, because now the producer must earn an additional premium over and above his profit to compensate him for the risk he is taking in breaking the law. When everything is price controlled, so that there is no line of work into which you can switch to make a profit, then everything is in short supply (except on the black market). One needs only to look at Russia or China where all prices are dictated by the State to see this truth dramatically demonstrated. You lose in another way to controls. The wider the controls, the greater the army of enforcers required. All the administrators and enforcers of price controls are lured away from productive jobs in private industry where they have been creating real goods and services. Their production is lost to you and to society. Remember Economic Law 4: When production falls, your standard of living falls. In addition to the lost production, you are taxed to pay the salaries of these nonproductive enforcers, and your standard of living ratchets down another notch. Before you rush to write to your congressman about controls, however, remember that he is not the force behind them. Price controls are a prime example of the sting. They exist because A wants to buy the product of B at a price lower than B wants to sell it. Since A cannot personally force B to sell at that price, he turns to the politicians and asks for government force. The politician who votes for controls is merely serving the interests of a multitude of his constituents, all of whom are hoping to benefit from swindling other producers out of their production. If you are selling a product, whether it is your labor to an employer, your professional expertise to a client, or manufactured goods to any buyer, and your price is controlled by the bureaucracy, you lose. And in the end, the person demanding the control loses as well, for eventually the product is driven from the market and there is nothing for him to buy at all. Wage Controls Wages are prices. They are the price an individual charges for his time and effort. Businessmen and consumers are quick to demand that politicians do something about the outrageous wage demands made by unions, and the political answer is the sister of price controls: wage controls. The result of wage control is just as bad as the result of price control. The controlled worker is unable to offer his labor at the price he feels it is worth because the employer has succeeded in getting the politician to force the laborer to sell it for less. The result is not less inflation, of course, because inflation is not caused by the wage demands of labor. The result is lower production. When wages are frozen while living expenses continue to rise, the worker will go on strike, will change jobs in order to get into some line of work that pays a higher wage, or will simply slow down in anger over his belief that he is being cheated. In any case, production falls. Wage controls have absolutely no effect on the inflation rate, and are destructive to production. Wage controls are as much a part of the sting as are price controls. The person demanding controls (usually the employer) hopes to benefit at the expense of the worker by forcing him to sell his labor at a lower rate. In many cases, the employer feels justified in this use of force, since his workers may have already used government power to extract higher wages through coercive labor legislation. Even if the worker has used force, however, the employer's answer should not be more force. This tit-for-tat approach only succeeds in expanding government and lowering production even further. Antitrust Laws It is hard for anyone who has listened to the blistering attack on the Organization of Petroleum Exporting Countries over the past years to accept the fact that cartels and monopolies cannot cause inflation. They cannot. All a cartel or monopoly can do is raise the price of one product. As I demonstrated earlier, if a member of a cartel receives a higher price, some other prices must fall. People do not realize this, however, and their ignorance has opened the door for an army of swindlers. Public demands for political action against cartels, monopolies, and other "combinations in restraint of trade" translate into antitrust legislation, another prime example of the sting. In brief, antitrust law is based on the premise that if a seller is able to dominate and control the market for his product, he can charge a higher price than he could if the market were competitive, and thus cheat the public. The laws state a seller cannot use price discrimination favoring one buyer over another, preclude a buyer from doing business with a competitor, nor acquire ownership of another company if this tends to create a monopoly. The first fallacy can be found in the initial premise itself: that sellers can control and dominate the market. Every producer is trying to maximize his profit in the marketplace, and will raise his price as high as competition will allow. Hordes of entrepreneurs roam the marketplace searching for the highest profit opportunities to employ their skills and capital. Nor is there any lack of capital keeping them out of products requiring large investments. There are literally billions of dollars of capital available to enter any market where the profit opportunities are larger than normal. If a manufacturer succeeds in capturing the major share of a market, he must do it through sharp competitive selling. The moment he has monopolized the market and attempts to raise his prices to benefit from his monopoly, he will find a flood of entrepreneurs rushing in to compete with him and to share in the higher profit margins he is reaping. As each competitor struggles to widen his share of the market, prices will be driven down once more. This time, however, they will fall even lower than they were originally, because now there are more producers competing for the available customers. The idea that a group of producers can band together and create higher than average prices for any length of time is also false. They may try, and may even join in a cartel agreement, but their success will be only temporary. Each member will always be looking out for himself, and will use every chance to gain an edge over the other members. Business history is strewn with the carcasses of cartel agreements that were destroyed by the competitive wrestling of the members themselves. Those who point to OPEC as an example of an effective cartel fail to understand the facts. First, OPEC is engaged in a constant internal struggle as each member country tries to force the cartel to set price and production at levels most beneficial to itself. Second, quadrupling the price of oil in one giant step was successful only because oil had been enormously underpriced in world markets. The price had not been adjusting over the years either to inflation in the industrial countries nor to the explosive rise in demand for oil. Furthermore, the supply of oil from U.S. fields had been curtailed because of price controls and other government regulation of domestic production. Once these restrictions are lifted, production will leap in the United States, and the increased supply will automatically bring the world price into line with the price increases of other products, OPEC or no OPEC. The second fallacy on which antitrust law is founded is that a person is cheated if someone charges too high a price for a product. This implies that one individual somehow has the right to the production of another individual. If you buy some wood and build a chair, who does that chair belong to? Does it belong to you, or does it belong to someone else? Now, if you tell me that is belongs to you, then you should be able to do with it as you please. You should be able to keep it, or sell it for whatever price you choose. If you feel that you would rather have the chair than $10, why should you be forced to sell it for $10? If you feel that the chair is worth $10,000 to you, how can someone else justify forcing you to take even $1 less? The person who wants your chair has no real claim to it unless he can induce you to part with the chair voluntarily. The chair is a result of your effort. A person who uses government to force you to give him the chair for anything less than you would willingly sell it for is simply using force to plunder your property on the basis that his need is a rightful claim on your effort. It is clearly a case in which he feels that you should be his slave. The laws of economics clearly explain why any type of theft results in lower production and a lower standard of living for all. To achieve a higher standard of living in a society, we must recognize the right of any individual to set any price he wants on the goods that he produces. Antitrust law is wrong, because it is based on the false idea that if you set your price too high, you are cheating your customer. The antitrust laws are not only unnecessary, they have a profoundly destructive effect on the output of goods and services in the country. First, they are horrendously expensive to enforce. The court cases involving antitrust actions are the most expensive in the judicial system. Companies are required to supply records to the court that cost millions of dollars to compile, or consist literally of tons of paperwork, and consume hundreds of thousands of hours of legal time by Justice Department attorneys. The millions of dollars of taxpayers' money used to prosecute these companies and the additional millions of dollars spent by companies to defend themselves is paid by you and me. We have less to consume because all that human effort is wasted. The second way the antitrust laws reduce your standard of living is by preventing the most efficient producers from developing their markets in the most effective way. Where companies could lower prices by merging and more efficiently catering to particular markets, the law says they cannot do it. These laws do not accomplish their stated objectives; that is, they do not lower prices by breaking up monopolies. They force you to pay much higher prices because they prevent companies from merging and using competitive business techniques to get your business. The laws make nonsense of the very thing they are trying to accomplish. They do not promote competition; they restrict it. Antitrust laws are more than simply a faulty concept; they are a fraud used by crafty businessmen to tap your pocketbook. They are no different than most other government regulations, in that they limit competition and thus control where you spend your money. Nowhere is the use of government as a sword of theft as easily documented as is the case of these laws. Read any of the cases of antitrust actions brought against businesses and you will almost always find the actions were initiated not by the government but by other businesses. Time and again, you read that Company A has filed suit against Company B for violations of the antitrust laws. Any company finding its market position threatened by the sharp marketing practices of a competitor has the opportunity to ferret out violations of these statutes and can file complaints with the Federal Trade Commission, or file civil actions on its own. Nor is it hard to find violations. A company that sells at a price below competition is automatically suspect of discriminatory price-cutting tactics, something illegal under the laws, and something that can give the higher-priced competitor a lever for legal action. Frequently, a business buying products from another industry will find the prices, because of competition, are all nearly the same from the various suppliers. This gives the buyer the opportunity to levy charges of price-fixing, and again bring the government down on the suspected companies. The buyer also has the ability to file charges of price gouging in the event a company is charging prices higher than the competition. In the world of antitrust, it is one businessman against another, each determined to use the sharp sword of the law as a weapon against his competitor. When the sword cuts, it always wounds or kills the business it's aimed at, and it always takes a little slice out of you, too. the businessman who can't attract your patronage through competitive pricing, quality, or service can get the government to destroy his rival and get your business by default. It is your wealth that is the ultimate target in the great antitrust sting. Subsidy Hardly a day passes in any modern industrial country that the news media does not carry stories about the failure of businesses. In our era of inflation-spawned business cycles, when boom and recession follow each other in metronomic procession, no business seems totally secure from bankruptcy. Businesses fail because individuals like you and I survey their products and turn down their offers. Their prices may be too high, their workmanship poor, their products outmoded, or, more likely, they have been whipsawed into trouble by inflation. In any case, competition has defeated them in the marketplace. We judge their products, count our scarce cash, and decide to spend our money on something else. When a product is rejected in the marketplace, however, that does not always mean that the seller goes down to defeat. If we refuse to by his products voluntarily, he still has the possibility of using force to get us to buy them. With some effort he may be able to get the government to take the money from you through taxation or borrowing to give it to him. Here is how it is done: You sell automobiles (or airline seats, or shoes, or potatoes), and suddenly markets change. Your sales decline, your costs soar, your competition has a new ad campaign, foreign imports undercut your price, or your union strikes. You are faced with bankruptcy. You think through the ramifications of the failure of your business, and recognize that more is at stake than just your own profits. Hundreds, perhaps thousands of shareholders will lose if you go under. Banks hold millions in notes that will be worthless if you collapse. You have employees, thousands of them, who will be out of work. The businesses that supply you with parts and raw materials will have to lay off their employees. All the merchants who depend on your employees' business will be hit by recession. The ripples from your bankruptcy will spread until they touch every corner of the nation. You have a bright idea. Why not appeal to the government for a subsidy? After all, it is in the best interest of thousands of people, perhaps the nation, to see that you do not go bankrupt. By pleading for the government to protect these others, you may be saved. You, the leaders of your union, and the bankers who hold your notes, all converge on Washington to argue your case before the bureaucrats and politicians. The government is a stern, concerned patriarch who admonishes you, and talks about free enterprise and the rigors of competition. Its accountants pore over your books; its committees listen with caution to your tale of woe. Finally, it agrees. The nation will be better off if you stay afloat. Congress offers loan guarantees, tax reductions, and outright grants to keep your workers on the line, and your creditors from foreclosing. A familiar story? Of course. Remember Lockheed? Pen Central? Chrysler? All have faced failure, and all have appealed to the government for subsidies. In addition to these familiar cases, many healthy companies receive government aid without asking, merely by being part of any industry that gains the sympathy of the State. When the State sets up programs to aid an entire industry, everyone involved is aided. Crop support prices, acreage allotments, low-interest home loans, milk support prices, government contracts for ailing industries, small business loans, grants to companies deemed injured by foreign competition, subsidies for minority businesses, government stockpiling of commodities and foodstuffs; all are examples of the largess government extends to help those faltering industries whose existence is deemed to be in the best interest of the country. The argument is that certain industries employ so many people and are so critical to the entire economy that they must not be allowed to fail. It is said to be better to take money from consumers through taxes and inflation in order to subsidize the ailing company, than to allow it to fail. Most Americans take it for granted that ailing businesses should sometimes be subsidized. Who is helped and who is hurt? Let's look at the basic issues. There is usually only one reason a subsidy is necessary. Individuals like you and I have been offered a product or service, and we have said, "No, we value other things more." The company applying for the subsidy is saying, in effect, "That individual over there does not want to pay my price for my product. Since he will not buy my product voluntarily, I demand that you take his money by force and give it to me. His judgment is faulty, and it will be in his best interest if he is forced to buy my goods." A corporation that fails in the marketplace would not be willing to come directly to you and force you to buy at the point of a gun. After all, that is both illegal and dangerous. Yet that is exactly what is being done under the guise of government subsidy - only this time the government is holding the gun, and the theft is called "legal," and "in the national interest." Remember now, the government has no money of its own. It produces no wealth. Everything it has it takes from individuals who are producers. it takes through taxes, or by deficit spending. Therefore, what it gives in subsidy, it must first take from a producer or a saver. Subsidies are plunder. Perhaps just pointing out that you are being ripped off by subsidies has not answered the central question. In certain cases, might subsidies still be beneficial to the nation as a whole? No. They do benefit some individuals in the short term (those who receive the subsidies), but they do so at the expense of all the others. In the long run, even those who receive subsidies are hurt. Let me demonstrate. You and Maynard are on your island again. You are producing fish, and he is producing bread. One day another person is cast up on your shores, and he turns out to be an accomplished breadmaker. He looks over your little economy, and decides to put his skills to work. He begins producing bread. He is not as fastidious as Maynard, taking less care in gathering his grain, and spending little time in cleaning up his bakery, but he is fast, and manages to turn out four loaves per day. he immediately offers to trade you two loaves for a fish. You look over his product. You recognize that its quality is lower than Maynard's, but still it is two loaves instead of one. You take him up on his offer. Maynard is dismayed. He can continue to produce bread, but if he wants to trade it for fish, he'll have to compete with the new baker's price, that is, a loaf for half a fish, or two loaves for one whole fish. This reduces his standard of living relative to yours and the other baker's. You and the other baker now each can consume one fish and two loaves of bread per day. Maynard now only has two loaves of bread and no fish. Maynard demands that the two of you share your new affluence. He wants you each to give him onethird of a fish, while he keeps both his loaves of bread. That way all three of you will have an equal standard of living. Maynard demands this on the basis that he has been injured by the efficiency of the new baker. If you subsidize Maynard, it reduces your standard of living while increasing his. There is absolutely no benefit to you from the subsidy. Even if Maynard goes completely out of business and stops making bread altogether, it does not affect you or the new baker. you both still enjoy the same higher standard of living. When Maynard stops producing, it only hurts Maynard. You point out to Maynard that if his inefficiency relative to the other baker justifies half a fish as subsidy, you would be justified in getting an even greater subsidy were you to switch to bread-making, since you are even less efficient than he as a baker. When you tried bread-making, you could only produce one loaf each day. By claiming he is injured by the efficiency of the newcomer, Maynard is really attempting to penalize you for his own lack of competence. If you do not subsidize Maynard, he will be forced to either subsist on his lower standard of living, increase his efficiency by working harder to produce more bread, or search around for another product to produce that will be appealing to both of you. In other words, he either eats less, produces more, or produces something else. Your refusal to subsidize him is a direct incentive for Maynard to be more productive. If he rises to the challenge, which human nature will force him to do, the whole society will be better off. The GNP of your little society is now eight units of production (two fish from you, four loaves of bread from the new baker, and two from Maynard). If Maynard increases his production, the GNP rises. He will be the first to benefit. But if his production goes even higher, eventually the increased production will be spread around through price adjustments. Members of an ailing industry claim they have been damaged because others will no longer pay them enough for their products. They also claim that if they do not receive a subsidy, they will not be able to buy the products of others, and everyone will be hurt. Just the opposite is true. If a producer is inefficient, or is manufacturing products others don't want, everyone else in the society is injured when money is taken from them and given to this producer to keep him producing. The victims of the plunder don't benefit from the wealth they have produced, and thus, according to Law Number 2, they will tend to produce less in the future. The recipient of the subsidy is sheltered from the truth that the market does not value his product, and thus he will continue expending capital and resources on it. Everyone loses the products that could have been produced had the producer been forced to search for a product the market valued more. In summary, subsidies are simply ways that individuals use the power of government to benefit themselves at the expense of others. In effect, they are asking the government to steal for them. We already know that any plunder lowers production and hurts the society. No matter how big a segment of the population is employed by a weak producer, no matter how many people trade with him, it still does not benefit society to subsidize him. In the case of your little island community, Maynard made up one-third of the total population. One-third of the population would have benefited from the subsidy, but it would have been at the expense of the other two-thirds. Even if one-third of the people in the United States were directly hurt by the failure of a major industry, it would still work exactly the same way. The only benefit they could get from a subsidy would have to come from those who were not in that industry, and those people would be hurt in direct proportion to the benefit received by those being subsidized. Even more significant than that, the subsidy would have the direct effect of causing those subsidized to continue to devote energy and capital to an industry which had proven itself inefficient, and to produce what people had already indicated they preferred not to have. That same capital cannot be used in two places at once, and the fact that it was misdirected to the less valued products means that it was denied to those products which the people preferred. All the preferred products it could have created are never seen. Subsidy does not create a net benefit to society. Either you get to spend your money on things you value, or the government spends it for you on things it decides you should value. One way, you are stimulated to produce more wealth; the other way, you are stimulated to produce less. Either way, the same number of people are still employed, only without the subsidy they produce more, and with the subsidy they produce less. We have been conditioned to think that this type of plunder is justified and that it is good for everyone. Just the opposite: it is bad for everyone. It is the worst kind of sting. Summary Inflation is a process that saps the purchasing power of your money, but its effects far exceed that simple loss. As money enters the economy via the Federal Reserve, it creates demand for certain products, a demand that would not have existed without the new money. This draws real human energy and capital away from the production of goods that consumers formerly demanded, and directs it toward other things. Soon the new money results in a falling value to all money (rising prices), and the marketplace is faced with falling real demand. Both the new industries and the old suffer as the economy falls into recession. Business slump is accompanied by cries for help from damaged businesses, and the Fed moves to create more money in order to prevent the recession from developing into a full-scale depression. This new money creates another business boom, again distorting capital allocation, and setting the stage for another, deeper recession. The business cycle is fully underway. Meanwhile, the separate problem of rising prices frustrates businessmen, labor, and consumers alike, and soon the politicians are pressured by their contributors and constituents for relief. Price controls, wage controls, and antitrust actions are the direct outgrowth of these public demands. Simultaneously, the business slumps generated by the misallocation of capital place many industries in jeopardy, and the politicians answer the demands of these industries by various forms of subsidy. All of these political responses to public demands merely make the situation worse, as all of them reduce production, increase the federal deficit, and place further pressure on the Fed to create even more money. Price controls, wage controls, antitrust actions, and subsidy are four confidence games camouflaged as methods to control inflation or stabilize the economy. They are born in the climate of economic turmoil that accompanies all inflations. Like the old shell game in which the con man cleverly diverts your attention while he palms the pea, these financial swindles are covered by a smokescreen of social turbulence. All four lift money directly from your pocket and transfer it to others. All four lower production, and thus your standard of living. All four result in higher prices, not lower prices as their advocates would have your believe. The strongest advocates of these four games are the individuals who gain directly by preventing you from dealing voluntarily with whom you please. These four con games are the tip of the iceberg. Compared to some other more subtle tricks the carnival hucksters have dreamed up, these four are obvious frauds. Let's move down the boardwalk a bit further and look into that popular game that everyone seems so enthralled with called business regulation. |
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To fully understand how the entire process of deficit spending and inflation affects your life, it is necessary to separate and examine the actions of the government and the actions of the Fed. As we do this, keep in mind two fundamental economic realities. First, resources are limited. Only a given quantity of goods is available at any moment. If a person spends his time doing one thing, it means he cannot be doing something else. If he spends a dollar on one item, it cannot be spent on something else. Second, individuals resist changing their occupations and businesses. They resist because change means an immediate sacrifice. To learn a skill or create a business requires an investment of time, energy, and money - in other words, capital. To change form one trade to another - for example, to change from being an engineer to being a psychologist - means that the individual must learn new skills, spend time in study and training, and then invest time in practicing. To change businesses means abandoning capital invested in old tools, facilities, and inventory. Starting over is costly.
John Pugsley is chairman of 