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Thursday, May 23, 2013

The inflationists

It is not surprising that mercantilists, with their concentration on greater revenues and power to the state, should fasten on inflationist schemes of creating bank paper and credit, as well as government paper money. Such proposals and schemes, however, had to wait for the discovery of printing in the fifteenth century, for the development of bank paper and fractional reserves in sixteenth century Italy, and finally, for the invention of government paper money and central banking, both dubious innovations of Britain in the 1690s.

The first English inflationist was William Potter, whose most famous tract was The Key of Wealth (1650). It was Potter whose theories and proposed schemes set the stage for more famous inflationist followers, such as the Scotsman John Law. Potter, who worked in the government land office, began with the generally agreed axiom that a greater amount of money is beneficial to society. But with impeccable logic, Potter asked: if more money is good, why shouldn't a perpetual and greater increase of money be even better? Why indeed? Why not an increasing supply of money leading to infinity?
Potter offered a plethora of money-creating schemes, in which paper money would be secured, not by specie, which is inconveniently scarce, but by the ‘nation's land’. More relevantly, of course, paper notes can actually be redeemed in physical gold or silver coin, whereas redemption of notes ‘in land’ would prove a chimera. How are you supposed to carry around a few acres of land with you to make exchanges? But that of course is the idea of a ‘land bank’: money seemingly and in the eyes of the deluded public backed by the land of the nation, but actually not backed at all.

William Potter saw other wonders emerging from a land bank. Thus, increasing the money supply would increase land values, and thereby increase the ‘value of the backing’ of the money: a sort of magical perpetual motion machine! Actually, of course, the increased land values simply reflect the increasing prices and values caused by the manufacture of more money.

Since Potter was anxious to inflate money and land values, he was almost frantically opposed to ‘hoarding’, since he realized that if the new money were ‘hoarded’, that is piled up in cash balances and not spent, the supposed benefits of inflation would not accrue. Indeed, one reason Potter greatly preferred paper money to specie is that paper is far less likely to be ‘hoarded’; this means, of course, that paper money is far more likely to depreciate sharply in value as people try to get rid of it rather than add to their cash holdings.

William Potter, however, was cagey about prices rising as a result of his proposed monetary inflation. He believed, instead, that the increased money supply would greatly expand the ‘volume of trade’ and therefore the amount of production of goods, and that wealth would therefore accumulate. Potter preferred to believe that all the increased money supply would be absorbed in increased production, so that prices would not rise at all; but even if prices rose, everyone would be better off. Rising prices, of course, is the Achilles heel of inflationists’ schemes, so that all of them deprecate the extent of subsequent price inflation and currency depreciation. They did not recognize, of course, that the ‘volume of trade’ may increase in money terms, but that this gain, like the alleged rise in land values, would simply reflect the increase in all monetary terms and values as more money supply is created and spreads throughout the system.

The argument of the alleged increase of trade and production largely rested on a flimsy analogy to the physical sciences. The Englishman William Harvey had only recently, in 1628, discovered the circulation of the blood within the human body. And Potter launched the very popular analogy between blood in the human body and money in the body economic. Just as people depend on the circulation of their blood, so the economy needs the circulation of money. But the inflationist notion of the more money the better can scarcely be supported by this feeble analogy; after all, who advocates the more blood the better in the human body, or the faster the circulation the better?27
In his bold moments, William Potter actually maintained that monetary inflation would cause prices to fall(!). Trade would be vivified and production would increase so greatly that supply would rise, and prices would fall.

William Potter, however, proved to be only preparation for the locus classicus of inflationism, the prince of proto-Keynesian money cranks, both theorist and activist, John Law of Lauriston (1671–1729). Son of James Law, a wealthy Scottish goldsmith and banker, John was born and grew up in Edinburgh, proceeding to squander his father's substantial inheritance on gambling and fast living. Convicted of killing a love rival in a duel in London in 1694, Law bribed his way out of prison and escaped to the Continent. After a decade in Europe pondering monetary problems, Law returned in 1703 to Scotland, where he was not subject to arrest. There, Law concentrated on developing and publishing his monetary theory cum scheme, which he presented to the Scottish Parliament in 1705, publishing the memorandum the same year in his famous or infamous tract, Money and Trade Considered, with a Proposal for Supplying the Nation with Money (Edinburgh, 1705). The Scottish Parliament considered but turned down his scheme; the following year, the advent of the union of Scotland with England forced Law to flee to the Continent once more, since he was still wanted by English law under the old murder charge.

Karl Marx, in a sense, should have been proud of the way John Law ‘unified theory and practice’ in his proposal. On the one hand, Law was the theorist, arguing for a central land bank to issue inconvertible paper money, or rather, paper money ‘backed’ mystically by the land of the nation. As a crucial part of his proposal, the grateful nation – in this case Scotland – was supposed to appoint Law himself, the expert and theoretician, in charge of putting this inflationist central bank scheme into effect.
John Law, as his subtitle states, proposed to ‘supply the nation’ with a sufficiency of money. The increased money was supposed to vivify trade, increase employment and production – the ‘employment’ motif providing a nice proto-Keynesian touch. Law stressed, in opposition to the scholastic hard-money tradition, that money is a mere government creation, that it has no intrinsic value as a metal. Its only function is to be a medium of exchange, and not any store of value for the future.
Even more than William Potter, John Law assured the nation that the increased money supply and bank credit would not raise prices, especially under Law's own wise aegis. On the contrary, Law anticipated Irving Fisher and the monetarists by assuring that his paper money inflation would lead to ‘stability of value’, presumably stability of the price of labour, or the purchasing power of money.
Law also anticipated Adam Smith in the latter part of the eighteenth century in his fallacious justification for fractional-reserve banking that it would provide a costless ‘highway in the air’ – furnishing a money supply without spending resources on the mining of gold or silver. In the same way, of course, any expenditure of resource can be considered a ‘waste’ if we supply our own assumptions that are not held by people on the free market. Thus, as Professor Walter Block has pointed out, if there were no crime, all expenditure on locks, fences, guards, alarm systems, etc. could be denounced as ‘wasted resources’ by external observers criticizing these expenditures. Similarly, if there were no such thing as governmental inflation, market expenditure on gold or silver could be considered ‘wasteful’ by observers.

If domestic price rises constitute the Achilles heel of monetary inflation, another worry has been the outflow of gold and silver from the country, in short, an ‘unfavourable balance of trade’ or of ‘payment’. But John Law dismissed this problem too. On the contrary, he declared that an increase in the money supply would expand employment and output and ‘therefore’ increase exports, thus causing a favourable balance of payment, with gold and silver flowing into the country. Note that there is no analysis of why an increase in the money supply should increase output or employment, let alone drag exports along with it in this seemingly universal expansion.

Interestingly enough, one of Law's talking points about the need for more money was, as in the case of low interest, based on a striking misinterpretation of the reasons for the prosperity of the Dutch, whom all other nations envied in the seventeenth century. We have seen that everyone saw that the Dutch had low interest rates, leading English mercantilists to put the cart before the horse and attribute Dutch prosperity to low interest rates, instead of realizing that high savings and higher standards of living had brought about these low interest rates. Hence the mercantilists suggested that England force the maximum usury rate still lower.

Similarly, John Law saw that prosperous Holland enjoyed a plenty of metallic money; he attributed the prosperity to the abundance of money, and proposed to supply paper money instead. Again, he overlooked the point that it was Dutch property and high production and export that brought a plenitude of coin into the country. The export surplus and abundant coin was a reflection of Dutch prosperity, not its cause.

Not that John Law neglected the low interest argument for Dutch prosperity. But instead of direct usury laws, Law proposed to arrive at low interest rates in what would become the standard inflationist manner: expanding bank credit and bank money and thereby pushing down the rate of interest. Indeed, Law worked out a proto-Keynesian mechanism: increasing the quantity of money would lower interest rates, thereby expanding investment and capital accumulation and assuring general prosperity.
To Law, as to Potter before him and Keynes after him, the main enemy of his scheme was the menace of ‘hoarding’, a practice which would defeat the purpose of greater spending; instead, lower spending would diminish trade and create unemployment. As in the case of the late nineteenth century German money crank Silvio Gesell, Law proposed a statute that would prohibit the hoarding of money.29
It took John Law another decade to find a ruler of a country gullible enough to fall for his scheme. Law found his ‘mark’ in the regent of France, a country that had been thrown into confusion and turmoil upon the death of its seemingly eternal ruler, Louis XIV, in 1715. The regent, the duke of Orleans, set Law up as head of the Banque Générale in 1716, a central bank with a grant of the monopoly of the issue of bank notes in France. Soon the banque became the Banque Royale. Originally, banque notes were receivable in French taxes and were redeemable in silver; soon, however, silver redeemability was ended. Quickly, by 1717, John Law had all monetary and financial power in the realm placed into his hands. To his old scheme he added the financing of the massive government debt. He was made the head of the new Mississippi Company, as well as director-general of French finances; the notes of the Mississippi Company were allegedly ‘backed’ by the vast, undeveloped land which the French government owned in the Louisiana territory in North America. Law's bank created the notorious hyperinflationary ‘Mississippi bubble’; notes, bank credit, prices and monetary values skyrocketed from 1717 to 1720. One aristocratic observer in Paris noted that for the first time the world ‘millionaire’ had become prevalent, as suddenly many people seemed to possess millions. Finally, in 1720, the bubble collapsed, Law ended a pauper heavily in debt, and he was forced once again to flee the country. As before, he roamed Europe, making a precarious living as a gambler, and trying to find another country that would adopt his scheme. He died in 1729, in Naples, trying to persuade the Neapolitan government to make him its inflationary central banker.

The cataclysm of John Law's experiment and his Mississippi bubble provided a warning lesson to all reflective writers and theorists on money throughout the eighteenth century. As we shall see below, hard-money doctrines prevailed easily throughout the century, from Law's former partner and outwitter Richard Cantillon down to the founding fathers of the American Republic. But there were some who refused to learn any lessons from the Law failure, and whose outlook was heavily influenced by John Law.31
Perhaps the most prominent of the post-Law inflationists in the eighteenth century was the eminent Anglo-Irish idealist philosopher, Bishop George Berkeley (1685–1753). Berkeley studied at Trinity College, Dublin, the intellectual centre of the Anglo-Irish Establishment, and his great philosophical works were all written in his 20s, while he was a fellow at Trinity. Berkeley then spent several years in the late 1720s vainly trying to establish a Christian college in Newport, Rhode Island. After that, Berkeley was appointed dean of Derry and then bishop of Cloyne.

Berkeley's major pronouncements on economic questions came in his pamphlet, The Querist (1735–37), published in three instalments. The Querist was highly influential, ten editions being published in Berkeley's lifetime. It was written solely as a series of 900 loaded questions, by which Berkeley hoped to influence public opinion through sheer rhetoric without having to engage in reasoning. Berkeley's monetary views were heavily influenced by John Law. A typical example of one of Berkeley's loaded queries is ‘whether the public is not more benefited by a shilling that circulates than a pound that lies dead?’ Money, for Berkeley, was a mere ticket, and the centrepiece of The Querist was the advocation of a Law-type central bank that would expand money and credit, lower interest rates (as Berkeley put it, ‘put an end to usury’), and expand employment and prosperity.

Berkeley was shrewd enough to recognize that he had to answer objections based on John Law's egregious flop, and so he hastened to put some distance between his own schemes and the ‘madness of France’. Like Law before him, Berkeley promised that his proposed bank notes would only be injected into the economy ‘by slow degrees’, and that he or his surrogates would take pains to keep the expansion of bank credit ‘proportional’ to the ‘multiplication of trade and business’. In that way, prices would supposedly not rise. But of course Berkeley embodied the usual inflationist failure to see that ‘the multiplication of trade and business’ in money terms would precisely be the result of the monetary inflation and the consequent inflation of all prices and monetary values. (Berkeley's manipulative query on this theme is: ‘Whether therefore bank bills should at any time be multiplied, but as trade and business were also multiplied?’)

Austrian Perspective on the History of Economic Thought (2 volume set)

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