In the previous article, I discussed the social consequences of the welfare state; now I want to focus on inflation—or more precisely, on central bank policy. Inflation can broadly be defined as an artificial increase in the money supply that ultimately drives up prices, but this definition overlooks the fact that it is a process in which prices first rise in the capital goods of industries furthest from final consumption and then gradually spread throughout the entire system. Therefore, in an inflationary process, there are a few winners who reap substantial profits, and many losers whose purchasing power declines.
It can be said that inflation is caused by governments, both through monetizing debt and by allowing commercial banks to violate general legal principles regarding the deposit contract. Inflation is a hidden tax with devastating economic and moral consequences; it encourages the population to go into debt by making credit cheaper, and it penalizes saving, reducing time preference. Not only that, but it is also a spiritual burden. It drives people to seek ways to protect their savings, making society more materialistic, causing people to prioritize money over happiness, and often forcing them to migrate, thereby breaking family and patriotic ties.
As Jesús Huerta de Soto explains, the Peel Act of 1844 forms the foundation of modern banking systems. This law correctly prohibited the issuance of banknotes without 100 percent backing, but not that of deposits, as it failed to recognize that deposits are part of the monetary base (M). While issuing unbacked banknotes constitutes forgery and fraud, fractional reserve banking is a form of embezzlement. The ruling issued by Judge Lord Cottenham in 1848 in the case of Foley v. Hill concluded that deposits were under the custody of the banker and, therefore, considered his money to do with as he pleased. This jurisprudence was both binding and disastrous. Moreover, it occurred at a time when grain depositors who had appropriated their clients’ deposits to speculate on the Chicago market were declared to be engaging in fraudulent activity.
On the other hand, human creativity produced a solution that lasted for half a century until World War I: the gold standard. The classical gold standard is a rigid system that prevents disproportionate expansions of the money supply, since the gold stock grows by only about 1-2 percent per year. At the same time, it also prevents any sharp contraction of that supply, and the process of credit expansion through loans not backed by voluntary savings—which creates intertemporal discoordination—cannot occur. With productivity growing at about 3 percent during that period, the years from 1865 to 1896 were marked by deflation. Yet this did not prevent it from being a time of great capital accumulation.
While there were inflationary episodes when rulers manipulated the currency, society did not live under constant inflation as it has in the 20th and 21st centuries. The key difference lies in the central banks. The Federal Reserve Act of 1913 granted the Fed the privilege of issuing banknotes and required all banks to hold their reserves in demand deposit accounts with it. The Fed, in Murray Rothbard’s words, is inherently inflationary because it acts as a lender of last resort and can expand its reserves without facing the constraints of a decentralized banking system.
It is no surprise that the Fed reduced the reserve requirements for commercial banks from an average of 21.1 percent to just 3 percent by 1917. Coincidentally, this system came into effect in 1914, and World War I greatly favored its implementation, just as the system facilitated the US entry into the war. Without the Fed, the government would have had to raise taxes directly or print greenbacks, which were highly unpopular. With this system, however, they managed to double the money supply between 1914 and 1919. By 1917, they had obtained permission to issue gold exchange notes and required banks to hold them as deposits with the Fed instead of in physical cash. These measures gradually detached the average American from the habit of using gold in daily life and accustomed them to checks and paper money.
Inflation caused by fiduciary media (although there are other types of inflation, which are neither as obvious nor as persistent over time) has the same redistributive effects as the welfare state, because credit expansion unfolds in several stages. New money enters the economy through specific channels, increasing the purchasing power of those particular actors, who can also consume goods at lower prices. Meanwhile, for the rest of the population, consumer prices rise, leaving them worse off and contributing to a redistribution of income. One could say that inflation promotes capital concentration.
Guido Hülsmann’s claim that the growth of the welfare state and the militarized state would not have been possible without inflation is entirely accurate. This phenomenon has transformed the economic structure since the 20th century. Industrial firms and corporations once relied on retained earnings for financing, with financial intermediaries playing a secondary role. But with the global regime of inflationary fiat money, the tables have turned, and debt has risen at all levels. This is because fractional reserve banking and fiat money violate the non-aggression principle: the latter does so by creating a product that would not survive in a free market and is only used because it is protected by legal tender laws.
As a result, the state’s potential monetary resources are unlimited, since the central bank has unlimited credit through the issuance of national paper money. Investors are aware of this, which is why they continue to buy government bonds even though they know that public debt will never truly be repaid. Credit offered at artificially low interest rates creates perverse incentives, whereby entrepreneurs take on massive debt—but the truth is that an entrepreneur-capitalist operating with only 10 percent equity and 90 percent debt is merely an executive. The real entrepreneur-capitalists are the banks, which act as creditors. Inflation reduces the number of true entrepreneurs—independent men operating with their own money.
The social consequences are numerous. Under inflation, Wilhelm Röpke describes the massive rise in consumer credit and installment purchases as a disorder worthy of parasites and freeloaders, contrary to the idea of living within one’s means—that is, maintaining a balance between income and expenses and living a coherent life. For him, the novelty of democratic-socialist inflation, brought about by the ideologies of mass democracy, is a moral disease stemming from mistaken beliefs about full employment. Inflation causes a vertical surge in investments not backed by real savings, thereby eliminating all incentives to save.
The culture of sacrifice is undermined. As Hülsmann states, “civilization crucially depends on the ability and willingness of at least some of its members to make genuine sacrifices, at least some of the time.” Saving, which is linked to sacrifice, also benefits the economy of giving, and deflation supports it—because falling prices discourage leverage, especially in households. As capital use becomes less profitable, the opportunity cost of making donations drops, which increases charitable giving both in absolute and relative terms. Inflation, by contrast, is harmful because it reduces the value of inheritances, and one of the strongest incentives to save before death is the desire to leave something to one’s loved ones. From this, it follows that one of the most powerful motivations for preserving wealth is the ability to make donations.
The reality is that human motivations are heavily influenced by the political and economic context. Hülsmann continues explaining that monetary expansion first reduces the incentives to save. Families are the school of love and virtue, and they are sources of sacrifice and generosity—but they are not only founded on spiritual grounds, but also on economic ones, rooted in the division of labor and capital accumulation. Inflation forces all participants to dedicate more time to money and investments rather than to starting a family. Under a debt-based system, family ties represent a far greater sacrifice, contributing to rising divorce rates, later ages of first marriage, and fewer children. Inflation has pushed women into the labor market, reduced the costs of leaving the family unit, and increased the number of single mothers and divorces.
To conclude, Hülsmann finally explains how inflationary culture also reduces the time spent on selfless activities like simply being with others, which becomes instrumentalized as “networking”—transforming friendships from relationships of trust into utilitarian arrangements. Every society has individuals with perverse attitudes, but they are usually few and must bear the consequences, including the cost and loss of good company. With inflation, however, these attitudes are subsidized, and the meaning of good and evil is reversed. It also creates tensions between taxpayers and recipients, employers and employees, men and women, or retirees and young professionals, fostering a sense of identity-based conflict or group polarization. Incentives to save in cash are eroded, and savings must either be spent on consumption or invested. In low-income households, the former is more common. The average worker, who only saves in ways he understands—namely, in cash—and who distrusts opening investment accounts with banks or brokers and knows nothing about financial markets, is left with no savings. Inflation has destroyed the working class’s culture of saving, erasing its sense of transcendence.
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