Sunday, November 06, 2005

How government invisibly confiscates wealth

This quote came to mind today. Well, more the incredible fact of who said it:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process 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.

Click here for the answer.

It doesn't even take severe devaluation of currency to control a society -- just, oh, 91 years or so of mostly gradual inflation, with spans here and there of higher inflation that prompt politicians to call for more central banking action that compounds the problem further. It's important to remember why Austrian economics so vehemently opposes inflation, which, strictly speaking, is not an increase in the price of "a basket of goods" (which can be from supply and demand), but a purely "monetary phenomenon" (as Milton Friedman himself called it). Inflation is implicity engineered by whichever entity has the power to issue fiat currency.

By purposely engineering inflation and controlling interest rates, a central bank hinders -- if not completely destroys -- people's ability to make rational economic calculations. The first part of the story is that a central bank's manipulation of interest rates distorts markets by preventing lenders and borrowers from approaching equilibrium. Austrian business cycle theory tells us that such intervention unavoidably introduces market errors, and if we're dealing with lower interest rates that led to a boom, it must necessarily be followed by a downturn as the errors correct themselves and markets realign.

The second part is that a central bank distorts money's true value, skewing the natural forces that otherwise push free markets toward their natural equilibrium. Here I'm not discussing the idea that the money supply must be inflated to correspond with population, but that a central bank is wrong to confuse supply and demand -- especially when price increases are temporary, cyclical and confined to only part of the economy -- with the universally reduced purchasing power that the central bank alone engenders. A weaker domestic currency makes goods and services artificially more expensive, of course, but there's more than the effect on the consumer: endeavors that supply certain demanded goods or services will be less profitable and could well disappear, in favor of other endeavors that are not as necessary (based on equilibrium market conditions) but become artificially more profitable. The flip side is a stronger domestic currency, or, if inflation is continuous, domestic currency that happens to be stronger than expectations. Then suppliers are not encouraged to offer as much of a scarce item, and buyers are not encouraged to consume less of it -- petroleum included.

Let's say that a firm plans its business model around developing an oil rig and, accounting for expectations of inflation, selling the oil two years from now at $60. The Fed might miscalculate conditions it cannot control, like population growth and foreign-held dollars, and tightens too much; then with a dollar's increased purchasing power, oil buyers settle on $59.50 per barrel. Or if the Fed is expected to tighten more in the future, a firm will simply not build the rig in the first place, because it is calculated to be unprofitable, which will make oil more scarce than it ought to have been. Either way, the central bank has induced a market error.

Today I'll admit a fear I've recently expressed in private, that the Fed may tighten too much and create a recession in the next couple of years. An economic crisis is all Hillary would need to capture the White House, just like her husband seized upon -- never mind the recession had ended 20 months prior to the 1992 election.

What a mess! It was easier in Biblical times: as Christ noted in a parable, people paid attention the signs, such as a season changing into another, that told them when to sow and when to reap. Conversely, Jefferson reputedly said, "Were we directed from Washington when to sow, and when to reap, we should soon want of bread." What would he say today, faced with the power of a central bank to invisibly discourage or encourage people in their production?

I suppose it could be worse: the Fed for the last several years has had inflation under control -- or it had, as we're now seeing. Nevertheless, even with "inflation" on the rebound, is "it could be worse" any excuse?


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