Free To Choose: a personal Statement

The Cure for lnflation
251
to the waterside when a vessel arrived from London, each carry-
ing a bundle of the best tobacco under his arm, and taking back
with him a beautiful and virtuous young wife.' And another
writer, quoting this passage, goes on to remark, "They must have
been stalwart, as well as gallant, to hasten with a roll of tobacco
weighing 100 to 150 pounds under the arm."
As money goes, so tobacco went. The original price set on it
in terms of English money was higher than the cost of growing it,
so planters set to with a will and produced more and more. In
this case, the money supply grew literally as well as figuratively.
As always happens when the quantity of money increases more
rapidly than the quantity of goods and services available for pur-
chase, there was inflation. Prices of other things in terms of
tobacco rose drastically. Before the inflation ended about half a
century later, prices in terms of tobacco had risen fortyfold.
The growers of tobacco were most unhappy about the inflation.
Higher prices of other things in terms of tobacco meant that to-
bacco would command less of those other things. The price of
money in terms of goods is the reciprocal of the price of goods in
terms of money. Naturally, tobacco growers turned to govern-
ment for help. One law after another was passed prohibiting
certain classes of people from growing tobacco; providing for
destroying part of the crop; prohibiting the planting of tobacco
for one year. All to no avail. Finally, people took matters into
their own hands, banded together, and went around the country-
side destroying tobacco plants: "The evil reached such propor-
tions that in April, 1684, the Assembly passed a law declaring
that these malefactors had passed beyond the bounds of riot, and
that their aim was the subversion of the government. It was en-
acted that if any persons to the number of eight or more should
go about destroying tobacco plants, they should be adjudged
traitors and suffer death."
6
The tobacco currency vividly illustrates one of the oldest laws
in economics: Gresham's Law, "Bad money drives out good."
The grower of tobacco, who had to pay taxes or other obligations
fixed in terms of tobacco, understandably used the poorest quality
tobacco to discharge obligations and retained the best quality for
export in return for "hard" money, i.e., British sterling. As a re-

---

252
FREE TO CHOOSE: A Personal Statement
suit, only poor quality tobacco tended to circulate as money.
Every device of human ingenuity was used to make tobacco ap-
pear higher in quality than it was: "Maryland in 1698 found it
necessary to legislate against the fraud of packing trash in hogs-
heads that contained good tobacco on top. Virginia adopted a
similar measure in 1705, but apparently it did not offer relief."
8
The quality problem was somewhat alleviated when "[i]n 1727
tobacco notes were legalized. These were in the nature of certifi-
cates of deposit issued by the inspectors. They were declared by
law current and payable for all tobacco debts within the ware-
house district where they were issued." ' Despite numerous abuses
of the system, "[s]uch receipts performed the office of currency
right to the eve of the 19th century."
8
That was not the last use of tobacco as money. During World
War II cigarettes were widely used as a medium of exchange in
German and Japanese prison camps. After World War II ciga-
rettes were widely used as money in Germany during the period
when the occupation authorities enforced ceilings on prices in
legal currency that were well below the levels that would have
cleared the market. The result was to destroy the usefulness of
the legal money. People resorted to barter and to the use of
cigarettes as a medium of exchange for small transactions, and
cognac for large ones—by all odds the most liquid currency of
which we have record. Ludwig Erhard's monetary reform ended
that instructive—and destructive—episode.
9
The general principles illustrated by tobacco money in Vir-
ginia remain relevant in the modern era, though paper money
issued by government and bookkeeping entries called deposits
have replaced commodities or warehouse receipts for commodi-
ties as the basic money of the society.
It remains as true now as it was then that a more rapid increase
in the quantity of money than in the quantity of goods and ser-
vices available for purchase will produce inflation, raising prices
in terms of that money. It does not matter why the quantity of
money increases. In Virginia the quantity of tobacco money grew
and produced an inflation of prices in terms of tobacco because
the cost of producing tobacco in terms of labor and other re-
sources fell drastically. In Europe in the Middle Ages, silver and

---

The Cure for Inflation
253
gold were the dominant money, and inflation of prices in terms
of gold and silver occurred because precious metals from Mexico
and South America flooded Europe via Spain. In the mid-nine-
teenth century inflation of prices in terms of gold occurred around
the world because of gold discoveries in California and Australia;
later, from the 1890s to 1914, because of the successful com-
mercial application of the cyanide process to the extraction of
gold from low-grade ore, primarily in South Africa.
Today, when the commonly accepted media of exchange have
no relation to any commodity, the quantity of money is deter-
mined in every major country by government. Government and
the government alone is responsible for any rapid increase in the
quantity of money. That very fact has been the major source of
confusion about the cause and the cure of inflation.
THE PROXIMATE CAUSE OF INFLATION
Inflation is a disease, a dangerous and sometimes fatal disease,
a disease that if not checked in time can destroy a society. Ex-
amples abound. Hyperinflations in Russia and Germany after
World War I—when prices sometimes doubled and more than
doubled from one day to the next—prepared the ground for
communism in the one country and nazism in the other. The
hyperinflation in China after World War II eased Chairman
Mao's defeat of Chiang Kai-shek. Inflation in Brazil, where it
reached about 100 percent a year in 1954, brought military
government. A far more extreme inflation contributed to the
overthrow of Allende in Chile in 1973 and of Isabel Peron in
Argentina in 1976, followed in both countries by the assumption
of power by a military junta.
No government is willing to accept responsibility for producing
inflation, even in less virulent degree. Government officials always
find some excuse—greedy businessmen, grasping trade unions,
spendthrift consumers, Arab sheikhs, bad weather, or anything
else that seems even remotely plausible. No doubt, businessmen
are greedy, trade unions are grasping, consumers are spendthrifts,
Arab sheikhs have raised the price of oil, and weather is often
bad. All these can produce high prices for individual items; they

---

254
FREE TO CHOOSE: A Personal Statement
cannot produce rising prices for goods in general. They can cause
temporary ups or downs in the rate of inflation. But they cannot
produce continuing inflation for one very simple reason: none of
the alleged culprits possesses a printing press on which it can turn
out those pieces of paper we carry in our pockets; none can legally
authorize a bookkeeper to make entries on ledgers that are the
equivalent of those pieces of paper.
Inflation is not a capitalist phenomenon. Yugoslavia, a com-
munist country, has experienced one of the most rapid rates of
inflation of any country in Europe; Switzerland, a bastion of
capitalism, one of the lowest. Neither is inflation a communist
phenomenon. China had little inflation under Mao; Italy, the
United Kingdom, Japan, the United States—all largely capitalist
countries—have experienced substantial inflation in the past
decade. In the modern world, inflation is a printing press phe-
nomenon.
The recognition that substantial inflation is always and every-
where a monetary phenomenon is only the beginning of an under-
standing of the cause and cure of inflation. The more basic ques-
tion is, why do modern governments increase the quantity of
money too rapidly? Why do they produce inflation when they
understand its potential for harm?
Before turning to that question, it is worth dwelling a bit longer
on the proposition that inflation is a monetary phenomenon. De-
spite the importance of that proposition, despite the extensive
historical evidence supporting it, it is still widely denied—in large