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A
Midsummer Night's Dream, who
shuns Helena, who is in love with him, to pursue Hermia, who
loves another, the Fed has given its heart not to controlling the
quantity of money but to controlling interest rates, something that
The Cure for lnflation
267
it does not have the power to do. The result has been failure on
both fronts: wide swings in both money and interest rates. These
swings, too, have had an inflationary bias. With memories of its
disastrous mistake from 1929 to 1933, the Fed has been much
prompter in correcting a swing toward a low rate of monetary
growth than in correcting a swing toward a high rate of monetary
growth.
The end result of higher government spending, the full employ-
ment policy, and the Fed
'
s obsession with interest rates has been
a roller coaster along a rising path. Inflation has risen and then
fallen. Each rise has carried inflation to a higher level than the
preceding peak. Each fall has left inflation above its preceding
trough. All the time, government spending has been rising as a
fraction of income; government tax receipts, too, have been rising
as a fraction of income, but not quite as fast as spending, so the
deficit, too, has been rising as a fraction of income.
These developments are not unique to the United States or to
recent decades. Since time immemorial, sovereigns—whether
kings, emperors, or parliaments—have been tempted to resort to
increasing the quantity of money to acquire resources to wage
wars, construct monuments, or for other purposes. They have
often succumbed to the temptation. Whenever they have, infla-
tion followed close behind.
Nearly two thousand years ago the Roman Emperor Diocletian
inflated by "debasing" the coinage—that is, replacing silver coins
by look-alikes that had less and less silver and more and more of
a worthless alloy until they became "no more than base metal
washed over with silver." '
2
Modern governments do so by print-
ing paper money and making entries on books—but the ancient
method has not entirely disappeared. The once full-bodied silver
coins of the United States are now copper coins washed over,
not even with silver, but with nickel. And a small-size Susan B.
Anthony dollar coin has been introduced to replace what was
once a full-bodied silver coin.
GOVERNMENT REVENUE FROM INFLATION
Financing government spending by increasing the quantity of
money looks like magic, like getting something for nothing. To
268
FREE TO CHOOSE: A Personal Statement
take a simple example, government builds a road, paying for the
expenses incurred with newly printed Federal Reserve Notes. It
looks as if everybody is better off. The workers who build the road
get their pay and can buy food, clothing, and housing with it.
Nobody has paid higher taxes. Yet there is now a road where there
was none before. Who has paid for it?
The answer is that all holders of money have paid for the road.
The extra money raises prices when it is used to induce the
workers to build the road instead of engage in some other pro-
ductive activity. Those higher prices are maintained as the extra
money circulates in the spending stream from the workers to the
sellers of what they buy, from those sellers to others, and so on.
The higher prices mean that the money people previously held
will now buy less than it would have before. In order to have on
hand an amount of money that can buy as much as before, they
will have to refrain from spending all of their income and use part
of it to add to their money balances.
The extra money printed is equivalent to a tax on money bal-
ances. If the extra money raises prices by 1 percent, then every
holder of money has in effect paid a tax equal to 1 percent of his
money holdings. The extra pieces of paper he now must hold (or
book entries he must make) in order to have the same purchasing
power in the form of money as before are indistinguishable from
the other pieces of paper in his pocket or safe deposit box (or
from book entries), but they are in effect receipts for taxes paid.
The physical counterpart to these taxes is the goods and services
that could have been produced by the resources that built the
road. The people who spent less than their income in order to
maintain the purchasing power of their money balances have given
up these goods and services in order that the government could get
the resources to build the road.
You can see why John Maynard Keynes, in discussing the infla-
tions after World War I, wrote: "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 eco-
nomic law on the side of destruction, and does it in a manner
which not one man in a million is able to diagnose." '
3
The additional currency printed and the additional deposits
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