Despite their many differences, four fundamental points of agreement underpin mainstream contemporary reasoning in Australasia about the importance and success of central banks, their policies and monetary policy more generally. First, since the 1980s Australia and New Zealand have (relative to their experiences during the 1970s) been “low inflation” countries. Second, disinflation (i.e., a decrease in the rate of inflation), low inflation and low rates of interest underpin the economic growth enjoyed (albeit more in Australia than New Zealand) during these years. Third, policies that maintain rates of inflation and interest at low levels perpetuate this prosperity. Finally, deflation is an invidious phenomenon that has thankfully been banished since the Great Depression. Regrettably, it apparently has re-emerged in Japan and must be fought reactively in that country and proactively elsewhere.

Six Points of Dissent

I dissent from each of these premises. Reasoning from first principles, this set of circulars shows that

1. semantic and logical confusion, not just on the part of journalists, analysts and politicians but also central bankers, underlies much contemporary thinking about inflation and deflation. As a result these terms are conventionally – and erroneously – defined in terms of their several possible consequences rather than their single and axiomatic cause.



2. this confusion has very effectively distracted attention from two facts. First, central banks are the sole cause of inflation; second, the rate of inflation in Australia, New Zealand and other countries has been and remains significantly higher than is conventionally recognised.



3. inflation has a range of invidious consequences. Artificially-low market rates of interest are a key accompaniment of high inflation that obscure the signals normally transmitted by prices in unfettered markets. Spurious rates distort the temporal structure of production and thereby encourage entrepreneurs and speculators to undertake “malinvestments” in plant, equipment and infrastructure.



4. these malinvestments must eventually be liquidated. The inflation of the 1990s thus sowed the seeds of economic difficulties in 2001-2002 (i.e, the boom and bust of Internet and broader stock market bubbles); and the renewed and massive inflation generated in the wake of the 11 September attacks has set the stage for difficulties for the future (i.e., the maintenance of the broader stock market bubble and the creation of a real estate bubble).



5. the relevant question to ask about inflation relates not so much to the stability of prices as it does to their integrity. Stability of prices is not a be-all-and-end-all: it can and does mask distortions introduced by easy money. Investors would therefore do well to ask themselves: given government intervention, do these prices (including, critically, the price of credit and assets) convey accurate information? Acting on them, would individuals make reasonable choices? Or, misled by subsidised market rates of interest, would they undertake “malinvestments” which must be liquidated when the boom ends?



6. when the boom ends, it does not cause difficulties; it merely makes apparent the difficulties that inhered all along in inflation. The sad truth is that an inflation-induced boom, such as that of the late 1990s and that which is recurring today in some parts of Australia, is not a period of “good business” – to a significant extent it is a period during which time, effort and other resources are squandered on bad investments

Logical and Semantic Confusion …

The terms “inflation” and “deflation” are today virtually never defined as changes (i.e., an increase in the case of inflation and a decrease in the case of deflation) in the supply of money or money substitutes such as demand deposits. Instead, they are almost without exception defined as changes in the prices of raw materials, consumer goods and services and wages. This is unfortunate. Reasoning deductively from first principles, Mises (The Theory of Money and Credit, 1912) shows that “there is only one meaning that can rationally be attached to the expression inflation: an increase in the quantity of money that is not offset by a corresponding increase in the need for money, so that a fall in the objective exchange value of money must occur. [And] deflation signifies a diminution of the quantity of money which is not offset by a corresponding diminution of the demand for money, so that an increase in the objective value of money must occur” (italics in the original).

Similarly, and also deductively, Rothbard (Man, Economy and State, 1962) concludes “the process of issuing money beyond any increase in the stock of specie [e.g., the monetary base of gold or silver] may be called inflation. [And] a contraction in the money supply outstanding over any period (aside from a possible net decrease in specie) may be called deflation. Clearly, inflation is the primary event and the primary purpose of monetary intervention. There can be no deflation without an inflation having occurred in some previous period of time. A priori, almost all intervention will be inflationary” (again, italics in the original). From the standpoint of Mises and Rothbard, then, inflation and deflation are conventionally – and erroneously – defined in terms of their several possible consequences rather than their single and axiomatic cause. Inflation has several possible consequences. These include increases of the prices of raw materials, producer goods and services (including wages), consumer goods and services, and assets. But it has only one cause, is defined as and is thus indistinguishable from an increase in the supply of money or money substitutes.

In Australia, New Zealand and elsewhere, the ability to create money and money substitutes is monopolised by the country’s central bank. It thus follows that central banks, most of which were created (or, in the case of the Bank of England, assumed their current guise) during the first half of the twentieth century and which thereafter almost invariably, continuously and at varying rates of profligacy increased the supply of money within their jurisdictions, are the sole creators of inflation. In this context it is more than co-incidental that, well into the 1990s, over 100% of Swiss francs were backed by gold at prevailing market prices; and until recently the supply of francs increased only to the extent that the Swiss National Bank’s store of gold increased. Switzerland thus possessed by far the world’s most stringent anti-inflation policy and (in the literal sense of the term) the world’s hardest currency. Absent this institutional cause of inflation, its consequences are difficult to find.

According to Michael Bordo (The Gold Standard: Myths and Realities, 1984), at the height of the gold standard between 1800 and 1913 wholesale and consumer prices in America and Britain decreased erratically but steadily. Conversely, with few but notable exceptions (such as the U.S. during the early 1930s) since the institutionalisation of central and fractional-reserve banking in the early twentieth century the supply of money has tended to expand ever more rapidly. The inevitable consequence of this quickening pace of inflation: prices of raw materials, goods and services and assets (such as stocks and real estate) have tended ever more sharply upwards. This confluence of cause and possible effect that inheres in today’s conventional definition of inflation has existed for centuries. Indeed, from David Hume, Adam Smith and John Locke in the eighteenth century to John Stuart Mill in the nineteenth to Irving Fisher and Milton Friedman in the twentieth, the Quantity Theory of Money is perhaps the oldest surviving theory in the economist’s kitbag.

Although some renderings of the QTM distinguish the cause and possible consequences of inflation, others blur it. Benjamin Anderson (The Value of Money, 1917), a sharp critic of the QTM, nonetheless expressed it in the mechanical and somewhat ambiguous terms to which many of its adherents would assent: “the essence of the quantity theory comes out in the following brief statement: given a number of units of money; given a number of units of goods to be exchanged; assume these two numbers to be independent of each other; assume all the goods to be exchanged for all the money; then the average price will be a simple function of the quantities of goods and of money respectively, such that an increase in the amount of money will increase the average price per unit of goods proportionately, if goods remain unchanged in amount, or an increase in goods will lower the price per unit proportionately, money being assumed to remain unchanged in amount.”

… Has Fundamental Consequences

The contemporary use – and, from a Misesian and Rothbardian perspective, misuse – of the terms inflation and deflation has a range of important and invidious implications. Perhaps most importantly, but also least concretely, there no longer exists any term to signify an increase and decrease in the quantity of money and money-substitutes. Accordingly, says Mises (Human Action), “it is impossible to fight a policy which you cannot name. Statesmen and writers no longer have the opportunity of resorting to [commonly understood] terminology when they want to question the expediency of issuing huge amounts of additional money. [If they wish to oppose it, which during the second half of the twentieth century they became increasingly and eventually greatly disinclined to do], they must enter into a detailed analysis and description of this policy with full particulars and minute accounts whenever they want to refer to it, and they must repeat this bothersome procedure in every sentence in which they deal with the subject. As this policy has no name, [inflation in the Misesian sense of the term] … goes on luxuriantly.”

Second, if inflation is defined in terms of a general rise in prices then anything that is positively correlated with an increase in the general level of prices will be dubbed “inflationary” and anything negatively correlated with an increase in the general level of prices will be dubbed “deflationary” – and in each case is prone to government regulation and control. From time to time disapprobation is therefore heaped upon “greedy” businessmen who engage in “uncompetitive behaviour” and “price gouging” and all manner of other activities that allegedly cause price rises and hence “inflation” to occur. Partly from this semantic misconception emerge wealth crimping and wealth destroying institutions such as the Australian Competition and Consumer Commission (see D. Armentano, Antitrust: The Case for Repeal, Ludwig von Mises Institute, 1999, ISBN: 0945466250; and D. Armentano and Y. Brozen, Antitrust And Monopoly: Anatomy of a Policy Failure, Independent Institute, 2d. ed. 1996, ISBN: 0945999623).

For the same reason, “irresponsible” trade unions such as the Australian Medical Association and the various states’ Law Societies who seek “unaffordable” price rises, damages claims and the like are also subject to regulation and periodic rhetorical abuse (recent from-first-principles analyses of how labour regulations harm the poor and enrich the better-off include L. Gallaway and R. Vedder, Out of Work: Unemployment and Government in Twentieth-Century America, Holmes & Meier Publishers, 1993, ISBN: 0841913315 and D. Bernstein, Only One Place of Redress: African Americans, Labor Regulations, and the Courts from Reconstruction to the New Deal, Duke University Press, 2001: ISBN: 0822325837). At the same time, this contemporary definition neatly and silently excises from notice (to say nothing of blame) that institution with a monopoly over the creation of money, i.e., the Reserve Bank of Australia, as the sole possible source of inflation in this country. Indeed, to add insult to injury in recent years central banks – which, in the Austrian sense of the word are the sole progenitors of inflation – have been enlisted and praised to the rafters as bulwarks in the fight against inflation (in the conventional sense of the word).

When viewed through Austrian eyes, this contemporary definition thus convicts the innocent and enables the poacher to become not just a gamekeeper but a monopolist gamekeeper. Partly as a consequence of semantic confusion and part-and-parcel of the growth of interventionist government, in other words, the central bank has become one of the most powerful institutions in society. Curiously, more than ten years after the fall of the Berlin Wall and the collapse of confidence in socialism in most places outside Western universities, the authority, competence and legitimacy of a Fabian (in Australia and New Zealand) and Progressive Era (in the U.S.) institution, whose primary purpose is to control a particular price, remains virtually unquestioned. In James Grant’s words, “to my mind the [U.S. Federal Reserve] is a cross between the late, unlamented Interstate Commerce Commission and the Wizard of Oz. It is a Progressive Era regulatory body that, uniquely among the institutions of that era, still stands with its aura and prestige intact.”

To Austrians, however, the reality is diametrically different. As Nobel Laureate Friedrich von Hayek wrote (Choice in Currency: A Way to Stop Inflation, 1978), except during the eighteenth and nineteenth centuries, when a proper gold standard prevailed, “practically all governments have used their exclusive power to issue money in order to defraud and plunder the people …” Also in 1978 Hayek wrote a letter-to-the-editor of The Wall Street Journal which stated “could you please print in front of every issue in headline letters the simple truth that INFLATION IS MADE BY GOVERNENT AND ITS AGENTS: NOBODY ELSE CAN DO ANYTHING ABOUT IT. It might do some good.” On 4 December of that year the WSJ published his note – alas, in lower-case letters.

...continued in Part II

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