Inflating War: Central banking and militarism are intimately linked
Wednesday, July 28th, 2010Thomas DiLorenzo
One can say without exaggeration that inflation is an indispensable means of militarism,” Ludwig von Mises wrote. “Without it, the repercussions of war on welfare become obvious much more quickly and penetratingly; war weariness would set in much earlier.”
This explains why American politicians have always resorted to the legalized counterfeiting of central banking to finance wars, the most expensive of all government programs. If citizens had a clearer picture of the true costs, they would be more inclined to oppose non-defensive intervention and to force all wars to hastier conclusions.
Government can finance war (and everything else) by only three methods: taxes, debt, and the printing of money. Taxes are the most visible and painful, followed by debt finance, which crowds out private borrowing, drives up interest rates, and imposes the double burden of principal and interest. Money creation, on the other hand, makes war seem costless to the average citizen. But of course there is no such thing as a free lunch.
As a general rule, the longer a war lasts, the more centrally planned and government-controlled the entire economy becomes. And it remains so to some degree after the war has ended. War is the health of the state, as Randolph Bourne famously declared, and the growth of the state means a decline in liberty and prosperity.
As Robert Higgs wrote in Crisis and Leviathan, among the effects of World War I were “massive government collusion with organized special-interest groups; the de facto nationalization of the ocean shipping and railroad industries; the increased federal intrusion in labor markets, capital markets, communications, and agriculture; and enduring changes in constitutional doctrines regarding conscription and governmental suppression of free speech.”
Inflationary war finance inevitably leads to calls for price controls, which inflict even greater damage on the private enterprise system by generating shortages of goods and services, which are falsely blamed on capitalism. The state uses this excuse to grant itself even greater central-planning powers. Inflating the currency as a method of war finance is often a first step in the adoption of what is essentially economic fascism.
Paper and printing were invented in China, but American politicians were the first to use government paper money. It was adopted by the colonial government of Massachusetts in 1690. As Murray N. Rothbard wrote, the Massachusetts government was “accustomed to launching plunder expeditions against the prosperous French colony in Quebec.” The loot was typically used to pay mercenary soldiers, but when one of the expeditions failed and the soldiers threatened mutiny, the Massachusetts government printed 7,000 British pounds in paper notes to pay them. The government promised to redeem the paper money in gold or silver, but took 40 years to do so. Meanwhile, the public was so suspicious of the notes that they depreciated by 40 percent in the first year.
By 1740, every colony except for Virginia had followed Massachusetts’ lead in issuing fiat paper money. The results were dramatic inflation, boom-and-bust cycles, and depreciated currency.
During the Revolution, a form of centralized banking was adopted when the Continental Congress issued “the Continental” in 1775. Because it was not backed by anything of value, the Continental depreciated so severely that it was virtually worthless by 1781. “Not worth a Continental” became a popular slang.
Some of the states attempted to deal with the inflation caused by the massive printing of Continentals with price-control laws. The predictable effect: shortages so severe that George Washington’s army almost starved in a field in Pennsylvania. The situation became so desperate that the Continental Congress issued a resolution on June 4, 1778 urging all the states to abolish their price-control laws: “Whereas it hath been found by experience that limitations upon the prices of commodities are not only ineffectual for the purpose proposed, but likewise productive of very evil consequences – resolved, that it be recommended to the several states to repeal or suspend all laws limiting, regulating or restraining the Price of any Article.” Within three months, “the army was fairly well provided for as a direct result of this change in policy,” write Robert Schuettinger and Eamonn Butler in Forty Centuries of Wage and Price Controls: How Not to Fight Inflation.
Despite the economic calamities caused by America’s first foray into centralized control of the money supply, at the end of the Revolutionary War the nation’s first central bank – the Bank of North America – was created, with defense contractor/congressman Robert Morris implanted as its president. Centralized banking might have been ruinous for the general public, but political insiders like Morris profited handsomely. The bank was given a monopoly license to issue paper currency, and it used most of its newly created money for loans to the central government. In so doing, it inflated its currency so rapidly that within one year the market lost all confidence in the bank and it was privatized.
Alexander Hamilton was the real founding father of central banking, as the Federal Reserve Board declares in one of its publications. His Bank of the United States (BUS), established in 1791 after a momentous debate between Hamilton and Jefferson over its constitutionality, was partly intended to finance “sudden emergencies” like war, in Hamilton’s own words. He rejected Washington and Jefferson’s foreign policy of commercial relations with all nations, entangling alliances with none. Instead, he advocated a permanent military establishment complete with a large navy and standing army that would pursue “imperial glory.” As historian Clinton Rossiter explains, “Hamilton’s overriding purpose was to build the foundations of a new empire.”
Hamilton praised public debt as a “blessing” and complained to George Washington, “We need a government of more energy!” Jefferson, on the other hand, opposed both a large public debt and a national bank, arguing, “the perpetuation of debt, has drenched the earth with blood” – a reference to European monarchs’ endless wars of conquest funded by public debt.
Hamilton’s Bank of the United States ran up 72 percent inflation in its first five years and created such economic instability that its 20-year charter was not renewed by Congress in 1811.
Then came the senseless War of 1812. There was no central bank, but the federal government still devised a way to monetize the war debt. It encouraged the creation of dozens of private banks, then in 1814 declared a “suspension of specie payment.” That is, banks were not required to redeem their paper currency in gold or silver. Thus, under the direction of the U.S. Congress, banks were allowed to inflate their currencies at will for two-and-a-half years as a means of monetizing the war debt, thereby disguising the costs of the conflict to the public. Inflation during the war years averaged about 35 percent.
This was exacerbated when the BUS was resurrected in January 1817 and empowered to create a national paper currency, purchase public debt, and receive deposits of U.S. Treasury funds. Rothbard explained the politics in his History of Money and Banking in the United States:
The Second Bank of the United States was pushed through Congress … particularly by Secretary of the Treasury Alexander J. Dallas … a wealthy Philadelphia lawyer [and] close friend, counsel, and financial associate of Philadelphia merchant and banker Stephen Girard, reputedly one of the two wealthiest men in the country. … Girard was the largest stockholder of the First Bank of the United States, and during the War of 1812 Girard became a very heavy investor in the war debt of the federal government. … [A]s a way to unload his public debt, Girard began to agitate for a new Bank of the United States.
The Second Bank of the United States “launched a spectacular inflation of money and credit,” writes Rothbard, coupled with a great deal of fraud. It promptly created the “Panic of 1819,” the first real depression in American history. For the first time there was large-scale unemployment in cities such as Philadelphia, where employment in the manufacturing of handicrafts fell from 9,700 persons in 1815 to only 2,100 in 1819.
After nearly 20 years of inflation, fraud, political corruption, and boom-and-bust cycles caused by the Second Bank of the United States, President Andrew Jackson heroically vetoed the bill to recharter the Bank in 1834, and it went out of business. But the Hamiltonian nationalists did not. They would wage a political crusade for the next two decades as members of the Whig and Republican parties to inflict central banking on the nation once again.
They finally succeeded during the Lincoln administration with the Legal Tender Act of 1862, which empowered the secretary of the Treasury to issue paper “greenbacks” that were not redeemable in gold or silver. The National Currency Acts of 1863 and 1864 created a system of nationally chartered banks that could issue bank notes supplied to them by the new comptroller of the currency. The Acts also placed a 10 percent tax on competing state bank notes to drive them out of business and establish a federal monetary monopoly.
The predictable effect was massive inflation, with the greenback dollars so devalued that within one year they were worth only 35 cents in gold. All of the negative economic effects of inflation – devaluation of private wealth, unfair redistribution of income from creditors to debtors, and hindrance to rational economic calculation – damaged the Northern war effort, but not as much as that of the South. The North funded most of the war with public borrowing; the South funded most of its wartime expenditures by printing Confederate dollars. Consequently, inflation in the Confederacy averaged more than 2,200 percent per year.
The nationalization of the money supply created an engine of inflation – and a powerful lobbying force to advocate that it keep running. Northern manufacturers realized that during periods of inflation, domestic currency tends to depreciate faster than prices are rising. A falling dollar makes domestic goods cheaper and the price of imports higher. Henceforth, they became a powerful political force in favor of an even further centralization of banking. Meanwhile, the heavily indebted railroads realized that inflation cheapened their debts, so they allied with manufacturers as a permanent lobby for inflation.
These special interests joined the political coalition that created the Federal Reserve Board in 1913, which became an important source of finance for America’s disastrous participation in World War I four years later. The Fed did not just print greenbacks, as was the case during the Civil War. It printed enough money to purchase more than $4 billion in government bonds that were used to finance the war. The amount of money in circulation doubled between 1914 and 1920 – as did prices. This was an enormous hidden war tax on the American people: wealth was cut in half, along with real wages, and just about everything consumers purchased became more expensive.
The boom created by the Fed’s war financing inevitably caused a bust – the Depression of 1920, the first year of which was even worse than the first year of the Great Depression of the 1930s. Gross domestic product declined by 24 percent from 1920-21, while the number of unemployed Americans more than doubled, from 2.1 million to 4.9 million. The Great Depression of 1920 only lasted one year, however, thanks to President Warren Harding’s inspired policy of cutting both government spending and taxes dramatically.
In the wars that have followed, central-bank financing has inflicted essentially the same kind of damage on American society: inflation, economic chaos, reduced real wages, price controls and other government interventions, and ideological attacks on capitalism rather than the real culprit, the Fed.
Adam Smith recognized the advantage of financing wars with taxes rather than public debt when he wrote, “Wars would in general be more speedily concluded, and less wantonly undertaken. The people feeling, during the continuance of the war, the complete burden of it, would soon grow weary of it, and the government, in order to humor them, would not be under the necessity of carrying it on longer than it was necessary to do so.” Central-bank inflation renders the costs of war even more invisible than debt financing does and is therefore even more disastrous for the American public.
Crisis and Leviathan: Critical Episodes in the Growth of American Government- Robert Higgs
Higgs, a political economist, analyzes how the American federal government has come to exercise so much control over individuals and the marketplace in this century. Essentially he proposes that government control, which increases during a war or economic depression, continues after the crisis, with each increase influencing the prevailing ideology, making further increases more acceptable to the public. The process involves government taking on new functions more than expanding traditional ones. Because of this ratchet-like movement toward ever bigger government, Higgs is somewhat pessimistic about the survival of individual rights and a free society.
A History of Money and Banking in the United States: The Colonial Era to World War II- Murray N. Rothbard
Rothbard employs the Misesian approach to economic history consistently and dazzlingly throughout the volume to unravel the causes and consequences of events and institutions ranging over the course of U.S. monetary history, from the colonial times through the New Deal era. One of the important benefits of Rothbard’s unique approach is that it naturally leads to an account of the development of the U.S. monetary system in terms of a compelling narrative linking human motives and plans that often-times are hidden, and devious, leading to outcomes that sometimes are tragic. And one will learn much more about monetary history from reading this exciting story than from poring over reams of statistical analysis. Although its five parts were written separately, this volume presents a relative integrated narrative, with very little overlap, that sweeps across three hundreds years of U.S. monetary history.
