Sheldon Richman, editor of The Freeman, has an article at FEE about the Austrian concept of inflation and the non-neutrality of money. Don’t worry, that’s not as wonky as it sounds. All it really means is that newly created money is not evenly distributed and does not affect each individual’s behavior in the same way or at the same time. The result is that inflation of the money supply does not affect the economy uniformly:

Take inflation. When the government expands the supply of money, it does not do so by dropping Federal Reserve notes evenly across the land from the proverbial helicopter. In the old days government would print money or filch precious metals to make coins, then spend the money as it liked. A few select people received the money first, and they could then enter the market and buy what they liked at prices still unaffected by the inflation. the late receivers were the losers.

These days the process is more complicated. The Treasury borrows money from private lenders by selling securities. With that cash it pays contractors and welfare-state beneficiaries. Meanwhile, the Federal Reserve creates money in the form of bank reserves by buying government securities. It’s called monetizing the debt. Banks then pyramid loans on these new reserves, expanding the money supply and lowering interest rates. Among the consequences is the depreciation of the monetary unit (rising prices) and the boom-bust trade cycle described by Mises and F.A. Hayek. (Hayek won his Nobel Prize in 1974 partly for his work on the trade cycle.).

Whichever method is used, the point is that the newly created money enters the economy at specific points rather than blanketing society evenly. The result is a diversion of the economy from the path it would have taken in the absence of the disturbance. A new pattern emerges the details of which cannot be predicted. Why not? Because people are people not robots. If your cash balance doubled tomorrow you wouldn’t mechanically double the quantities of everything you buy now . Instead, you would change the proportions–buy more of this and less of that–and even buy things you don’t buy today. You yourself can’t predict exactly what you would do in these circumstances.

“The additional quantity of money does not find its way at first into the pockets of all individuals; not every individual of those benefited first gets the same amount and not every individual reacts to the same additional quantity in the same way…,” Mises summed up. “The additional amount of money offered by them on the market makes prices and wages go up. But not all the prices and wages rise, and those which do rise do not rise to the same degree.”

The reason this is important is because it affects the distribution of income in the economy. Government is essentially taking money from one group and giving it to another. If the moniker government is removed, one would call that theft. Generally, the distribution is not from the wealthy to the poor as one would expect. If anything the shift is in the other direction. Think about how the government will parcel out the coming stimulus money. It will be those with the best political connections or the best lobbyists who will benefit from the new money first. These are not generally poor people. By the time the poor and unemployed receive the money it will have passed through many hands and prices will have risen and reduced the purchasing power of the money. As Mises put it:

“But even in the end the different commodities are not affected to the same extent. The process of progressive depreciation has changed the income and the wealth of the different social groups. As long as this depreciation is still going on, as long as the additional quantity of money has not yet exhausted all its possibilities of influencing prices, as long as there are still prices left unchanged at all or not yet changed to the extent that they will be, there are in the community some groups favored and some at a disadvantage…. As long as the inflation is in progress, there is a perpetual shift in income and wealth from some social group, to other social groups.”

President Obama has talked many times about how he wants to close the gap between rich and poor. While that is certainly an admirable goal, his prescription will not reach that outcome. If anything, new spending financed with newly printed money will exacerbate the problem in the long run. Mr. Obama will attempt to offset that by raising taxes on the rich and giving tax credits to the poor, but even that will be counterproductive. Lower investment (because the “rich” won’t have as much to invest) will result in less growth which will affect the poor through fewer jobs. Ironically, if the new President wants more even income distribution, the government needs to do less, not more. All he really needs to do is enact policies which stabilize the value of the dollar. Ironically, his stated policy preference will do the opposite.

I wonder sometimes whether politicians really want to achieve the goals on which they base their campaigns. There is plenty of evidence, academic and anectdotal, that inflation is the greatest source of income and wealth inequality, but no politician seems to want to enact policies that would actually achieve their goal. Could it be that they want to preserve the problem so they have something on which to base their campaign? Why not accomplish the goal and base successive campaigns on success? Or maybe politicians aren’t that smart and really believe that the policies they advocate will accomplish the goal despite evidence to the contrary? Nah, that couldn’t be…..

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