A Weekly Dose of Hazlitt: Cheap Money Means Inflation

Cheap Money Means Inflation” is the title of Henry Hazlitt’s Newsweek column from December 12, 1955. Here, Hazlitt notes that the fed had been suppressing interest rates since the onset of the Great Depression. The lesson to be learned is that interest rates can be kept low for decades without resulting in hyperinflation or economic collapse. We have seen the same conditions prevail in Japan and I expect that the ailing economies such as those of the US, EU, etc. will follow the same path.

The Federal Reserve Board is to be congratulated on its
courage in approving an increase in the discount rate
from 2. to 2. percent. Only a firm rein on interest
rates can prevent a new spiral of inflation.

This mild action was promptly denounced, not only
by Democrats in Congress but even by some bankers
and businessmen. “Money was tight enough already,”
complained one banker; “they’re going to make it
unavailable.” If one takes comparisons for the last
twenty years alone, a 2. percent discount rate (the rate
at which member banks can borrow from the Federal
Reserve Banks) may indeed seem high. It is the fourth
increase this year, and the highest discount rate since
1934.

But our generation has become so accustomed to
cheap money that we have lost our perspective. In 1929
the discount rate of the Federal Reserve Bank of New
York was raised to 6 percent. It had averaged around 4
percent for the preceding decade. It had been as high as
7 percent in 1920. Nor is the present discount rate high
compared with official discount rates in the rest of the
world. Money has been getting tighter everywhere. A
recent compilation by the London magazine The Banker
showed that in early August the discount rate in Britain
was 4.5 percent; in Germany, 3.5 percent; in Sweden, 3.75
percent; in Denmark, 5.5 percent.

In fact, if the Federal Reserve System were operating
on pre-Keynesian policy it would today be charging
a much higher discount rate. The late Benjamin
M. Anderson, who was for many years economist of
the Chase National Bank, declared in discussing the
belated increase of the rediscount rate in 1920: “The
Federal Reserve System should have held to the orthodox
rule of keeping the rediscount rate above the rate
to prime borrowing customers at the great city banks.”
Today this rate is 3. percent. The purpose of this
“orthodox” rule was, of course, to penalize and discourage
borrowing from the Federal Reserve Banks rather
than to encourage the commercial banks to overlend
to their own customers and then to reborrow at the
Federal Reserve at an actual profit to themselves.

I do not mean to suggest that the Federal Reserve
System could return overnight to this traditional rule,
so long neglected. But it is time for us to recognize
more clearly the direct causal connection between artificially
low interest rates and inflation. Many bankers
and economists talk and write today as if the sole cause
of present-day inflation were a budget deficit financed
by unloading government securities onto the banking
system. But the inflation will be brought about, even
without a budgetary deficit, whenever interest rates are
kept too low in relation to the supply of and demand
for real savings. This leads to overborrowing, and an
increase in the money supply which pushes upwards
on prices.

Some reasons why the Federal Reserve Board has
now increased the discount rate are clear. The board is
concerned about the upward pressures on the price level
of steel, other primary metals, and building materials.
Most of our economy is already operating practically at
full capacity—at “full employment” of available men
and resources. Any further increase in loans would tend
merely to push up prices rather than lead to any further
expansion in output.

Consumer spending has been rising more rapidly
than consumer income. Installment credit and mortgage
debt are at record levels. In September total consumer
credit outstanding was at $34.3 billion, compared
with $28.9 billion a year previous, and with $8.4 billion
at the end of 1946. The stock market has been buoyant.
Industrial companies have been announcing the most
ambitious expansion programs on record. The country’s
money supply (total bank deposits and currency outside
of banks) stood at the end of September at $215
billion—an increase of $7 billion over the year before.
Total bank loans stood at $78.4 billion—an increase of
$11 billion over those of September 1954.

It was time for the government to take its foot off
the accelerator.

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