A Weekly Dose of Hazlitt: Transitory Magic

Transitory Magic” is the title of Henry Hazlitt’s Newsweek column from June 11, 1956. Here, in yet another discussion about inflation, Hazlitt has the courage to point out one of the great acts of fraud perpetrated by the federal government: turning war bond investments into losses.

I listen to a lot of old time radio shows. One of the most annoying features of such shows is the constant propaganda for war bonds during WW2. Not only did the stars of the shows make explicit appeals to listeners to purchase bonds, but many plots were based on bond purchase drives with constant shaming language directed at those who didn’t pour every spare penny into bonds. With the benefit of hindsight, I can only shake my head and laugh at the useful idiots who were going to be robbed by inflation.

The storm of criticism that has beaten upon the Federal
Reserve authorities since they made a small increase in
prevailing discount rates to 2. percent in April, and
the indications that as a result those authorities are now
planning to make money “easier,” raise some fundamental
questions. One of them is whether constant new
doses of easy money and inflation can really keep a “full
employment” boom going indefinitely.

It is the present prevailing belief that they can.
The most direct challenge to this popular belief from
any official source has come from the chairman of the
Federal Reserve Board himself, William McChesney
Martin, Jr., in a statement quoted in this column of May
21: “We fight inflation partly because it is the forerunner
of deflation. . . . If I thought inflation would create
jobs and prosperity, I might be for it. But I am convinced
that, apart from transitory effects, the result of
inflation is the destruction of jobs and prosperity.”

Price -Wage Race

It is hard to get people to realize this today. Moneyand-
credit inflation has seemed to work its “fullemployment”
magic in the United States for the last
fifteen years. Nevertheless, inflation can bring “full
employment” only under special conditions, which are
unlikely to prevail for more than a limited time.

The first of these special conditions is that prices
must rise faster than wage costs in order to restore or
increase profit margins. A second condition is that businessmen
must be convinced that prices will continue
to keep ahead of wage rates and other costs, otherwise
business will not embark upon ambitious expansion
plans. A third condition is that lenders, on their
side, must be convinced that the inflation has come to
an end. If they also believe that inflation will continue
into the future, they will refuse to lend except at high
rates that compensate for the expected depreciation of
their money.

Whenever any one of these three major conditions
ceases to exist, monetary inflation will cease to create
“full employment.” Yet for these three conditions
to exist, both workers and lenders must be the victims
of what the economist Irving Fisher called the “money
illusion.” The workers must fail to recognize that their
real wage rates are going down (because prices are going
up faster), and creditors must fail to recognize that they
will lose real purchasing power as a result of their loans.

The Money Illusion

An instructive table published in the May letter of the
First National City Bank of New York showed that
those who bought U.S. Savings Bonds at any time
between 1935 and 1946, and held them for a ten-year
period, suffered an actual loss from their investment.
The interest received has not been enough to compensate
for income-tax payable and the “inflation tax” levied
in the form of a shrinkage in the buying power
of the dollar. This condition continues. In the week
ended, May 22 last, for example, wholesale commodity
prices showed an average increase of more than 4
percent for the twelve-month period. This means that a
businessman who lent out his money at 4 percent or less
twelve months before got practically no real interest at
all. When lenders come to expect any such annual rate
of price increase in the future, they will insist on adding
it as a “price premium” to what the rate of interest
would otherwise be. That is why money rates tend to
soar in the late stage of an inflation.

An inflation brings “full employment,” in short,
only as long as prices are rising faster than wage or
interest rates, or keeping ahead of them. As soon as
wage costs start to race ahead of prices, as they now
show signs of doing, then, whether or not there is more
inflation, the result will inevitably be unemployment.

Inflation always brings about great strains and
distortions in the economy. This is why Chairman
Martin of the Federal Reserve Board is correct when
he declares that the ultimate result of inflation is
“destruction of jobs and prosperity.” The longer inflation
is continued, the greater the correction that must
ultimately be made. It is much better to permit a relatively
mild adjustment now, than to force a more violent
correction later.

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