How Yesterday’s Inflation is Tomorrow’s Solution:

A Contemporary Review on Hazlitt’s What You Should Know About Inflation (1960)

According to the U.S Bureau of Labor Statistics, the three disciplines of economics are Keynesian, Neoclassical, and Marxian. Foundational economic courses may offer lessons on Laissez-faire capitalism or Malthusian economics. However, not often does one learn about Austrian economics, at least I — an economics major — have not. Founded with the publication of Menger’s Principles of Economics in 1871, the Austrian school of economics values an individual’s choice as the foundation of all economic analysis (Boettke, 2020). While the Neoclassical school suggests that price determination is held by the equilibrium of supply and demand, Austrian economists argue that prices are subject to individual preferences. As a supporter of Laissez-faire capitalism, the Austrian economic theory champions zero government intervention (Hall, 2022). So how is an economic theory, excluded from the popular American narrative, relevant to us today?

Austrian economics began gaining traction in Britain and the United States during the 1940s. One of the economists credited for bringing in these theories to the American economic scene was Hazlitt: a libertarian philosopher with multiple publications in The New York Times, The Wall Street Journal, and Newsweek (Boettke, 2020). Hazlitt’s literary reviews on Ludwig von Mises’s and Hayek’s work catapulted their names and theories to fame. His own publication, Economics in One Lesson (1946), became an instant classic, serving as an essential influence on the modern libertarian economic movement. Despite being pressured by publishers, Hazlitt was adamant with his opposition towards government interventions, which is often reflected within his work (“The art of economics,” 2014). Originally published in 1960, Hazlitt’s What You Should Know About Inflation examines the subject through an Austrian economics lens, exposing popular “fallacies” behind rising prices and critiquing government interventions designed to subdue its consequences. It has since been 63 years, yet to an extent, Hazlitt’s observations in the sixties can be translated to the current economy. To a greater degree, his answer for the cure of inflation could be what our future economy should and is already moving towards.

When I describe the “current” economy, I am referring to the 8.6 percent annual inflation rate in May of 2022 — the highest it has been since 1981. I am alluding to how first quarter inflation was almost four times the rate recorded in 2020 (DeSilver, 2022). And I am illustrating a time where in a year, food prices have increased by 11 percent and energy by 13 (Koop, 2023). When you do a quick search on Google for the definition of inflation, it’ll regurgitate: “a general increase in prices and fall in the purchasing value of money”. This — is one of the major fallacies Hazlitt claims the public has surrounding inflation.

According to Hazlitt, the erroneous identification of the rise in prices as inflation itself — rather than just a mere consequence — leads the public to overlook its genuine cause: increase in the money supply. Thus, efforts to curb inflation by implementing price controls, in the face of growing money supply, would only hamper production and fail to bring about the desired economic recovery. Price controls refer to government regulations that prescribe either a ceiling or floor on the price of goods and services. The last broad-based price cap mandated by the federal government was during the Nixon administration. The plan only proved efficient in its early phases, as inflation rose almost immediately after restrictions eased. Most economists today would agree with Hazlitt’s sentiment that price controls are simply ineffective. It hasn’t really worked in the past, so it really shouldn’t be used today. Nevertheless, conversations surrounding price controls have once again been ignited by left-wing economists due to the recent spike in inflation. Rather than the full Nixon model, they are advocating for limited price controls. Specifically, on areas where the pandemic has notably impacted the supply chain such as in gas, meat, and computer chips (Casselman & Smialek, 2022).

Other than inflation itself, what may be exacerbating the rise in prices is corporate greed. Supporters of product-specific price controls further argue that short term caps prevent companies from taking advantage of high demand through exaggerating profit margins. Democrats are progressively attributing the recent growth in prices to corporate profits. As stated by Brown, chairman of the Senate Banking Committee, “profits at the biggest U.S companies shot above 3 trillion dollars this year, and the margins keep growing… Mega corporations would rather pass higher costs on to consumers than cut into their profits” (Casselman & Smialek, 2022). Surprisingly, consumer behavior has not declined despite high prices and companies have been taking advantage of this trend by implementing price hikes. Quincey, the CEO of Coca-Cola, observes that a potential recession gives companies a bias to action as catching up on pricing becomes a burden in recessionary environments. In their recent earnings call, Quincey states: “we’re going to err towards taking the price increase rather than not taking the price increase. That’s kind of our modus operandi” (Debter, 2022). Although price controls haven’t gained major momentum yet, consumers are increasingly pushing for price caps as they are fed up with being the bearer of high prices (Casselman & Smialek, 2022).

However, following the impacts of the pandemic, money supply has grown as an emergency remedy by the central bank (Vanjani, 2023). According to the Federal Reserve Bank of St. Louis, between 2020 and 2022, M2 money supply has increased by over 25 percent. During the same timeframe, the consumer price index also grew by over 6 percent, indicating a positive correlation between the two. By the same token, both inflation and M2 money supply peaked around June and July of 2023, and have since been on a steady decline (YCharts, n.d.). Some may argue that M1 money supply has been relatively stable during peak inflationary periods. However, M2 money supply is a better indicator of the economy because it not only encompasses M1 money supply, but also liquid assets that would not have been accounted for. Recent conversations surrounding price controls indicate that the public seems to once again falsely attribute the rise in prices as inflation itself. Price caps only work to temporarily hold down prices while the roots of inflation remain festering. Price controls shouldn’t be the remedy we turn to when there is a hefty money supply going after finite goods — which is what ultimately drives up prices.

Society’s next fallacy, Hazlitt claims, is blaming supply chain issues for the rise in inflation. Hazlitt contends that a general rise in prices is not usually caused by a shortage of goods. The economist reinforces his claim by underscoring how industrial production was a 177 percent higher during a time with increasing inflation rate compared to a time without (Hazlitt, 1968). Today, the Biden administration attributes the current inflation to — you guessed it — issues with the supply chain. During his recent White House briefing, Biden notes that “one of the key ways to fight inflation is by lowering the cost of moving goods through the supply chain”. While that may be true, supply-side disruptions is just one constituent of the broader set of complex factors that contribute to inflation. Economist Milton Ezrati argues that inflation is being driven by a combination of factors, including supply-side issues, fiscal policy, and monetary policy (Ezrati & Anderson, 2021). Many economists and notable figures wouldn’t even prioritize supply chain issues within their overall narrative of the current inflationary environment. Larry Summers, former United States Secretary of the Treasury, claims that the unprecedented monetary and fiscal stimulus executed in response to the pandemic has been the main contributor to the cause of inflation. The stimulus coupled with near-zero interest rates further enacted upward pressure on prices (Powell, 2022). It’s hard to pinpoint what the exact cause of inflation truly is, as more often than not, the culprit cannot be traced back to just one. Still, placing too much emphasis on a suspect when the evidence does not completely match up, will cause more damage than good.

Our supply chain issues are rooted in the pandemic, yet the timing of inflation does not match with its disturbances. The pandemic occurred around 2020 but prices in 2021 remained relatively stable. It wasn’t until the upcoming years after 2021 where prices rose significantly. Adverse supply shocks, like the pandemic, have historically increased prices much faster than what was observed recently. Furthermore, supply shocks tend to be momentary: as disturbances begin to subside, prices will reflect those changes. Not only has inflation continued to rise even as early disruptions caused by the pandemic are being resolved, officials of the federal reserve also state that prices will be “permanently elevated” despite the ensuing fall in inflation. This isn’t to say that supply chain issues aren’t playing a role in the ongoing inflation, merely a suggestion to re-examine other potential influences (“The first problem”, 2022).

As I read through this book, it became glaringly obvious that Hazlitt isn’t a fan of government intervention. As an economist subscribed to Austrian economics thinking, Hazlitt’s underlying theme for What You Should Know About Inflation accentuates the poor monetary policy to inflation pipeline. Although I cannot say that I fully agree with his observations, exploring multiple perspectives on a widely debated issue would only strengthen my understanding of the subject. Therefore, considering the shortcomings of a supply chain narrative, I turn to an explanation Hazlitt would agree with: faulty monetary policies.

In Monetary economics, the equation of exchange offers a dynamic framework expressed in terms of growth rates. The equation states that the difference between the growth rate of nominal spending (gNt ) and the growth rate of real output (gYt ) is equal to the growth rate of price levels (gPt).

Hence, price levels would increase if either real output falls, and or nominal spending grows.

According to the American Institute for Economics Research, gYt was negative 3.4 percent in 2020 and 5.6 percent in 2021. The negative shock to output elucidates much of the inflation experienced in 2020. However, not only did real GDP growth rate recover by 2021, it also exceeded the average growth rate preceding 2020. Thus, gYt was not a major contributor to inflation after the beginning of the pandemic. Data further reveals that the growth rate of nominal spending increased significantly in 2021. gNt was negative 2.2 percent in 2020 and rapidly grew to 10.1 percent by 2021. As depicted by the dynamic equation of exchange, much of the inflation experienced in recent years may be a consequence of the substantial growth in gNt. An increase in the growth rate of nominal spending could mean that the central bank either failed to decrease the growth rate of money despite velocity picking up, or it increased money supply too quickly — either way, a reflection of poor monetary policies utilized by the government (Cachanosky, 2023).

After investigating the roots of inflation, Hazlitt begins advocating for a particular solution: returning to the gold standard. Seashells have been used as currency throughout history but ultimately replaced as problems began to arise. The supply of seashells greatly increased when humans started building boats that were more advanced. As seashells became easier and easier to harvest, its value as a currency diminished. The same could be said for the fiat currency we use today. After World War I, countries transitioned from the gold standard in order to print large quantities of money to support war efforts. The same circumstances applied during the Great Depression as the government expanded money supply without backing to support the economy (Ammous, 2018). Hazlitt maintains that the gold standard is the only type of inflation-proof currency since its quantity acts as a tool that limits the issuance of money. Without being pinned to gold, government issued money will always run the risk of high inflation.

“I have great confidence that the world will return to the gold standard in some form because the people in so many counties have learned that they need protection from the excesses of their political leaders.” — Hazlitt

Ammous’ The Bitcoin Standard (2018) offers an insightful addition to this discussion. The author employs the history of money and gold as a basis for why bitcoin is a major contender as the new anchor for monetary systems. Bitcoin encompasses three essential qualities of sound money that our present currency does not: stability, security, and scarcity. Like gold, bitcoin needs to be “mined”; the cryptocurrency can only be earned through processing powers solving increasingly intricate mathematical problems. As bitcoin gains popularity, the price will rise, and more people will try to mine. In order to ensure that blocks continue to take around 10 minutes to produce, bitcoin would increase the complexity of problems forcing miners to use more processing power. The digital currency is also secure as it is almost immune to manipulation. Everyone is able to access the blockchain, a public ledger, and view all recent transactions without permission from a central authority. Above all, Bitcoin addresses Hazlitt’s main concern for inflation because it is scarce. Since it will be capped at 21 million units, bitcoin’s limited supply parallels the gold standard. Unlike fiat currency, where the issuance of money is limitless, bitcoin entirely avoids the risk of high inflation. A modern twist on a classic solution.

I, like many others, have my hesitations. Krugman and Friedman, both Nobel Prize-winning economists, argue that unlike the fiat currency, the gold standard is too inflexible to meet modern economic demands (Krugman, 2012; Friedman & Bordo, 2017). The skepticism deepens as the conversation shifts to cryptocurrency. Warren Buffett, chairman of Berkshire Hathaway, claims that cryptocurrencies are speculative assets with no intrinsic value; a trend that will come to a bad ending (Lovelace, 2018). And Buffett’s speculations are not entirely unfounded, the cryptocurrency market is saturated with risk. Cryptocurrency is incredibly volatile as it is new and subject to frequent fluctuations. From an investor’s standpoint, investing in crypto implies that you are willing to undertake the high risks, at least for the short run. If society collectively adopts crypto as the new money, digital currencies would eventually stabilize like other assets have in the past. But universal adoption is not guaranteed. From an environmental point of view, cryptocurrency is simply unsustainable. The White House reports that cryptocurrency mining accounts for 0.3% of global greenhouse gas emissions — an amount surpassing individual countries such as the Netherlands and Argentina (Lauterbach, 2023).

Nonetheless, as IRS official Thomas Fattorusso puts it, “Cryptocurrency is here to stay”. The same sentiment is further echoed by prominent figures from traditional financial institutions, such as Goldman Sachs and BlackRock (Reniers, 2023). The impacts of blockchain technology and digital assets are undeniable, having become increasingly intertwined with our everyday lives. Cryptocurrencies such as Bitcoin and Ethereum are becoming more commonly accepted as a means of payment. Virtual real estate and in-game items have emerged as a new class of investment, offering opportunities for trading and financial speculation. If we can address certain issues with cryptocurrency, we may be well-positioned to overcome the limitations of fiat currency. By harnessing the advantages of a new gold standard, we can pave the way for a more robust and innovative financial system. I am rather excited to see how the role of digital currency will continue to unfold. Especially with high inflation still being a nuisance for most.

References

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