Inflation: 'Destroying governments since 1789'

http://www.thisismoney.co.uk/news/article.html?in_article_id=443494&in_page_id=2
William Rees-Mogg,
Mail on Sunday
23 June 2008, 11:39am
Reader comments (5)

One of the best books about inflation is The Great Wave, by David Hackett Fischer. I read it with admiration when it was first published in 1996 and I have been re-reading it now inflation is back.

I have experienced only too much of the recent history of inflation over the past 60 years.
For most of that time I've been reporting on it as a financial journalist. I share Fischer's belief that the best way to study inflation is to study its history. Theoretical economic models do not tell the whole story.

Karl Marx analysed the French Revolution, primarily in terms of class conflict. Yet inflation was a potent revolutionary influence. As Fischer writes: 'From 1789-99 every twist and turn of fortune in the French Revolution was closely tied to movement of prices.'

The French Revolution is usually thought to have begun on July 14, 1789, the day the Paris mob stormed the Bastille. Fischer provides a graph that shows July 14 was also the day on which bread prices peaked in Paris.

Inflation destroyed King Louis XVI, the constitutional monarchy, the Jacobin dictatorship and the Directorate. It brought Napoleon to power, just as the German inflation of the Twenties helped to bring Hitler to power in 1933.

In Britain today the extraordinary swing against Gordon Brown's Government has happened as the price of energy and food are rising and the price of houses falling.

There are parallels between the present inflationary situation and the great inflation that started in the mid-Sixties and ended in the mid-Nineties.

In the Sixties, America was pouring troops and money into Vietnam. When President John F. Kennedy was assassinated, there were only a few thousand Americans in Vietnam. By the time President Lyndon B. Johnson retired in January 1969, there were about 500,000.

President Johnson is praised for his expansion of the American services. Yet he expanded social expenditure and fought a war in South-East Asia without raising taxes to pay for them.

In the past seven years, President George W. Bush has fought wars in Iraq and Afghanistan while cutting taxes. Both wartime presidents have financed their wars by borrowing.

'The rate of American inflation,' as Fischer observes, 'trebled from 1961-66.' The global Bretton Woods system, with its fixed rates and dollar convertibility into gold, could not stand the strain, and was wound up by President Richard Nixon between 1971 and 1973.

There is another parallel between the oil price inflation of 2008 and those of the Seventies. Now we are worrying about a peak in oil production and growing Asian demand, then we were worried about the Organisation of the Petroleum Exporting Countries (Opec) Cartel. But oil prices have surged to unheard-of prices in both periods.

The Seventies was a horrible economic decade, British unionism became militant and successive governments were on a conveyor belt to electoral defeat. British Prime Ministers fell in succession: Harold Wilson in 1970, Ted Heath in 1974, and James Callaghan in 1979.
Inflation only came under control in the Eighties, partly due to Margaret Thatcher, and partly due to Paul Volcker's monetary policies at the US Federal Reserve Board. As inflation was brought under control, the Tories remained in power for 18 years followed by Labour's 11 years to date.

When inflation started to rise in the mid-Sixties, there were few convincing policies for bringing it back under control. The dominant economic doctrinism was Keynesianism, derived from John Maynard Keynes, the most eminent British economist of the early 20th Century. Its guns were all pointing at unemployment, not at inflation.

Only in the Seventies did the alternative doctrine of monetarism, based on the work of a Chicago professor, Milton Friedman, begin to replace Keynesianism as the standard orthodoxy. Friedman believed inflation could be cured only by stabilising the money supply.

Most economists recognise the principle that lies behind the monetarist revolution of the Seventies, but they see that monetarism is dependent on other factors; pure monetarism is almost as hard to maintain as a pure gold standard.

Friedman argued that inflation was a disorder of money, which could only be cured by monetary policies. There is evidence from the gold standard itself that a fixed but gradually rising money supply can provide price stability over very long periods.

Sir Isaac Newton was Master of the Mint in 1717. He reorganised the English currency on the basis of the golden guinea. This gold system had to be suspended during the Napoleonic Wars and in the First World War, but essentially it lasted from 1717 until Britain left the gold standard in 1931. It seems almost incredible that the purchasing power of gold in 1931 was only three per cent below what it had been when Newton created the gold system.

Gold has the advantage that it cannot be created by central bankers, still less by governments seeking re-election. New mined gold provides for industrial use and jewellery, and for some growth. Yet gold gave the world a stable money supply for 200 years.

The modern world might have a more stable economy and far more stable prices if the gold standard had survived. Nevertheless, there is no possibility of recreating it. The modern world does not accept the authority of objective standards.

The gold standard worked so well because it provided a stable monetary base for a growing economy with relatively stable prices and interest rates.

Successful central bankers often mimic in their monetary policy what the gold standard might have done automatically.

Even so, based on history, we can forecast that every major currency in the world will lose at least 90% of its value by 2100. Inflation is here to stay.