MEANING OF INFLATION

Greymouth Evening Star, 13 February 1940, Page 12

MEANING OF INFLATION

CAUSES AND EFFECTS. It is common knowledge that the war can be financed in three ways—by taxation, borrowing and inflation. Lt is also apparent that many people fear that the latter is inevitable, and are wondering what will be the effect on their securities. What, then does inflation mean, and what are its symptoms and consequences? (writes Norman Crump, City Editor of the London “Sunday Times”). Finance by taxation or borrowing means the diversion of existing money from the private citizen (who is both taxpayer and investor) to those who are being paid for war work and services of every sort and kind, ft equally means a diversion of the power to buy commodities from the private citizen and the industries serving him to the war workers and war industries. Thus there is no net increase in the total quantity of workers or demand for commodities and labour.

Inflation implies something different. It rarely takes so crude a form as the printing of new and redundant currency, but takes the subtler form of Government borrowing from the banking system. There are two main forms —primary and secondary inflation, but their consequences differ only in degree. Assume first that the Government sells Treasury bills (or other securities) to the commercial banks. The proceeds of these sales are spent on the war and banked by their recipients in their deposits at the commercial bank deposits, offset by an increase in the banks’ holdings of Treasury bills and securities. Now if the holders of these new deposits regard them as savings, little harm is. done; for the banks become no more than intermediaries in the investment of these savings in Government securities. But if the holders regard' them as money to be spent, then new money has been called into existence, bringing with, it a new demand for commodities and labour. This is secondary inflation. In either event, there is a limit to this process, for sooner or later the banks will find their deposits growing too big for their cash; and so will refuse to take up more Treasury bills. The Government then is tempted to resort to primary inflation. This consists of borrowing from the central bank —in this country, the Bank of England. When the proceeds of such borrowing find their way into deposits at the commercial banks, the counterpart is an increase in the commercial banks’ balances at the central bank, that is, in their cash. Thus their cash is reinforced, and so the way is made clear for further secondary inflation,

EMPLOYMENT REACTIONS. So long as there are unemployed reserves of labour, machinery or commodities, inflation may not do overmuch harm. There will be some rise in prices, costs and wages, due to the creation and exercise of this new power to buy, but it will be off-set by the existence of these reserves ready to meet it.

Once,- however, full- employment is reached, or supplies of commodities are used up, then further inflationary borrowing reproduces the conditions of the irresistible force when met by the immovable object. There is inevitably an explosion, which in this case takes the form of the Uncon-

trollable upward spiral of prices, wages ’and costs. The only remedy, in fact, is that of a complete totalitarian control over every side of a country’s economic system. This may prevent a rise in prices, though equally it may only hide it. It does mean the end of personal liberty, and it also means drastic rationing and control as a hardly more palatable alternative to rocketing prices. Now let it be said as clearly as

possible that we have not reached that stage yet. There has so far been no serious inflation in England. Take the banking position first. Since the outbreak of war, clearing bank discounts (mainly Treasury bills) and loans against bills have risen by 16 per cent. Cash has only risen by 5.3 per cent., and deposits by 4.6 per cent. Some of these new deposits are probably savings. Some secondary inflation perhaps, but very little primary inflation, and tax collection next quarter will operate in tlie direction of deflation. Meanwhile, wholesale prices have risen by 25 per cent., and the cost of living by 11.6 per cent. The former increase is due to world causes rather than to our methods of financing the war. The latter increase is partly seasonal, the real increase being only about 8 or 9 per cent. Wages admittedly are rising, but unemployment is greater than at the outbreak of war. Apart from shortages of certain types of labour and certain commodities, we are in this import respect farther off inflation than at the outbreak of war. Still the- demand for- man-power is grow- ' ing every day, and so while the full red light of inflation is not in sight, we can begin to discern in the distance the yellow or preliminary warning light.

EFFECT ON SECURITIES. To avoid serious inflation when full employment is reached, two things are necessary. The first is a universal reduction in “real” wages and incomes, sufficient to compensate for the diversion of production from private to war ends. Next, even if money incomes rise, sufficient must be tapped off by taxation or voluntary investment in War 'Loans to ensuie that the remainder buys less than before the war. The holder of fixed-income securities rightly fears that inflation Will diminish the real value of his holding, though he should reflect that he would be no worse off if he held cash. Equity holders similarly hope that as prices, wages, and costs rise, company profits will grow in the same proportion. This might be true, were it not for war taxation. But the present scale of taxation ensures that the bulk of war excess profits will go to the Exchequer and not to the ordinary shareholder. An increase in trading profits is in this case more than offset by heavier appropriation for taxation, and the ordinary dividend is reduced from 20 to 15 per cent. This example suggests that inflation plus war taxation will not necessarily prove an equity-holder’s paradise.