Front Page Titles (by Subject) CHAPTER 11: Inflation 1 - Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War
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CHAPTER 11: Inflation 1 - Ludwig von Mises, Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War 
Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War, edited and with an Introduction by Richard M. Ebeling (Indianapolis: Liberty Fund, 2012).
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Inflation and Devaluation
There are two options for the government to meet its enormously increased financial demands to cover the costs of the war.
The first one is for the government to issue war bonds. Subscribers pay the specific amount for the bonds by drawing upon their own capital or borrowing the money from third parties who have the liquid assets to lend. A practical and important example of this is the major banks that use their customers’ deposits and savings to finance the war loan.
The second option is for the Treasury to issue debt to the Austro-Hungarian Bank. Since the Bank has no assets of its own to lend to the state, the only method at its disposal to meet the government’s request is by issuing banknotes. The Austro-Hungarian Bank is currently little more than a purely formal intermediary between the Treasury and the public. In practice, it would make little difference if this intermediary were to be removed and the two Treasury departments [of Austria and Hungary] were to directly put paper money into circulation.
Ample use has been made of this method for financing the war. The amount of currency issued by the Austro-Hungarian Bank has become something of an avalanche.
The figures are as follows:2
The increase in the quantity of paper money in circulation has resulted in a loss of purchasing power of the monetary unit, that is, the crown. This was neither a coincidence nor an unexpected and surprising consequence. The fact that an increase in the supply of money (also known as inflation) must necessarily lead to a decline in the value of the currency has long been taught by economic theory, and also has been confirmed over and over again by historical experience.
The devaluation that results from an increase in the supply of money manifests itself, on the one hand, in a general increase in the price of all goods and services, and, on the other, in the increased cost of foreign currency, that is, a rise in the exchange rate.3 Both of these phenomena, the increased cost of goods and the rise in the exchange rate, are inextricably linked to each other. One is inconceivable without the other; they are two aspects of one and the same phenomenon, and all economic policy tools are powerless to combat them as long as the inflation continues.
Imposing price controls or taxes on prices, or imposing penalties on profiteering and the like, have proven to be ineffective and unsuccessful measures, just as have the various attempts to reduce the exchange rate through the imposition of currency controls.4 This, too, does not come as any kind of surprise as a result of the war. It was already well known to those who have made a study of economic policy, and historical experience has taught us that there is no other remedy than to restore order to the nation’s finances. All attempts by the authorities to combat rising prices with the full force of the law have come to naught, from the “edictum de pretiis rerum venalium” issued by the Roman emperor, Diocletian,5 through the “Maximum” that was decreed during the French Revolution,6 down to the price controls imposed by the belligerent powers today.
The massive increase in the price of goods that we have witnessed cannot, however, be entirely attributed to the money side, as the supply of goods also plays a role. Goods of all kinds have become scarcer as a practical consequence of the war, with imports cut off from abroad and production crippled at home. But this explains only one part of the rise in the price of goods. The increased amount of paper money would necessarily have led to a rise in the prices of goods, even if there had been no inflationary factors on the supply side of goods.
A general increase in the prices of all goods can only arise as a result of an increase in the money supply. This is the situation in which we currently find ourselves. The reduction in the availability of goods has gone hand in hand with the enormous increase in the supply of money. We can trace the disruption in relative price relationships to the reduction in the availability of various individual goods; and we can trace the increase in the overall level of prices to the increased quantity of money. The former is the cause of the shortages from which we are suffering and will continue to endure as long as the current war situation persists, whereas the latter is the cause of the rise in the general price level.
It is true to say that part of the increased circulation of paper money reflects an increased demand for money. The setting up of military payment facilities for soldiers, the extended circulation of our currency in the occupied territories,7 the spreading of money at home, and, by no means less important, the hoarding of earnings that some sectors of society have been frightened into—these have all contributed to the increased demand for money; so a moderate increase in the amount of paper money in circulation has taken place without, at the same time, contributing to the rise in prices. However, the increase in the issue of banknotes has far exceeded the amount needed to cover the increased demand for money without causing a rise in prices.
Implications of Changes in the Value of Money for National Finances
For the Treasury, which has primary responsibility for all debts incurred by the state, devaluation offers financial relief. As the value of the currency falls, the burden carried by the debtor decreases; he still has only the same fixed amount of principle and interest to eventually pay back in crowns, regardless of whether or not the purchasing power of the crown has decreased in the meantime. On the other hand, as the currency is devalued, state revenues partly will increase. The revenues from various taxes will increase because real estate, dividends, and income expressed in money terms will also go up. This explains the favorable trends in income taxes, capital gains taxes, stamp duties, death duties, and various other taxes. So while state revenues as expressed nominally in money terms are largely on the increase, the greater part of the state’s debts, also expressed in money terms, remain unchanged.
However, it should not be overlooked that these favorable effects for the Treasury from devaluation apply to only a part, albeit the major part, of the national budget; but looked at from a different perspective, they are accompanied by unfavorable consequences for the exchequer. To the extent that the state has incurred debts expressed not only in crowns but also in a foreign currency or in gold, a devaluation of the crown means that, expressed nominally in money terms, the debt becomes more of a burden. The higher the foreign exchange rate and the more the price of gold rises against the currency, the greater the required expenditure in crowns in order to obtain the same amount of marks or gold coin to pay the interest on the foreign loan.
On the other hand, not all state revenues rise as a result of the de-valuation. Some taxes, such as property taxes and some business taxes, and fixed duties, remain unchanged, as they have been set at certain amounts. Devaluation thus results in relief for these taxpayers, expressed in real terms. If they are to be brought into line with current conditions, these taxes and duties in particular need to be increased. Tax increases such as these, however, only can be gradually introduced and involve great political difficulties because the population, having been hit hard by the rise in prices, will regard any such increase in taxation as an additional and unbearable imposition, rather than as an attempt to adjust the tax burden to the changed circumstances.
The extent of the Treasury’s financial relief from devaluation is, therefore, undoubtedly far less than is often claimed. But even this presumed benefit is, to a great extent, offset by the disadvantages arising from the decrease in the value of the currency, including the threat to the creditworthiness of the state. It is fear of a further decline in the value of the currency, more than any other consideration, which deters potential creditors from investing in war bonds. This is why, in spite of the central bank’s interventions, there has been such an unfavorable trend in the interest rates paid by the state on war bonds and its debt in general, and why subscriptions to the war bonds have been so disappointing. Certainly there would be no greater incentive for subscription to these bonds than an end to any further borrowing from the Austro-Hungarian Bank and an end to any further inflation.
Side Effects from Devaluation and Their Social Consequences
As the currency is devalued, all pension payments are reduced in real terms. There has been a decrease in the number of those holding government bonds, as well as in the number of creditors and mortgagers, together with holders of railway bonds and creditors of any other kind who may only claim interest on and final repayment of principle in terms of the original nominal amount lent, regardless of whether or not the purchasing power of this sum of money has diminished in the meantime. They continue to earn only the same nominal payment, even though they can now only purchase and consume less with this amount than they were previously able to.
In general, a debtor’s loss is a creditor’s gain. Seen against this background, a superficial view might suggest that a shift in the relationship between creditor and debtor in favor of the latter is always a positive development. It is a popularly held belief that the debtor is always the poor, needy person while the creditor is the rich capitalist. This view is very wide of the mark. The vast majority of debt is not owed by poor individuals; it has not accumulated from consumer credit being extended to the poor, but, instead, consists of loans extended to industrialists to finance production. It is a credit supplied for capital investment and to cover operating costs that have been taken out by landowners, entrepreneurs, and the public sector. The creditors are by no means always “rich” and the debtors by no means always “poor.” The major part of all outstanding debt is owed by the richer portions of society to the poorer ones. The less well-off classes of society are disproportionately represented among the creditors. They make up the majority among savings bank members and savings account holders at banks and with cooperatives. Therefore, anyone who regards as an unquestionable “social good” the disadvantage for the creditor and the accompanying advantage for the debtor from devaluation is deluding himself. The greatest amount of wealth rarely exists in monetary form, but, instead, exists in land and property values, in industrial enterprises and in shares, all of which remain immune from inflation; the money value of these assets tends to rise in proportion to the rate of inflation.
It is the middle classes, above all others, who have their assets invested in receiving interest payments from the public purse. Civil servants, army officers, and other professions rely on salaries from the public purse. As a result of the general liquidation of commercial enterprises caused by the war, we can now add to the list of state dependents practically all members of the middle class previously engaged in commerce and retail business. During the course of the war, these shopkeepers and tradesmen have had to sell their stocks and inventories; the sums of money that they received in exchange for them, together with the sums that would have been earmarked for maintenance and repair of their business enterprises, have long since been invested in loans, primarily into war bonds.
Thus the lost purchasing power of the currency has deprived the middle classes of their standards of living and the means of earning a living, as well as depriving the thrifty factory worker or farmhand of the fruits of his labor. The bourgeois is dragged down into the proletariat and the aspiring proletariat is dragged down to the level of the “Lumpenproletariat”8 subclass. These classes seethe with rage, even though their adherence to social norms previously would have withstood all temptation or sedition.
Nothing contributes more to political upheaval than the economic destruction of those strata of society that are most responsible for its maintenance.
[1. ][This article was delivered as a lecture in German in Vienna in late summer 1918. It has not been previously published.—Ed.]
[2. ][After the war, the Austro-Hungarian Bank publicly released more complete data on the growth of the money supply during the war. In July 1914, before the start of the war, the quantity of money in circulation was 3.4 million crowns. By the end of 1916 it had increased to over 11 billion crowns. And at the end of October 1918, shortly before the conclusion of the war in November 1918, the currency had expanded to 33.5 billion crowns. From the beginning to the end of the war the Austro-Hungarian money supply in circulation had expanded by 977 percent. A cost-of-living index that stood at 100 in July 1914 had risen to 1,640 by November 1918.—Ed.]
[3. ][As an indication of the depreciated value of the Austro-Hungarian crown on the foreign exchange market during the First World War, in August 1914, 100 crowns traded for 97.5 Swiss francs. But in June 1918, shortly before Mises delivered this lecture, 100 crowns exchanged for only 43.01 Swiss francs, reflecting a 45 percent decline over this four-year period.—Ed.]
[4. ][On the extensive system of price and wage controls and production regulations and planning methods imposed on the Austrian economy during the First World War, and their many negative consequences on the functioning of the market, see Joseph Redlich, Austrian War Government (New Haven: Yale University Press, 1929), pp. 107-35.—Ed.]
[5. ][“Edictum de pretiis rerum venalium,” or the “Edict of Maximum Prices,” was issued in ad 301 by the Roman emperor Diocletian in the face of dramatically rising prices due to the debasement of the currency to finance the huge spending of the Roman government. The price controls failed abysmally, merely succeeding in creating massive shortages of food and an extensive black market. By ad 305, around the time of Diocletian’s abdication, the edict was virtually ignored throughout the empire because of its distortive effects on economic activity.—Ed.]
[6. ][Shortly after the start of the French Revolution in 1789, the revolutionary government resorted to the printing of a new paper currency, the assignat, to finance its expenditures, leading to a massive price inflation for the next several years. In 1793, the government began imposing price and wage controls throughout the French economy. The attempt to artificially regulate prices in the face of the monetary inflation merely created shortages of virtually all essentials. In spite of a vast bureaucracy to harshly stamp out violations of the price controls, black markets emerged everywhere in France. Finally, in December 1794, the price controls were lifted and food and other goods once again flowed into the market.—Ed.]
[7. ][In March 1918, the new Bolshevik government in Russia signed a separate peace with Imperial Germany and Austria-Hungary, taking Russia out of the First World War. A large area of western Russia at that time, which included what is today Estonia, Latvia, Lithuania, Belarus, Moldova, and Ukraine, came under German and Austro-Hungarian occupation as a result of the peace settlement. Most of southern and part of central Ukraine fell under Austrian occupation, with the Austrian crown widely used in this occupied territory.—Ed.]
[8. ][“Lumpenproletariat” often is used to refer to the lower and ignorant segment of the working class. The term seemingly was first used by Karl Marx in his 1845 work German Ideology, designating a portion of the working class lacking in proper “class consciousness” of their “true” class interests.—Ed.]