CHAPTER II
PUBLIC FINANCE AND CHANGES IN THE VALUE OF MONEY
I. Inflation as a Method of Taxation
A Government can live for a long time, even the German Government or the Russian Government, by printing paper money. That is to say, it can by this means secure the command over real resources,—resources just as real as those obtained by taxation. The method is condemned, but its efficacy, up to a point, must be admitted. A Government can live by this means when it can live by no other. It is the form of taxation which the public find hardest to evade and even the weakest Government can enforce, when it can enforce nothing else. Of this character have been the progressive and catastrophic inflations practised in Central and Eastern Europe, as distinguished from the limited and oscillatory inflations, experienced for example in Great Britain and the United States, which have been examined in the preceding chapter.
The Quantity Theory of Money states that the amount of cash which the community requires, assuming certain habits of business and of banking to be established, and assuming also a given level and distribution of wealth, depends on the level of prices. If the consumption and production of actual goods are unaltered but prices and wages are doubled, then twice as much cash as before is required to do the business. The truth of this, properly explained and qualified, it is foolish to deny. The Theory infers from this that the aggregate real value of all the paper money in circulation remains more or less the same, irrespective of the number of units of it in circulation, provided the habits and prosperity of the people are not changed,—i.e. the community retains in the shape of cash the command over a more or less constant amount of real wealth, which is the same thing as to say that the total quantity of money in circulation has a more or less fixed purchasing power.[9]
[9] See also Chapter III., [Section I].
Let us suppose that there are in circulation 9,000,000 currency notes, and that they have altogether a value equivalent to 36,000,000 gold dollars.[10] Suppose that the Government prints a further 3,000,000 notes, so that the amount of currency is now 12,000,000; then, in accordance with the above theory, the 12,000,000 notes are still only equivalent to $36,000,000. In the first state of affairs, therefore, each note = $4, and in the second state of affairs each note = $3. Consequently the 9,000,000 notes originally held by the public are now worth $27,000,000 instead of $36,000,000, and the 3,000,000 notes newly issued by the Government are worth $9,000,000. Thus by the process of printing the additional notes the Government has transferred from the public to itself an amount of resources equal to $9,000,000, just as successfully as if it had raised this sum in taxation.
[10] It will simplify the argument to ignore the fact that the value of gold in terms of commodities is itself a fluctuating one, and to treat the value of a currency in terms of gold as a rough measure of its value in terms of “real resources” generally.
On whom has the tax fallen? Clearly on the holders of the original 9,000,000 notes, whose notes are now worth 25 per cent less than they were before. The inflation has amounted to a tax of 25 per cent on all holders of notes in proportion to their holdings. The burden of the tax is well spread, cannot be evaded, costs nothing to collect, and falls, in a rough sort of way, in proportion to the wealth of the victim. No wonder its superficial advantages have attracted Ministers of Finance.
Temporarily, the yield of the tax is even a little better for the Government than by the above calculation. For the new notes can be passed off at first at the same value as though there were still only 9,000,000 notes altogether. It is only after the new notes get into circulation and people begin to spend them that they realise that the notes are worth less than before.
What is there to prevent the Government from repeating this process over and over again? The reader must observe that the aggregate note issue is still worth $36,000,000. If, therefore, the Government now prints a further 4,000,000 notes, there will be 16,000,000 notes altogether, which by the same argument as before are worth $2.25 each instead of $3, and by issuing the 4,000,000 notes the Government has, just as before, transferred an amount of resources equal to $9,000,000 from the public to itself. The holders of notes have again suffered a tax of 25 per cent in proportion to their holdings.