“Repressed Inflation”: The Ailment of the Modern Economy


The article is excerpted from Against the Tide. It originally appeared in Neue Zürcher Zeitung, June 14 and 15, 1947.

Inflation Plus Collectivism

0003_repressed_inflationRecent experience in many countries enables us to draw the picture of a strange distortion and stasis in economic life and to diagnose an economic ailment that, more and more, is proving to be the worst of all, and that to a very large extent explains the persistence of Europe’s distress. I have in mind that cross between collectivism and inflation, for which I have suggested the name of “repressed inflation” — first in my essay “Lehren des deutschen Wirtschaftsmarasmus”[1] and later, more systematically, in “Offene und zurückgestaute Inflation”[2] Typically, what happens is as follows. As a result of the war and of postwar mismanagement, serious inflation developed in the sense that the means of payment are increasing strongly, while the production of goods stagnates. Were the government to permit an “open” inflation, this disproportion between the volume of money and the volume of goods would lead to the consequence we all know, namely, a general rise in prices and incomes. To its credit, the government in question does not wish this to happen. However, it cannot make up its mind to dam back the flood of money, either because, as in countries governed under the paralyzing three-party system, it lacks the political strength to do so, or because it does not wish to give up an economic policy that is incompatible with sound money (full employment, cheap money, or a socialist economic policy).

Now, what does a government do in such a situation? It prevents excess demand from working itself out in a rise of prices and exchange rates and replaces the regulating and stimulating functions of price by a system of rationing at fixed prices, together with the inevitable controls — a system well known from the war economy and, within its limits, useful and indeed indispensable. If the inflationary surplus of money pushes up prices, costs, and exchange rates, the increasingly comprehensive and more and more elaborate apparatus of physical controls tries to oppose this upward movement of values by a sort of police counterpressure. This is how open inflation has come to be replaced by another type, repressed inflation, which might also be called “forbidden inflation.”

It is this repressed inflation that is associated with our present age of collectivism, and associated in the double sense that collectivism is at once a cause of inflation and an instrument of its repression. A host of subtle questions are connected with this, but it would lead us too far to discuss them here. One might analyze the different degrees and types of repressed inflation, and one might also argue about whether, and in what circumstances, a temporary and moderate repression of inflation is the lesser evil. The question I ask, however, is this: Where does repressed inflation end, if, in today’s more normal peacetime conditions, it becomes a system dominating economic life?

There is only one answer to this question, and it can be found in the economic marasmus of several European countries, of which Germany is the extreme case. The longer the system of fictitious, controlled values is continued, the more fictitious these values become, in the double sense of corresponding less and less to the real scarcity relations and of serving for fewer and fewer exchanges of goods. The distortion of all value relations, the co-existence of “official” and “black” sectors, and the contradiction between the directives of the market and those of the authorities desperately fighting for their power eventually lead to chaos and to the virtual absence of any economic order whatever, whether of the free-enterprise or the collectivist kind. So long as the government succeeds at least in the negative purpose of preventing transactions from being switched to a gold or foreign-exchange basis, the economy relapses into the stage of primitive barter and payments in kind, but at the same time into a correspondingly primitive, low level of productivity. Eventually, as in the final stages of open inflation, money loses not only its function as a means of exchange and yardstick of value ordering the economic process, but also its other, and no less important, function as an incentive to produce and market as many goods as possible. The more the persistent inflation pushes up values, the more the government strengthens the counterpressure of controls, but the more fictitious becomes the system of controlled values, the greater the economic chaos and the general listlessness, and the more threadbare either the government’s authority or its claim still to be democratic. There can be no doubt that unless repressed inflation is stopped in time, it will increasingly cause forces to develop that lead to the dissolution of the economy and even of the state itself.

Half a year ago or so, I had occasion in this newspaper to discuss the German case of repressed inflation. I tried then to distinguish what was typical and what was peculiar to Germany, which is the worst case of all because the disproportion between the repressed volume of purchasing power and the volume of goods is bigger than anywhere else, and because the disrupting effects of advanced collectivism are here combined with the well-known disturbing factors of politics. Despite all the warnings, nothing significant has been done in this half year toward a comprehensive currency and economic reform, such as would stop repressed inflation by removing the quantitative disproportion between purchasing power and goods through a drastic reduction in the volume of purchasing power, and by overcoming the chaos of paralyzing, collectivist policies through the re-establishment of a free-market economy. Failure to do so must in large part be held responsible for last winter’s dismal misery, and it is, at least in part, the fault of socialist ideology. This is true in the two senses that, first, those responsible could not bring themselves to get out of the chaos at the cost of sacrificing socialist doctrine, and that, secondly, this selfsame doctrine paralyzed the decision to carry through a currency reform that, in view of the attitude of the Russians, demands independent action on the part of the Western allies in their respective occupation zones in Germany.

But many non-socialists, too, have so far resisted the necessary currency reform. Their argument has been that it would be more expedient to remove the excess of purchasing power by an increase in production rather than by a diminution of the money supply; meanwhile, they have thought it best to carry on with the present policy. They overlooked that it is precisely the continuing repression of excess purchasing power, with all its consequences, which again and again prevents the increase in production needed for the removal of the disproportion — assuming it can be removed at all from the side of production — because it deprives the economy of the required incentives. The longer the delay in breaking out of this vicious circle, the further recedes the desired end of production’s growing into the outsized money supply. The truth of this is proved in the most distressing manner by the way the German economy has been going these last few months. It has confirmed the prediction that complete collapse was to be expected unless repressed inflation were stopped with all possible speed. After things were just left to drift for two years, the German economy lost so much blood that salvation now seems hardly possible without an all-out and very costly operation to bring in food, raw materials, and manufactures from abroad.

The longer the Western allies hold back from doing this, the larger will be the sum that they will eventually have to decide must be sacrificed. Thus ends this experiment in repressed inflation. But it ends also with the allied military authorities’ stealing the thunder of the Russian threat to use military force for taking food away from the farmers. In so doing, they not only display singularly little understanding for the laws of economics but also prove the utter collapse of the whole system of controls on which repressed inflation rests.

As the German example demonstrates, the principal error of the champions of repressed inflation consists in their being unable to shed the idea of a more or less given deficit of goods, which, on the pattern of the war economy, have to be distributed as equitably as possible. They cling to the dismal idea of a “poorhouse socialism,” and they defend their system with the argument that at least all are equally bad off (or even, as in England, venture the strange assertion that the masses are indeed better off under the rationing system than they were before); they gain a cheap success with the rhetorical question of how the masses are supposed to live if rationing were discontinued. But they do not see the essential point or do not want to see it. They disregard the fact that the repressed inflation they defend makes sense only in the presence of a major disproportion between the volume of purchasing power and the production of goods; in other words, their defense of controls rests on the assumption of inflation. Unless, being socialists, they perhaps harbor the secret wish that this disproportion would last forever, so that they can always justify socialism as an instrument of repressing inflation, their aim should not be the most equitable distribution of an insufficient amount of goods, but its increase. And they should aim at an increase such that, for example, all the inhabitants of so rich a country as France should be given their fill once more by the former, proven methods of the free economy, except for those who, then as now, need special assistance. It is astonishing that so reasonable a man as the French Prime Minister M. Ramadier, who, it is to be hoped, agrees with us on this point, will not admit also that the very system that he stubbornly defends against the mounting storm of public protests prevents ample and appropriate deliveries to the market by paralyzing production and withdrawing from the official markets a growing proportion of such goods as are still produced. France, too, can break out of this circle only if it gets rid of inflation and socialism together.

All those countries of Europe that suffer from the paralyzing, hampering, and disruptive effects of what I have called “repressed inflation,” a combination of inflationary pressure and economic controls, are, like France, impoverished countries — with the sole exception of Sweden, where it needed the activities of doctrinaire socialists to create a similar situation artificially and, finally, to turn a “hard” currency into a “soft” one. Everywhere impoverishment is invoked to defend the collectivist inflation, and nowhere is it realized that this system of fictitious, controlled values perpetuates and aggravates the disproportion between the supply of money and of goods in the name of equitable distribution, while even this latter is turned into blatant injustice by the irresistible triumph of the “black” markets. Impoverishment is precisely what makes the return to the market economy and monetary stability a compelling necessity. How else except by the system of collectivist inflation is it to be explained that the soil of France, which is as fertile as it used to be, no longer seems to be able to feed that country? Is it not almost grotesque when the French prime minister tries to save the battered prestige of socialism with the bogey of the rich, who, if the market economy were to return, would snatch the most savory tidbits away from the mouths of the majority of the inhabitants of “la douce France”? When Henry IV promised the French the proverbial chicken in the pot, he certainly did not have in mind that mixture of meat coupons and inflation that is today vaunted as a means to the same purpose. And when, at last, will it be understood everywhere how absurd it is in the long run to keep price controls that discourage production exactly in the measure in which maximum production is wanted? When indeed will anyone even have the courage to admit that this is, in effect, what today’s system of repressed inflation amounts to?

The Case of England

The vicious circle in which this system moves can be clearly observed in England as well. The country emerged from the war so impoverished that it was obvious it would be constrained for some length of time to lower the standard of living and produce more than ever. But the more time goes by, the less plausible does it appear that the deficiencies the British still suffer should solely be due to their initial impoverishment. One is led to the heretical idea that England is so bent on consuming less that it neglects to produce more, and a growing number of people are coming to blame this neglect of production on an economic system that, all over again, is that combination of socialism and inflationary pressure known to us as “repressed inflation.” In this sort of poorhouse socialism the tightening of the belt, “austerity,” becomes a permanent state of affairs that one would accept with resignation, were it not that here, too, it is associated with a steady deterioration of the economic situation and with a race between increasing controls and decreasing law-abidance. There is a credit expansion that, under the somewhat faded banner of “cheap money,” causes investment to exceed saving, deficient as it is because of underproduction, overtaxation, and artificially low rates of interest. As a result, the British economy is under constant inflationary pressure, which the government curbs with the counterpressure of controls. But, as J. H. Jewkes and E. Devons remind us in an article eminently worth reading,[3] this suppression of inflation is bound, in its turn, to curtail production. “We succeed merely in preventing the vicious upward spiral of prices at the cost of having a vicious downward spiral of productivity.” Thus are our English witnesses. They add that this downward pressure on productivity heightens the inflationary pressure, to which the government must react by still further restrictions on the use of consumers’ purchasing power, which, in their turn, again depress productivity. The vicious circle is closed, and it seems that the British economy is moving around and around in it, notwithstanding the nervous protestations of the authorities. As Jewkes and Devons rightly observe, it is no use trying to break out of this circle by moral appeals to producers. “It is futile to expect individuals to work harder unless each one feels that his own standard of consumption depends on his own efforts and that he will get a greater share of the total cake as a result of his efforts.” Like others, the British socialists will have to learn to make a distinction between the climate of war, which justifies a high degree of collectivism, and that of peace, which forces us to take account once more of normal human nature. But the costs of this lesson are borne by the whole country.

Nor is this the worst. If our English spokesmen note that success “in preventing the vicious upward spiral of prices” has to be paid for with a “vicious downward spiral of productivity,” they do not name the full price, nor does it follow that success is assured. Heavier even than the loss of productivity entailed by such a system is the sacrifice of elementary liberties imposed upon the British people even now, together with the certain prospect of having to sacrifice more and more in the future. The country of habeas corpus, of the Bill of Rights, and of the proverb “My home is my castle” has become a country where the government is entitled, in peacetime, to enter your house, with a search warrant at any time, where an economic secret police spreads its tentacles, where the rights of the Parliamentary opposition are curtailed in a unique manner — and where all this promises to be only the beginning. To quote the excellent weekly Time and Tide of March 8, 1947: “The present Government is composed of men who, we are convinced, would not wittingly take advantage of the power they have; unwittingly, they have already done so. But the fact remains that the physical basis of our liberties has been cut right away. The Government controls it all. The Parliamentary basis is fast going. The mechanism for the total destruction of freedom is already complete. It is too late to say ‘it can’t happen here.’ It has happened.”

Although there are no doubt a good many people in England, too, who do not take Professor Hayek‘s warning of the “Road to Serfdom” seriously or who regard it as a reactionary intrigue, there are various signs that suggest that the moment is not far off when those who govern will have to decide between what Time and Tide in another remarkable article calls “the cherished ideal of the Planned State” and the “equally cherished ideal of liberal humanism.” And there are signs in England, too, that the high price that has to be paid for repressed inflation in the form of the loss of liberties formerly regarded as inalienable is buying a success that is rendered more and more doubtful by the steadily decreasing respect for the majesty of the law. We have a vivid memory of this process in the case of prohibition in America, and we know that legislation of this kind in the end becomes a poisonous source of corruption. Can anyone seriously believe that what did not succeed in the case of drink is likely to succeed in the case of inflation, that is, simply to forbid it? The recent open rebellion against economic controls in France has rightly caused a sensation, but it is only one among many symptoms of the war against the forces of the free economy on which such a country’s government has embarked and which it can hope to win even temporarily only by adopting the political methods of Hitler or Stalin.

France as an Example of Missed Opportunities

All these considerations prove that under a system of repressed inflation time works against the government. In returning once more to the example of France, we see that on this road there is one particularly critical moment that it is fatal to miss. The above-mentioned April issue of Lloyds Bank Review contains another very interesting article called “The Economic Regeneration of France,” in which the author, Paul Bareau, rightly points out that France had at the time of the liberation a unique opportunity of getting rid of repressed inflation. If at that time, when the control mechanism was still effective in holding back the inflationary pressure, and when the psychological climate was as favorable as could be for an energetic “monetary purge,” repressed inflation had been stopped by getting rid in one sweep both of inflation and controls, France would have been spared much suffering and disorder. As soon as the provisional French government announced a general wage increase of forty per cent, immediately after the liberation of Paris, it was a foregone conclusion that a vicious spiral would now set in, by which repressed inflation was bound to turn into open inflation to the accompaniment of all the well-known phenomena of economic disintegration and paralysis. The French have always argued so far that things could not be put right from the monetary side, but only from the side of production. But this is just a convenient excuse, the faulty economic foundation of which we have demonstrated with the help of the German example. In France, as elsewhere, everything of course depends on producing more and on supplying the market with the additional output, but one of the principal conditions for that is the liberation of the economy from the shackles imposed upon it by repressed inflation. The removal of repressed inflation implies two things: the end of the restrictive measures and the end of inflation. It is misleading, therefore, of the French prime minister to raise the bogey of more-than-ever runaway inflation in order to frighten those who call for the removal of controls, for no one can reasonably desire the end of controls without at the same time demanding the end of inflation. And the latter must be the aim of the prime minister. How is he going to achieve it if he makes no effort to break out of the vicious circle of repressed inflation? Nothing is more dangerous than socialism’s becoming an end in itself at a moment when the most elementary considerations and unequivocal evidence prove that there is only one choice left, namely, to continue on the socialist course or to overcome the economic calamity.

The lessons that other countries can learn from the French case are plain. Think of Belgium as the example of a country that patently took advantage of the right moment for getting rid of repressed inflation and that is now reaping the fruits of its clear-sightedness. Or think of the Netherlands, which made earnest efforts to follow the Belgian example, but perhaps made the mistake of concentrating too much on sound money to the detriment of the removal of controls and, while doing its best to eliminate inflation as one part of the dangerous combination of repressed inflation, kept the controls. And, in conclusion, think once more and above all of Germany, where time is running out fast — the time, I mean, during which repressed inflation can still be removed before the price-wage spiral gets going, notwithstanding all the controls of the occupation authorities.


[1] Neue Zürcher Zeitung, Nos. 1931 and 1939, October 26 and 27, 1946.

[2] Kyklos, 1947, No. 1.

[3] Lloyds Bank Review, April, 1947.

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