Wednesday, March 11, 2009

Hayek on Inflation, Unemployment, and Money

Inflation causes Depressions. The solution is stable money, which Hayek sees guaranteed by competing money (a gold standard no longer being possible, in his opinion). Fascinating dialog, and our theories of where to go forward should start here.

Hayek's one sentence statement about the destructive effects of inflation bode very ill for us today. The giant inflationary bubble economy of the last 20 years has left us a legacy of massive restructuring that needs to occur. America has been artificially held high by the status of the dollar as reserve currency, enabling our entire debt- and deficit-based economic-governmental structure.

Hazlett: How does inflation cause unemployment?
Hayek: By drawing people into jobs which exist only because the relative demand for the particular things is temporarily increased, and these employments must disappear as soon as the increase in the quantity of money ceases.

Hazlett: Yet, if the United States, for example, went through a period of temporarily high unemployment--say we have double the current rate of unemployment for one to two years--wouldn't all the automatic income-maintenance programs, such as unemployment insurance, welfare, etc., run up such an enormous bill as to bankrupt the federal government, which already runs a deficit of S50 billion or $60 billion in a so-called recovery period?
Hayek: Yes, they probably would. There would be an enormous political struggle on the question of whether social-security benefits ought to be adapted to inflation or cut down. I don't think that you can effect a permanent cure without a substantial alteration of the social-security system.

Hayek: Yes, they do occasionallv. The trouble is, in the mechanical system what forces politicians is the gold standard. The gold standard, even if it were nominally adopted now, would never work because people are not willing to play by the rules of the game. The rules of the game that the gold standard requires [say] that if you have an unfavorable balance of trade, you contract your currency. That's what no government can do--they'd rather go off the gold standard. In fact, I'm con- vinced that if we restored the gold standard now, within six months the first country would be off it and, within three years. it would completely disappear.

The gold standard was based on what was essentially an irrational superstition. As long as people believed there was no salvation but the gold standard, the thing could work. That illusion or superstition has been lost. We now can never successfully run a gold standard. I wish we could. Its largely as a result of this that I have been thinking of alternatives.

Hazlett: You have, at various times, championed a commodity-reserve monetary system and competition in the money supply. Are these practical alternatives to a govemment con- trolled central banking system?

Hayek: Yes. I have been convinced that while the idea of the commodity-reserve system is a good one, practically it is unmanageable. The idea of accumulating actual stocks of com- modities as reserves is so complex and impractical that it just cannot be done.

Then I came to the conclusion that the necessity of actual redemption of the real commodities is only necessary if you have to place a discipline on an authority which otherwise has no interest in keeping its currency stable. If you place the issue of money in the hands of firms whose business depends upon their success in keeping the money they issue stable, the situation changes completely. In that case, there is no necessity of depending upon their obligation to redeem in commoditei: it depends on the fact that they must so regulate the supply of their money that the public will accept the money for its stability. This is better than anything else.

From an interview in 1977.

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