The Hindu Business Line : Why the government needs inflation

Inflation is of great value to government in that, as somebody once put it, it helps it to pluck the geese in such a manner as to obtain the greatest number of feathers with the least amount of hissing.

I work for a government I despise for ends I think criminal.

— John Maynard Keynes, Letter to Duncan Grant, December 15, 1917

IT IS that time of the year when the Union Finance Ministry tells us in mind-numbing detail how the government spends all the money at its disposal, including a good deal of it which is not. Further, to the mounting misery of many, we are told how the government proposes to soak the public for the money it does not have, but which it has already spent or plans to do so at the earliest.

The media, which thrives on compounding public confusion, marks the occasion by featuring entirely dreary discourses on the implications of whatever it is that the ministry has to say. As most people are concerned about getting the most out of a buck before the government gets around to grabbing it, most of these discourses deal with something called inflation.

They point out that this pesky inflation which shrinks the rupee relentlessly is caused by a variety of things: The withdrawal of subsidies, the consequent increase in the prices of commodities (petrol, diesel, LPG et al), rising wages and so on. In addition, these discourses reflect sombre concern about the continuing profligacy of the government which plunges it ever deeper into debt.

All these contentions are completely off the mark. Inflation is not caused by wage increases or rising fuel prices or an increase in consumer demand. Take prices, for example. The prices of certain goods go up because of a rise in demand for them.

The prices of other goods go down for the obverse reason. In any case, a price increase in one section of the economy is invariably accompanied by a drop in some other. Inflation is, at all times and in all places, caused by government printing money. And governments will continue to print money because inflation is central to a racket that they run.

To understand how and why governments the worldover resort to this white-collar swindle, it is necessary to know something about money.

Money is paper or a string of numbers in your bank statement or any other intermediary method of keeping score while you exchange goods and services. Economists inform us that money has no intrinsic value as it is not wealth. As is the case with most assertions made by economists, this is only partially true. Money is what psychologists describe as a "a conditioned reinforcer"— it works because if you give people money, they give you goods and services which you want and will continue to work as long as most of us believe that it will continue to work. Psychologists tend to be as unreliable as economists but, in this case, they have a point, and it can be said that money does, in fact, have intrinsic, real value. But let us set aside what the psychologists have to say for the moment and go along with the economist's position that fiat money has no intrinsic value. This lack of value is central to governments' stratagem to shortchange the public, as we shall see.

Governments, by their very nature, want to control everything in sight, including money. Thus, in most countries today, government holds a monopoly in the supply of money though there is no valid reason why an individual or an organisation cannot make new money backed by gold or a basket of commodities or anything of value.

However, government establishes a monopoly so that it can buy whatever it is that it wants — usually votes — for the price of printed paper. In addition, this monopoly helps government in not repaying people in full the money it has borrowed from them. Just about every government in the world loves to create more money and, thereby, cause inflation so that it can skimp on the repayment of the money it has borrowed from people.

But they usually do not make a fuss if they do not know that they are being plucked. Inflation pretty much guarantees that they do not know what is going on till they have no feathers at all.

This is how most modern governments pluck the geese.

First, a government borrows a pretty large sum of money from the people. It then gets its central bank to print some new money which, after it being deposited in banks, borrowed, repaid and so on, effectively multiplies about 10 times.

And that is precisely what the value of your little nest egg goes down by. But that is your problem. As far as the government is concerned, the scam that it has pulled off gives it a whole bunch of benefits. To begin with, by printing new money, it gets to buy goods and services for the relevant amount with some strips of printed paper. Second, it is able to repay the money it has borrowed from people with money of lower value.

Third, people are thrilled because they believe that the value of the stuff that they own has gone up — even though all that has gone up are the prices in a deflated currency — and feel good about the fine government they have.

Finally, as wages rise (though not their value), the real level of wages at which people pay tax goes down as a result of which they end up paying more tax without realising it.

The last is known in tax circles as the "creep" and is a source of much hilarity in these circles at the expense of the taxpayer.

While we are on the subject of government borrowings, it bears mentioning that all the wonderful benefits which accrue on account of inflation get hit if a government actually gets around to paying off the national debt. Government, in order to milk all the benefits of inflation, must keep borrowing more and more.

The next time you see a finance minister looking doleful about mounting government debt, do not be fooled. He is merely putting on an act so that you will not realise that you have pretty much lost all your feathers and start hissing furiously.

This time around, one hopes that the comrades of the Congress in the Central government will remind the Finance Ministry about what Keynes had to say in Chapter VI of The Economic Consequences of Peace: "Lenin was right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."