Money Builds Civilizations; But in the Wrong Hands, It’s Dangerous

Dr. Alex Tokarev

Associate Professor, Economics and Philosophy

Dr. Alex Tokarev
April 29, 2024

Money Builds Civilizations; But in the Wrong Hands, It’s Dangerous

Money was the tool that built our civilization. But, in the hands of the government, it can become a weapon of mass destruction.

Let’s start with a simple explanation of how money greases the wheels of the economy:

Step 1: Tom has $1 in the bank. Dick knits a scarf. Harry borrows $1 to buy it. Dick puts $1 in the bank. Abracadabra: Tom and Dick have $1 each on deposit. Is this economy better off because there’s more money in the bank? No, the improvement comes from Dick, who produced something of value to Harry.

Step 2: Harry bakes a pie, sells it to Tom for $1, and pays his debt. Tom is happier, though he no longer has $1 in the bank. There’s less money in the economy. Is that bad? No, the economy has grown; more goods give people more satisfaction.

Step 3: Now Tom writes a book and sells it to Dick for $1. Bank records show, as initially, $1 in Tom’s account. But it has done some traveling, improving lives by facilitating production, exchange, and consumption.

Now let’s examine how mismanaging the monetary system under a government-created monopoly like the Federal Reserve can derail our progress:

Value of Dollar Falls When Fed Grows Currency Faster Than Entrepreneurs Grow Economic Output

“Inflation,” noted Milton Friedman, “is always and everywhere a monetary phenomenon.” The purpose of money is to be exchanged for goods. If the Fed grows our currency faster than entrepreneurs grow the economy’s output, the value of the dollar falls. You must spend more dollars to buy the same goods. But there is more to inflation than an increase in the general level of prices.

If most new money enters through the banks, it lowers interest rates. If a big chunk of the funds goes first to consumers, demand for certain goods increases according to their preferences. This leads to higher demand for loans by businesses and higher interest rates.

The new money enters the economy in a step-by-step process with a significant impact on relative prices and real incomes. Those who get the funds first enjoy a temporary boost in living standards. Others get it later when prices are higher. Some are on fixed incomes and are forced to consume less.

Redistributive Costs of Inflation Disrupt Social Harmony

The redistributive costs of inflation disrupt social harmony, as pointed out by Ludwig von Mises. Before the Bulgarian lev was pegged to the German currency in 1997, we witnessed many strikes of angry professionals whose actions harmed innocent people — teachers obstructing the progress of students and frustrating parents; doctors and nurses hurting patients and their families; public transportation employees inconveniencing commuters; garbage collectors menacing residents, tourists, and businesses.

Inflation increases uncertainty; forces people to waste additional resources to cope with innumerable problems; leads to poor choices between current and future consumption; and distorts investment, paving the way for the next economic bust. In the early stages, inflation creates the illusion of a strong economy that generates many jobs. If you fail to control it, you end up with stagflation as the one experienced by Americans 50 years ago.

Why Politicians Engage in Inflationary Policies

When President Carter’s policies failed to deliver the promised prosperity, he blamed the economic hardships on the lack of confidence in his overly materialistic fellow Americans. Today, President Biden blames the shrinking size of Super Bowl snacks on corporate greed. Why are politicians so often tempted to engage in inflationary policies? And why are they so reluctant to deal with the problem? Because inflation is like drug addiction. The good effects come first — additional spending causes a temporary “high” for some consumers and businesses.

At the same time, the cure is known for inflation’s immediate painful effects — the economy suffers a recession until inflation gets squeezed out. And it takes a lot of political courage to go through the withdrawal phase.

Friedman noted the Fed tried to cope with the problem four times between 1957 and 1978: “But each time, we lacked the will to continue. As a result, we had all the bad effects and none of the good effects.”

The Fed was periodically bullied into sacrificing long-run price stability for the sake of short-run boosting of economic growth and adding — temporarily — some jobs. Thus, monetary policy exacerbated the volatilities of global markets and compounded the problems of the fiscal irresponsibility of Congress and the White House.

When Nixon cut the link between the dollar and gold and imposed price controls, the result was disastrous. American farmers were squeezed between rising global feed costs and fixed prices for the meat they were trying to sell in the domestic market. People watched in desperation on national TV as the owner of one hatchery drowned thousands of baby chicks.

We Can Weather Through Inflation Addiction Withdrawals

When one of Friedman’s disciples, Paul Volcker, ended up in the hot seat as the Federal Reserve chairman, he immediately assaulted inflation by raising the discount rate. As the economy slowed, the public was waiting to see when the contractionary policy would be reversed. Like the British Prime Minister Margaret Thatcher, our Fed Chair proved that he was “not for turning.”

The economy’s withdrawal from its inflationary addiction was so painful that a magazine for homebuilders featured a “wanted” poster for Volcker, accusing him of “cold-blooded murder of millions of small businesses.” With the election of Ronald Reagan, the Fed was finally given enough time to administer the cure until the economy was fully recovered. Ignoring the warnings from the polls and the defeats in the 1982 midterm elections, the President never withdrew his support for the war on inflation.

Reagan and Volcker challenged the idea that the country should be run as a statist corporation on the pillars of big government, big business, and big unions. Achieving monetary stability produced economic expansion for 25 years, a period known as the Great Moderation. The free enterprise system triumphed, restoring our power to choose, based on the principle that we are responsible for our personal actions, to live our lives as we desire so long as we do not violate the rights of others.

About the author

Dr. Alexander Tokarev, Associate Professor of Economics and Philosophy at Northwood University, originally is from Bulgaria and holds dual-citizenship. He is a fierce advocate for an entrepreneurial society based on human rights, individual freedoms and personal responsibility. This piece was authored as part of the March/April 2024 When Free to Choose, Northwood’s signature publication dedicated to promoting free enterprise.

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