Inflation: The Winners and Losers Haven’t Changed Much.

Inflation: The Winners and Losers Haven’t Changed Much.

By Walter Donway

Britain in the late 17^th and early 18^th centuries had the dubious honor of inventing central banking and inconvertible paper money—that is, the mechanics of “modern” inflation. (“Modern” because gold and silver—"specie”--that earlier poured into Spain from the New World did inflate Europe’s money supply, which was specie, setting off rocketing price increases as they disseminated across the continent.)

But as the 18th century dawned, Britain’s monarchy faced ruinous, virtually continuous expenditures for conflicts. Britain was at war on some level in 49 years of the seven decades between 1744 and 1815. There never seemed to be enough tax revenues (and British rulers by then were wary of sparking public revolts) nor was unlimited borrowing possible from lenders (often goldsmiths) who watched national debt accumulate and witnessed defaults.

Schemes for paper money to be created by government via a “national bank,” conceived by men such as Scots banker William Peterson (its eventual founder), appealed to King William and Queen Mary who saw their potential to “stabilize”—as inflationists today have not stopped repeating—the public finances in his war against Louis XIV of France. 

The schemes, to say the least, did not escape controversy. The “bullionists” insisted that paper money must be fully convertible to specie; if not, there would be no limit on fiat (government-created and decreed) money and added to specie, it would relentlessly drive up the general price level. The Bank of England, duly created in 1694 by act of Parliament and royal charter, was nevertheless private, supported by subscriptions (George Washington was an investor throughout the Revolutionary War). 

Unsurprisingly, the bank’s available specie in time began a steady decline and as, this became known to the public, there were periodic crises. In 1797, with the total face value of the notes in circulation almost exactly twice the actual gold reserves held (£10,865,050 of notes, compared to £5,322,010 in bullion) its directors appealed to Parliament to suspend convertibility of the bank notes into specie. This set off a vigorous and fascinating debate that generated famous pamphlets on economic theory, but in the end parliament granted the ”restriction” of convertibility, which restriction was periodically renewed until 1821. Not till 1844 did the bank acquire the exclusive right to issue British bank notes backed by a “fractional reserve” of specie and deposits.

The first, earliest recipients of the new fiat money benefited from its full-face value, but those who received the money later, when it had disseminated through the economy and raised prices, received increasingly devalued money.

This brief account could be called, of course, an inflation “classic”—the first such saga of its kind. Thus, my focus here is on another argument advanced as part of the debates, one not much discussed today. The bullionists objected to the debasement of the currency, certainly, and the resulting rise in prices and destruction of savings, but they developed and debated another argument. It was this. The first, earliest recipients of the new fiat money benefited from its full-face value, but those who received the money later, when it had disseminated through the economy and raised prices, received increasingly devalued money. They were the ones who paid, in effect, the cost of the inflation. The anti-bullionists replied, handily changing the subject, that suspending convertibility maintained “stability” during a time of financial stress—i.e., permanent war. 

"Inflation benefits groups closest to the money-creation process–like banks and government contractors–at the expense of the general public, whose purchasing power is eroded."

Murray Rothbard sums it up in An Austrian Perspective on the History of Economic Thought: "Inflation benefits groups closest to the money-creation process–like banks and government contractors–at the expense of the general public, whose purchasing power is eroded."

The argument is not yet resolved. Nor is it my impression that it is much discussed—certainly it is not remotely at the center of the debate over inflation today as it was some 350 years ago in England. But let us see if it still has relevance.

‍It is called “quantitative easing, now

Faced with the COVID-19 pandemic, the federal government-mandated “lockdowns, a disease-control measure unprecedented in history to “close down” the economy. The U.S. Federal Reserve panicked at the specter of depression and reached for the prescribed Keynesian medicine: inflation. Between late February 2020 and mid-April 2022, in a series of four steps dubbed “quantitative easing”—creating new money by fiat—the Fed ballooned its balance sheet 115.6% higher.  To put it another way, it conjured up $4,807 billion ($4.8 trillion) of new fiat dollars and pumped them into the economy by buying back (“monetizing”) US. Treasuries and mortgage-backed bonds. In two years, this more than doubled the entire U.S. money supply. 

The quantity of dollars, actual “inflation,” drives the general level of prices.

The quantity of dollars, actual “inflation,” drives the general level of prices. Economics Nobelist Milton Friedman characterized the process in words that have become famous. In his massive Monetary History of the United States he summed up the lessons as “Inflation is always and everywhere a monetary phenomenon.” A greater quantity of money, bidding for a relatively unchanged quantity of goods and services, bids up general prices. Economists today choose to call that increase in prices “inflation” although the increase in the money supply “inflation” is the cause of the general price increase.

The result achieved by the Fed, as expected, was a historic inflation spike, the primary U.S. Inflation gauge rising to extremes not seen in four decades. The Consumer Price Index (CPI), the most closely watched inflation measure, surged. In June 2022, as quantitative easing peaked, the CPI hit its own 9.1% peak—the highest in some 40 years since November 1981. 

Since then, the “Fed” has dominated financial headlines almost daily with breathless reports on its “fight against inflation” (price increases) as if had invaded from Mars or was a new pandemic being ferried into the country by enemy drones. The Federal Open Market Committee from mid-March to early November 2002 frantically hiked interest rates a historically unprecedented 375 basis points (3.75%), including a string of four virtually unheard-of monster .75% hikes. This acceleration drove the U.S. Dollar index up 14.3% between mid-April and late September to a staggering 24.4-year high. That in turn unleased panicked selling of gold-futures, which crashed 17.9 % lower. (The Federal Reserve System was created by an act of Congress in 1913 with a mandate to enhance the stability of the American banking system.)

‍Who owns stocks? The winners

To return now to our question: Who benefited from the high tide of new money, receiving it early at full value, and got richer?  And who paid the costs, receiving the debased dollars later and faced the skyrocketing prices for goods and services?

Here is a suggestive statistic. Since the Fed began its “quantitative easing,” the Dow Jones Industrial Average has increased by approximately 50.6%, the S&P 500 by around 84.1%, and the NASDAQ Composite by 112.7%. Over two-and-a-half years or so, anyone who simply invested in one of the stock indexes came near to doubling their money—or better. During the same period and later, as noted above, consumer prices shot to a peak increase of 9.1%, averaging an annual surge of 8%. (Many observers of the U.S. economy, however, point to changes in the calculation of the CPI that have consistently low-balled these inflation reports: “Some critics argue that switching from a cost of goods index (COGI) to a cost of living index (COLI) skews the facts, allowing the government to understate inflation. There are at least three distinct ways to calculate the CPI, and each leads to a different measurement of inflation.”) 

So who benefited from the unprecedented doubling of the money supply that caused almost a doubling of average U.S. stock prices, even as it caused the consumer’s dollar to lose at least 8% of its purchasing power?

According to the Federal Reserve, as of the third quarter of 2024, the wealthiest 1% of Americans held some 50% of stocks, worth $23.3 trillion. If you expand that to the top 10% of Americans, you account for 87% of ownership of stocks with a value of $35.5 trillion. Actually, the stock ownership of the rest of the country has been dwindling, so that the bottom 50% of Americans in terms of net worth owns only 1% of stocks worth about $480 billion. The wealthiest Americans, by contrast, never have owned so large a percentage of stocks. Why not, stocks have been an awfully good place to be invested. 

‍Follow the buck

Let’s try to follow the flow of the buck. 

Broadly speaking, earlier recipients of new money during an inflation, including banks and other investors, experience the benefits first. They see asset prices rise and can leverage new opportunities. Later recipients (like average consumers) face higher prices when the new money circulates more broadly.

Broadly speaking, earlier recipients of new money during an inflation, including banks and other investors, experience the benefits first. They see asset prices rise and can leverage new opportunities. Later recipients (like average consumers) face higher prices when the new money circulates more broadly. With layoffs and other unemployment, wage increases don't keep up with price increases, further reducing real income and purchasing power. How does that work? 

Central banks, including the Federal Reserve, start their “quantitative easing” by purchasing large quantities of government bonds and other assets. This injects new money directly into the financial system. The initial recipients of the new money are primarily banks and other financial institutions. The injection of liquidity is intended to encourage lending and investment. (Think: corporations refinancing their debt at lower rates, corporations using debt for multi-billion-dollar stock “buy backs,” companies launching initial public offerings (IPOs) to sell themselves to the “public” in a financial system afloat in new funds.)

With the influx of funds, financial institutions must invest somewhere and that means mostly in financial assets: stocks, bonds, and mergers and acquisitions.

As financial conditions “ease,” the fiat money flows in, banks lend more to consumers who find it easier to finance big ticket items such as homes, cars, furniture, and travel. During the COVID crisis, one benefit ordinary Americans did receive was a series of “stimulus checks” to support their purchases. Increased business investment, as the Fed hopes and expects, leads to creation of new enterprises, more job creation and hiring, more competition for workers. It is explicit: “In all…QE strategies, the Fed reasoned that…a reduction in longer-term [lending] rates would allow firms to save on their debt refinancing, and…achieve higher earnings and profits thus helping their stocks, and restoring the wealth of households that held such stocks as a driver of stabilizing the real economy.” [My emphasis.]

Some 325 years after the British battle attending the birth of central banking, unconvertible paper (fiat) money, and the debate over who won and who lost from inflationism, today’s Fed followed the same policies, with actual inflation called “quantitative easing” and price increases called “inflation” by the media and in treated as an affliction of ill-defined origins. Supply-line disruptions? Corporate greed? CEO pay raises? The exploitive butchers and bakers that Democratic presidential candidate Kamala Harris vowed to bring to heel for “price gouging”? The Mexicans? The Japanese?

During his 2024 State of the Union address, President Joseph Biden said: “We know prices are still too high because of what I call ‘greedflation’ and ‘shrinkflation.’ I’m calling on corporations to pass their savings on to consumers, for God sake.”  Earlier, in March 2022, Biden said “Make no mistakes, inflation is largely the fault of Putin.” This was one month after Russian troops began a full-scale invasion of Ukraine.

‍Chairman Powell as John Law?

Back in Britain, history’s most infamous inflationist, John Law (1671-1729), a Scotsman, had tried to peddle his inflation schemes in England but then had to flee (he escaped prison where he was locked up for killing a rival in a dual). England succumbed to more sober inflationists, but in France, Law tried again with much more success. In 1716, he proposed to the Duke of Orleans, Regent for the infant Louis XV, a scheme to rescue France’s finances with a new paper currency. He duly launched the “private” Banque Generale, with himself as Controller General of Finance. A year later, it was nationalized as the Banque Royale. Briefly, the term “millionaire,” for the first time, became widespread in France. So did investments in the infamous, cataclysmic “Mississippi Bubble.” And then, inevitably, came the crash and sustained economic misery.

The demonstration did wonders for the case of the “hard money,” or bullionist, camp. Britain returned to and redoubled devotion to the original continental tradition of hard money. Murray Rothbard writes that the lessons of the John Law catastrophe remained with “all reflective writers and theorists on money throughout the eighteenth century…” so that “hard-money” doctrines prevailed easily…including among the Founding Fathers of the American Republic.”

Fast-forwarding to the 2024 U.S. Presidential election, voters consistently ranked inflation a priority problem.

Fast-forwarding to the 2024 U.S. Presidential election, voters consistently ranked inflation a priority problem. Candidate Donald Trump tuned into their bitterness by repeatedly referring to price increases that were “killing” the public. At the same time, new “billionaire” majority stockholders in “hot” new companies seemed to keep popping up in public life and politics.

We can say, at least, that the inflation issue was not ignored. But neither the rhetoric of the candidates (did anyone mention the Fed or quantitative easing?) nor the passion of voters suggest comparison with 18^th-century Britain’s robust allergic response to the John Law economic quackery.

If the Fed’s truly brazen and incomprehensible performance, waving away 350 years of experience with inflationism, were better known by the American public could Fed Chairman Jerome Powell be cast as John Law? His audition for the role was a winner.