Inflation Upside Down


THE unhappy layman, the lowest person in the financial hierarchy, has every right to howl his distress at the moon. The professors and economists, many of the bankers, and most of the brokers’ customers’ men have scared the wits out of him. They have told him more things in three short years about the humble dollars in his pocket than could possibly be true at one and the same time about any object under the sun.

They have told him his dollars were being inflated, that inflated dollars would lead to his financial ruin, that inflated dollars would drive down the value of bonds held by his insurance company or his savings bank until his life’s savings would shrivel before his very eyes. They have hung before his miserable gaze not only French assignats, but also post-war German marks, post-war French francs, pictures of Mississippi Bubbles, and horrible flapping things called greenbacks. As he groaned responsively, they have piled horror upon horror.

But they have also confided to him that he must receive smaller dividends from his insurance policies and lower dividends from his savings bank and a lower return on his bond investments because ‘easy money’ was raising bond prices and lowering the interest rate! Something has obviously gone wrong with inflation. It seems to be working upside down. The frightened layman sold his bonds before they were scheduled to drop through the subcellar. Now he can hardly find them in the stratosphere. He rushed to convert his dollars into shoes before they rose to $25 a pair — but shoe prices are still clinging to the sidewalks. Yes — he has every right to howl!

The real trouble is, of course, that our monetary crystal gazers indulged in that alluring modern habit of forgetting to define their words. They also forgot, in their anxiety about Federal deficits and Federal borrowings, to examine the total debt structure of the country, public and private, and to balance against rising public debt the stupendous decline in private debt. But, first and foremost, they forgot to define words. They picked on the word ‘inflation,’ — which has, at the very least, four distinct and separate meanings, — and forgot to tell the layman the difference between one kind and another.

The late Theodore Roosevelt once described to me the political campaign of a certain candidate by saying that ‘he told the country there was a great national crisis, but forgot to say what the crisis was!‘ Our prelates of finance have been singularly guilty of just that sort of forgetfulness.

We can have, quite obviously, a general monetary inflation, during which the total quantity of money —that is, bank deposits plus circulating currency — rises faster than the gold reserves behind that money. That is one form. As a second form, we can have a currency inflation, during which circulating currency rises faster than its gold backing. This happened, for example, from 1931 to early 1933, reaching its climax in the bank holiday of March 1933.

Then there is a third and much less technical form of inflation which we might define as a state of being ‘overextended.’ This is a form which the layman instinctively understands, because it has nothing to do with gold standards, managed currencies, or other supposed money mysteries. The man who knows that his resources are dwindling while his debts are piling up knows very clearly that he is becoming ‘overextended’ or inflated. When an entire country gets into this condition, we have an acute case of national inflation. Each of these three forms of inflation involves an obvious state of strain and stress in the financial structure, raises the cost of borrowing money, and often the cost of goods as well. In 1920, when you could buy Liberty Bonds at eighty cents on the dollar, and when shoes did cost $25 a pair, we had a combination of a general monetary inflation, a currency inflation, and a greatly overextended nation-wide debt condition, quite apart from the huge Federal debt.

This brings us to the fourth kind of inflation — the kind that seems to work upside down because it raises bond prices, lowers interest rates, and at the same time permits rising stock markets. This fourth kind is an inflation of the supply of money. It increases the supply of money without a corresponding increase in the demand for money, and by this simple process of changing the relation of supply and demand reduces the market price (or the interest rate) for the use of money. It so happens that we have been going through just this kind of inflation since March 1932, and that bond prices by and large have been in a gigantic bull market since shortly after that date. In the meantime, the National Industrial Conference Board tells us the cost of living has risen less than 10 per cent above the average for 1932.


The layman can well afford, for his greater peace of mind, to take a quick and reassuring glance at the exact state of affairs to-day in each of these four major forms of inflation. Both currency and total bank deposits plus currency have a larger backing in gold than at any other known time in our financial history; and this, too, with gold measured at its old value. At the new value, of course, there are nearly twice as many gold dollars in the country as there would be at the old value. But even at the old value there is more than $1.10 in gold for each dollar of circulating currency. That represents extreme deflation rather than inflation. For total money, there is about eleven cents in gold at old value for every dollar in use. This compares with an average of from eight to nine and one-half cents in the general post-war period up to 1929, and, once more, represents a thoroughly deflated condition. It is one reason, perhaps, why the cost of living has not yet exploded through the roof.

As to whether or not we arc ‘overextended,’ a few facts which most of the financial bigwigs have failed to emphasize help vastly to relieve immediate anxiety. They are facts of the kind which appeal to the layman’s common sense. Suppose, first of all, we look our debts squarely in the face. They fall easily into two major forms, money owed the banks and money owed in the form of notes and bonds held by the investing public. These notes and bonds include bonds of corporations (railroads, utilities, and the like) and obligations of municipalities, states, and the Federal Government. We can omit corporation bonds, as the total has not increased greatly in the last few years. We can also omit municipal and state bonds for the double reason that accurate figures are very hard to obtain and that the recent increase, although large in proportion, does not bulk significantly compared to the increases in Federal debt. It is fair to say that we get a good estimate of the trend of our total indebtedness if we simply add together the total of our bank loans and our Federal debt.

But is it fair to add together these two very different forms of debt? The fact is that we, the American public, owe both our Federal Government’s debt and the total of all bank loans. In the end we pay for both. This point is so important that it is worth lingering over with some care. The man who owes nothing at his bank is apt to balk at the idea that he and his neighbors really owe the debts of other people at their banks. But the fact remains that he helps to pay both the interest and the principal on those loans. The furniture maker who borrows money at his bank includes the interest charge on his loan as part of his manufacturing cost. When we buy a chair from him, we pay a high enough price to cover the cost of his materials and labor, the repayment of a share of his loan, and the cost of the interest on that loan — all this in addition to something for his own profit. As we are also paying the salaries of his employees, we are even providing the funds with which those employees buy radios on the loan or installment plan. Thus, from top to bottom, the buying public ultimately pays both interest and principal on all the bank loans of the country. It is an invisible levy, but just as inexorable as the visible and more painful taxes. Bank loans are an intimate part of our aggregate national indebtedness.

In 1929, before the ‘official’ depression started, we owed in the form of bank loans the round sum of 36 billion dollars. But at the close of 1935 this vast sum found itself reduced to 15 billions—a tangible and undeniable reduction of our national indebtedness of no less than 21 billion dollars. Moreover, if we remember that the average bank loan in 1929 drew 6 per centinterest, compared to an average of not over 5 per cent to-day, the reduction in our annual interest bill amounted, over this six-year period, to the tidy sum of $1,410,000,000. In 1929 we were paying something over two billions annually in interest charges on bank loans — paying it silently, of course, and indirectly, every time we bought bread, or automobiles, or radios, or settled our rent, but paying it we were. To-day the bank-loan interest bill is only about three quarters of one billion.

But what of Federal debt? What of the immense borrowings of the Federal Government which we all owe directly as citizens, and on which we must pay the interest bill in direct and painful and visible taxes? In 1929, we owed in Federal debt something over 16 billion dollars, on which we paid an interest bill of 678 millions a year, or slightly over 4 per cent. At the end of 1935, our Federal debt (including federally guaranteed obligations) had risen to 33 billions, on which we were paying an interest bill, at slightly under 3 per cent, of not more than 990 millions a year.

With these two sets of figures, we can do a quick sum of addition and subtraction. In six years, bank loans had declined 21 billions and Federal debt had risen 17 billions. The total of the two forms of national debt had thus dropped four billion dollars. The annual interest bill had dropped even more in proportion. Against a total interest bill of $2,838,000,000 in 1929, we were paying only $1,740,000,000 — a difference in our favor, as debtors, of over a billion dollars. In percentages, the principal of our combined debt had dropped 7.7 per cent, and the interest payments 38.7 per cent. This is a rather comforting thought for the much abused and barrel-clad layman who must pay the combined bill in various forms. He may still worry about the future and keep an anxious eye on the Federal budget, but at least he owes less to-day than six years ago, and pays far less in interest.

To be sure, the appraised value of our national assets has dropped somewhat more in percentage than the debt total. The National Industrial Conference Board has not, at this moment, completed its appraisal of 1935 national wealth. But if we assume it to be 10 per cent higher than the 1934 estimates, then national wealth at the close of 1935 was 314 billions, or 13 per cent less than the 1929 appraisal. Since debt has dropped only 7.7 per cent, we are, in relative terms, more ‘overextended’ than in 1929. But so far as current annual obligations, or interest charges, are concerned, we are far less overextended or inflated than in 1929.

In simple figures, the interest position on the two forms of debt included above can be stated this way: our national income in 1929 was appraised as 78 billions, out of which we paid nearly three billions (or 3.6 per cent of our income) in major interest charges; our national income for 1935 is estimated, in preliminary studies, as 54 billions, out of which we paid one and three quarter billions (or only 3.19 per cent) in interest charges. For every hundred dollars of income in 1929, we paid $3.60 in interest, compared to only $3.16 of interest for each hundred dollars of 1935 income. This is a saving of $4.40 on every thousand dollars of income. Our income is lower, but a larger percentage of it is left over after visible and invisible interest bills are paid.


With total money well deflated, with currency wholly deflated, with a moderate inflation in debt structure (compared to decreased national wealth) and an offsetting deflation in current interest charges, the facts appear to lay low many of the most alarming ghosts of the last two or three years. But we do have an inflation of money supply. Of that there can be no question. The figures fairly scream from the weekly reports of the banks.

To give but one example: in June 1929, the weekly reporting banks of the Federal Reserve System owed their depositors 21 billions in deposits — but the depositors owed these same banks in various forms of bank loans no less than 16.4 billions. In other words, if all depositors had paid off their bank loans, they would have had left only 4.6 billions. But in January 1936, with deposits in this same group of banks amounting to 24.7 billions, the depositors owed the banks only eight billions. After paying off all loans, the depositors would have had left 16.7 billions — or more than three and a half times as much as in June 1929.

Just how this dramatic increase came about is a long story, involving the technique borrowed from the British by which government borrowings from the banks have been converted into funds owned outright by the public. But, quite aside from how it all happened, the fact remains. The average bank depositor owns, free and clear, over three and a half times as much money in the bank as he did in 1929. That situation is precisely what is meant by a ‘money-supply inflation.‘

This greatly increased supply tends to bring down the wages of money and reduce our annual interest bill.

In brief, we do have an inflation, but not of the kind with which so many eminent souls were scaring the unhappy layman a year ago and two years ago. We have simply turned more of our assets into money and thereby cut borrowing costs, whereas the prophets of doom, without defining their terms, and without figuring the offset between rising Federal debt and declining bank loans, were describing the horrific results of exactly the opposite process by which we turn more of our money into assets and thereby withdraw money from lending channels and raise our interest costs.

The doom-dogglers have been describing 1920, for example, when people bought their heads off in commodities and inventories and borrowed to buy. It has merely been tragic for the falsely alarmed layman that, from 1932 to 1936, people have bought as little as possible on directly borrowed money and have curtailed loans instead of borrowing. The only fact in common between the two periods was the increase in Federal debt — for war and reconstruction in 1920 and for relief in 1931-1936.

The point is that it takes two to make an inflation — the government and the public. When they move in opposite directions, the actions of one offset the actions of the other; and if the public deflates more rapidly than the government inflates, then the sum total is still deflation. Perhaps tomorrow the public will begin to follow the government’s lead and work toward a new 1920. But, unhappily for the puzzled layman, many of his professors and bankers and customers’ men will then call it, not inflation, but ‘widespread business recovery.’ In the end, the poor layman wall still be howling his distress at the moon!