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Fiat Money Inflation in France

by Andrew Dickson White
(1914)

 

Fiat money inflation then and now
by Michael J. Kosares

Andrew Dickson White ends his classic historical essay on hyperinflation, "Fiat Money Inflation in France,"with one of the more famous lines in economic literature: "There is a lesson in all this which it behooves every thinking man to ponder." This lesson -- that there is a connection between government over-issuance of paper money, inflation and the destruction of middle-class savings -- has been so routinely ignored in the modern era that enlightened savers the world over wonder if public officials will ever learn it.

The list of nations succumbing to very high and/or hyperinflationary episodes since the French experience at the end of the 18th century is legion. Here are a few of the more notable occurrences:

1. The Greenback and Confederate states inflations in the United States during and after the Civil War between the States;

2. A rash of national hyperinflations after World War I including Russia (1921-1924, 213 percent annualized); Poland (1922-1924, 275 percent annualized); Austria (1921-1922, 134 percent annualized); Hungary (1922-24, 98 percent annualized) and the most famous of them all, the Nightmare German Inflation (1920-1923, 3.25 million percent annualized);

3. Another round of episodes during and after World War II including Greece (1943-1944, 8.55 billion percent annualized); Hungary (1945-1946, 4.19 quintillion percent annualized) and China (1949-1950, unmeasured);

4. A rash of post World War II episodes including two in Argentina, and one each in Brazil, Chile, Nicaragua, Bolivia, Peru, Poland, Russia/Ukraine and Yugoslavia/Serbia (1);

5. The Asian contagion (1997-1998) including Indonesia, Thailand, South Korea, the Philippines and Malaysia which managed to display deflationary and inflationary symptoms simultaneously.

According to an International Monetary Fund sponsored study by Stanley Fischer, Ratna Sahay and Carlos Veigh (2002), hyperinflations have been a rare commodity since 1947 and the dawn of the Keynsian era, but "much more common have been longer inflationary processes with inflation rates above 100 per cent per annum." These they classify as "very high inflation" episodes. The study finds that close to 20% of the 133 countries studied experienced inflations of that magnitude. The average duration of these episodes was 40 months with a minimum of 12 months and maximum of over 200 months.

Not covered in the study is the myriad of double-digit inflation episodes since World War II (like the 1970s inflation in the United States) even though these events carried significant political and economic implications for the countries affected. Quite often though, these lesser inflations served as preludes to more debilitating events at some point down the road. Other times, as in the United States, public policies were instituted to smother the inflationary fires before they reached the critical stage.

All in all, it is difficult not to classify inflations of any size and duration as significant to the middle class. Few of us would gain comfort from the fact that the inflation we were experiencing failed to transcend the 100% per annum threshold or failed to escalate to a state of hyperinflation. Just the specter of double-digit inflation is enough to provoke some judicious portfolio hedging.

In 2012, the famous Andrew Dickson White essay you are about to read will celebrate its 100th anniversary. How can something written over 90 years ago describing monetary events occurring almost 215 years ago in France carry relevance for investors in the United States (and the rest of the industrialized world) today? The short answer is that the United States increasingly appears to be travelling a path similar to that of France in 1789 when the debasement of the currency, as Dickson White so matter of factly tells us, left the bulk of the population penniless. Fisher-Sahay-Veigh conclude that "the link with the French revolution supports the view that hyperinflations are modern phenomena related to printing paper money in order to finance large fiscal deficits caused by wars, revolutions, the end of empires and the establishment of new states." How many Americans would read those words without some degree of apprehension?

What makes this particular dollar inflation even more dangerous than the assignat inflation studied by Dickson White is the potential corrosive effect it is having on the international economy as a whole. The French inflation was localized; the dollar inflation is internationalized transcending national boundaries and encompassing not just the world's most powerful economies but, in one way or another, most of the world's smaller, less-developed economies as well. Since the global village as a whole has never been in this situation before, it is difficult to determine how the current situation might resolve itself. Suffice it to say that the potential for an international dollar crisis is something about which we should all be concerned.

One of the better assessments where the present situation might lead us comes from former World Bank economist Richard Duncan, author of the recently published book, 'The Dollar Crisis: Causes, Consequences and Cures.' Duncan raises the specter of a dollar-based international hyperinflation:

"The most aggressive experiment in monetary policy in order to buy dollars in such extraordinary amounts that global interest rates are being held at much lower levels than would have prevailed otherwise. In essence, the Bank of Japan is carrying out the unorthodox monetary policy that the US Federal Reserve intimated it was considering in mid-2003. In other words, the BoJ is creating money and buying US Treasury bonds, which is helping to drive down US interest rates and underwrite US economic growth -- and, by extension, global growth...

The amount of new yen that Japan 'printed' and converted into dollars during January 2004 alone was enough to finance 13 per cent of the US budget deficit. The investment of those dollars into dollar-denominated debt instruments clearly explains why the yield on the 10-year US Treasury bond fell last month in spite of the 10 per cent upward revision in the Bush administration's budget deficit projections. By accident or by design, Japan is carrying out the most audacious endeavour to conjure wealth out of nothing since John Law sold shares in the Mississippi Company in 1720."

Hugh Hendry of London's Odey Asset Management suggests in a recent Barron's magazine interview what this might mean for savers and investors:

"What's happening today happened 300 years ago in the French economy when John Law, another Scotsman, was allowed to launch the first government-sanctioned bank, which replaced coins with paper money.

Commerce boomed. Politicians recognized this correlation between issuing more money and people liking you. They issued more and more money, but it was a false promise. Nothing intrinsically was being added to the economy except promises, which could never be redeemed. Selling by speculators caused the stock market to correct. The correction encouraged the authorities to print more funny money. Ultimately, the continued pumping of liquidity destroyed the economy, the stock market and France's currency.

More recently, the U.S. came off the gold standard in 1971 and the Dow Jones Industrial Average bottomed in 1974. Over the next 25 years, the Dow goes up 20-fold because every period of economic anxiety brought forward an orthodoxy of generous liquidity. Money has to go somewhere. It seeks to perpetuate itself by going into a rising asset class. This time, it is financial assets. Just like the Mississippi stock scheme in 1720 and the South Sea Bubble in London at the same time.

The authorities have broken their trust with us. Middle-class society preserves its wealth in paper assets and the honesty of the paper asset is that the central banks will not dilute your financial assets by printing too much money. We're having to go to extreme measures to preserve our wealth by owning gold, a barbarous relic. Greenspan is the smartest guy on the planet, but you know what? Wise guys make mistakes."

The Andrew Dickson White essay tells the story of how good men -- with nothing but the noblest of intentions - can drag a nation into monetary chaos in service to a political end. Still, there is something else in Dickson White's essay -- something perhaps even more profound. Democratic institutions, he reminds us, well-meaning though they might be, have a fateful, almost pre-destined inclination to print money when backed to the wall by unpleasant circumstances. You will no doubt see the inescapable similarities between France then and the United States now.

Dickson White's section sketching the hedging aspect of the roughly one-fifth gold ounce coin, the Louis d'Or during this tumultuous period speaks volumes. And after all is said and done, it might end up being the most important lesson of all. Gold, the one primary portfolio asset which is not another's liability was the best defense in France in 1795; it is likely we will rediscover that it is the best defense now.

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