The Sky Is Falling


It's always embarrassing to prophesy doom and have the world come up with only a measly few arguments and scuffles. To friends and relatives I said, the evening of August 15, "I wouldn't be at all surprised if the stock market dropped 50 points tomorrow and 500 by the end of the week." There was more along that line, all gloomy.

So what happened is history, and it ain't what I said. True, I did half-way cover myself by saying, every third or fourth sentence, "It all depends on how gullible the American people are. They swallowed an awful lot from Roosevelt, and it's possible that they'll allow themselves to be persuaded that a wage-price freeze is the best thing for the home of the brave since—what?"

In truth, I never expected anyone to be this gullible. At my most wildly optimistic I thought people might wait and see, but as I write the Man in the Street (both Main and Wall) seems to be saying that it's about time somebody did something to stop inflation.

I had an elaborate scenario worked out, August 15th, and in order to explain away some of the egg on my face, I pretty much have to go through all of that again, recognizing that to do so also reminds one and all of the inaccuracy of my prediction.

So, before I do the scenario, let me recapitulate some basic economic truths. Basic, not popular. Even M. Friedman in NEWSPEAK refers only vaguely to them, and it is clear from the kinds of things both advocates and enemies of the freeze are saying that they do not argue from these truths, may in fact never have heard of them.


First, a thing is worth what buyer and seller compromise on. That's an analytic definition. Obviously, thing A is worth to the seller less than the purchase price, or he would not sell; it is worth to the buyer more than the purchase price, or he would not buy. Analytic definitions have, heaven knows, their disadvantages, but they are as nothing to the practical and theoretical disadvantages offered by all other notions of value in other economic theories.* The only important thing which my theory (called the "subjective valuation" theory or some such) does not offer is a basis for saying that such and such is a "fair price" or "the real value" or the like, and that sort of judgment is after all usually a moral, not an economic, one.

This being so, it follows, again analytically, that, interferences with the transaction between equal, free bargainers results, by analysis, in a lessening of at least one's values. In other words, when I want to buy ice cream for a dime and you want to sell, but Harry says I must pay more, or less, or he rations ice cream, or forbids its sale, he is depriving either you or me of the benefit which was expected from the deal—and he is probably hurting both of us, assuming we both wanted to deal.**

Another truth, ultimately derived from the first: If you and I, instead of swapping directly, swap indirectly by the use of money, then the "value" of the money is set by what it will get us. It seems only fair, then, that money should at all times be "worth" the same to everybody. My dollar should buy what yours buys. In real life, however, as is known, it doesn't work that way. There are those, and they are everywhere, who seem to be saying that you could make money worth less by paying me more. The proposition is never stated that baldly, but I have never seen it boil down to anything else. Isn't that what all the "wage-price spiral" stuff means?

Anyway, the notion is given currency (pardon) that money becomes worth more or less because of actions of individuals in the market. If, that is, there are 500 actual dollars in existence at some period of time, and a lot of people raise their prices (regardless of whether anyone produces more or less), then each of those dollars will be "worth" less. So far, the notion is unobjectionable. What is peculiar is the accompanying notion that everyone will be able to raise prices and the same quantity of actual goods and services will still be sold. If I have 30 of those 500 dollars, and everyone raises his prices, then I will be able to buy as much (in percent) as before, only I will have to pay more, runs the argument.

Nonsense. The only way that my 30 dollars could be worth less (or, equivalently, that all prices could rise) would be for the 500 dollars to increase (without an accompanying change in goods, etc.), following which, clearly, if I don't get my share of the increase, my stock of money will be worth less. Wherever the new dollars come from, if they are instantaneously distributed proportionately to all holders of old dollars, all that happens is that all prices go up instantaneously and proportionately.


In anything like a real world it doesn't happen that way. To start at the end, it is damned near impossible to imagine a way for everyone to change his prices simultaneously, instantaneously, and exactly proportionately. Clearly, some people will be able to pay debts with new dollars at old dollar prices and sell at new dollar prices—meaning that someone else will be paid new (cheap) dollars for old (dear) dollar debts, and someone will have to pay new dollar prices from an old dollar treasury. The first people to get the new dollars, or the news of the change, will gain, at the expense (necessarily and directly) of those farther down the pipeline.

That's the inflation story, and that's all there is to it. Even some textbook writers have heard of it, however much they push other stories. The derivation from the first truth should be clear: the source of additional dollars cannot just say, "My dollars are worth exactly what the 500 dollars are each worth, and everybody will so regard them." Why, after all, should anyone so regard them? Each holder of a new dollar will regard his dollar, at least for the moment, as exactly equal to all the other dollars, and the only difference it will make to him will be that he can afford to pay a little more for what he wants. When the holders of new dollars are aggregated, clearly they will bid prices up, not because of any change in the "worth" of the things bought, I remind you, but because of a change in the quantity of the medium of exchange, which itself is, qua medium of exchange, valueless—few treasure money for its own sake. The difference between backed and fiat money is irrelevant here. If you insisted, you could call the rise in prices "inflation," just as you could call a fever an infection.


So far I have avoided concrete references to the issuer of the new money. One reason is that in an unimpeded economy, chances are there would be several issuers of money, and someone who insisted on issuing new money would lose favor with those to whom his money is offered: who would take money that would be worth less by the time he wanted to spend it? (This is remotely the case in the international money market now, or it would be if the United States didn't have enough clout to keep others in line, and the others weren't scared shitless what would happen if the United States wobbled.) The other reason is drama. Enter the State.

If you issue money, and prohibit competition in the field, you have an important power. You cannot, as we have seen, make anything (besides money) really "worth" more or less—only buyer and seller can do that—but you can, by issuing new money, benefit the first in line at the expense of those at the end of the line. Being first in line would be important, and a lot of folks would do right by you to see that they get firsties.

That, of course, is what the State does, and these days it is one of that institution's most important functions. Using among others the device of the "budgetary deficit," the contemporary State gives new dollars to some so that they will have an advantage over others. For public relations purposes, the State is unlikely to go to the trouble of informing the hind-teaters of how these things work; if it wanted to do that, it would have gone ahead and taxed them directly. Everybody objects to taxes, though, but few are willing to foreswear a system in which they might someday get front-teat rights. (Even a rigged lottery would be a more honest way of filling State coffers.)

Anyway, even the most short-sighted hind-teater notices sooner or later that he is getting scrawnier and scrawnier while some of his siblings get fat and sassy, and all the while the teats get harder to reach. He squeals, and the head pigs ring another change on their propaganda bells. They might say, "We shall forbid prices to rise." Piglet is content.

I am reminded of the famous cynical comment on law (Voltaire's?) that the law is just because it forbids rich and poor alike from sleeping under bridges. A wage-price freeze of the best kind, i.e., one actually accompanied by an end to inflation, merely puts an end to hopes of future privilege for those at the front; it does nothing for those at the back but assure them they will fall no farther behind. Big deal.


Our wage-price freeze, of course, is not of the best. Nobody has made a sound about ending deficit spending (nobody has admitted knowing that's where the problem comes from). New dollars continue to pour in. No new resources, physical or human, have been created by Nixon's edict.

Now we can discuss my embarrassment. This is how I saw it:

Businessmen are prohibited from raising prices. Not counting the tax break Nixon is trying to offer them, the only way a business can increase profits under the freeze is to reduce costs. It is unlikely that anyone's suppliers will suffer a fit of generosity and lower prices unless someone farther down the line lowers his, and so on. Unlikely. So the only cost that can be lowered is labor.

Okay, so the boss will go to his workers and say, "I've got to lower costs, and the only one I can move is labor, so what do you suggest?" Is it likely that the workers will cry out in unison "Lower our wages!"? In fact what seems most likely is that the boss will bump off a few of his least valued employees (by union rules, chances are that means those with least seniority, although of course pull will help), and even so outrage will be expressed all over the place. Also, people will be out of work.

People will be out of work in increasing numbers. That means there will be fewer people able to buy things, which means that producers will have fewer sales, which means they will have to cut back more. On and on. (If the price of labor were elastic—if it could go down as easily as up—this aspect of the problem would vanish in a new equilibrium, assuming no further inflation.)

Several things will happen as unemployment spreads, (besides the self-feeding). Most notable among those things will be an increasing clamor for some kind of State activity to help the unemployed. Something along the lines of a WPA would probably be less unpalatable to Republicans, if there are any left, than a straight dole. The result is the same: someone who is working has to pay, in straight taxes or in more inflation, for those not working.

And guess what—thanks to the dislocation caused by taxation, and the inevitable bureaucratic leakage, national demand will drop even further, which will accelerate that particular cycle yet more.

In addition, some of the taxes will come, directly or indirectly, from producers, meaning another increased cost, meaning—you're getting ahead of me.


Let's change the subject for a moment. In fact, let's have another economics lesson, this time about banks. You probably always thought that a bank was basically a place where money is kept. Wrong again.

If that was really what a bank was, then everyone who has money in a bank ought to be able to go, everybody all at once, and get all his money out. But it doesn't work that way. Oh, no. There's nowhere near enough money in any bank. Thanks to a special dispensation of the State, a modern bank is only required to keep a small fraction of deposits on hand. This sleight of hand is called the fractional reserve system by most; really, it's fraud.

The purpose of the fraud is clear: to give bankers and their friends more money, and effectively free money at that, to play around with. The appeal of that is obvious. What is not so obvious is why anyone not a banker should put up with it. The answer is that the rest of us are assured that no bank will run out of money, at least up to a certain limit, thanks to the creative powers of the Federal Deposit Insurance Corporation. Those powers can be summed up in two words: printing press. The FDIC does not itself have a stash of money to pass out to member banks in trouble. It simply puts in an order at the Mint.


In ordinary times, when there is no drag on banks, that makes no difference. The FDIC does have a small stash, and a little overtime at the presses doesn't make much difference in the regular flood. However, when a lot of folks are thrown out of work and have to begin drawing on their bank accounts to keep nose above water, things change. It is not impossible that a bank would run out of liquid reserves.

At that point, the bank has two possible courses, and it might well take both. It can appeal to the FDIC. It can call in outstanding loans.

These loans in general go to two classes: individuals and businesses. Individuals, in this scenario, are becoming unemployed, that is, unable to pay debts. Businesses take out loans in expectation of increasing revenue (that, of course, is why banks offer loans). When a business finds itself forbidden to raise prices, and, according to our scenario, facing declining sales, it may well find it difficult to pay back loans. Thus, banks will find their reserves shallower than they might have expected, and the FDIC will get more calls, passed on immediately to the master of the presses.

Before we continue with the descent down the spiral, another digression, back into inflation. The wages and prices that have been frozen are money wages and prices, not real ones. If a loaf of bread went for 30 cents during July and August, then it will go for 30 cents until hell unfreezes, regardless of how much "money" is around. If the amount of "money" doubles, that effectively halves the value of each unit. For buyers, this is a (temporary) bonanza: the 30-cent loaf sells for 15 "real" cents. On the other hand, for the seller, this is not such a good thing. He has to take 15 cents instead of 30.

It may be objected that the seller after all can replenish his stock using new money, so he doesn't lose. However, when the value of "money" changes, economic calculation gets tough. Does one keep an inventory by old prices or new? If there is a freeze, how long does he plan on the freeze's continuing before economic reality catches up? If there is no freeze, how does he forecast the rate of inflation?

The chances are good that, because of this indecision, a business might well hedge on inventory.*** Whether or not there's a freeze, there's a good chance prices won't keep up with the actual inflation (still because of the uncertainty). Demand, in short, will outstrip supply, with the usual consequence: prices rise. The trouble is that money prices are held back, by inertia or the freeze, and so would-be customers must find some device besides money to satisfy their demand before the supply runs out. When there is rationing or a freeze, this activity outside the formal price mechanism is called the black market. The more effective the controls, the more active the black market: have you tried to get a "rent-controlled" apartment in New York City recently? (For that matter, a queue is simply another find of price: time is money. Those willing to wait in line outbid the others.)

Back to the main story. So far we have rampaging unemployment, plummeting sales, raging inflation, collapsing banking, and epidemic "criminality" in the black market. There is more.


After a while, those who are still employed will get downright paranoid about their future. Unless Labor loses its political touch, there will be a great demand for some kind of job guarantee or firing freeze or whatever euphemism may be called on. (Many a union strike has been called for exactly this kind of motive, after all.)

What happens to the employer then? He cannot raise the prices on what he sells. His suppliers will be unlikely to lower their prices to him. He will no longer be able to reduce labor costs by laying off people. Sales and revenue will be dropping. Taxes will be climbing. Bank loans will be unavailable. Economic calculation will be fantastic. Some employers must go out of business.

This, of course, increases unemployment and reduces bank resources (assuming any loans outstanding). It also further reduces supply, putting even more pressure on buyers to enter the black market.

The consequences of widespread bankruptcies will be so evidently unpleasant that the public will demand the only reasonable thing: not, don't be silly, a move towards a free market, but a bankruptcy freeze. Employers will be required to stay in business. The possibilities for bureaucratic empire-building this would make possible, as exceptions are auctioned off, boggles the mind. Those employers who can manage it, or those who are afraid to buck the system, will stick it out as well as they can, scrambling for any subsidies available. Those who can't will head for Galt's Gulch. They'll make themselves hard to find.

In the meantime, there is the foreign market to consider. The import duty and the devaluation will to some extent offset each other. However, once the spiral begins, all the factors which make economic calculation and transaction difficult domestically will operate at least as strongly internationally. Furthermore, monetary systems parasitical on the dollar will collapse, compounding the difficulty. Americans will realize how much of what they buy—not just Italian shoes on their feet and German cars on their streets, but Japanese nails in their houses and Indonesian spices in their food—is imported, and they will realize how much that well provided only when it has gone dry.

All through the process, as I have indicated, there will be bureaucratic fortunes to be amassed by the creation of exceptions, subsidies, doles, and priorities. Whether those fortunes are monetary or political is irrelevant: what is this process but the ultimate politicization of economics?

That's the vision. Uncomfortable. Logical. Why isn't it coming true?

In the first place, who knows it isn't coming true? Maybe these things just take longer than I thought, and even as you read this the termite tunnels are beginning to intersect beneath your floor. The descent could start with the gradual accumulation of countless small inconveniences, or things could struggle along until one spectacular collapse (how about, say, Lockheed?) dominos the rest.

In the second place, remember that all of this follows from the premise of subjective valuation. If things are worth only what people say they are, then what's to keep people from floating the whole apparatus on an elaborate, phantasmagorical, but universally-held wish? If we all tell ourselves that every day in every way we are at least getting no worse, then are we not saving ourselves by the simple act of believing in our salvation? Is there anything economically wrong with a society held together by a delusion?


Theoretically, formally, perhaps not. But economics is in the end only the study of how valuations interact: it is the study of manipulation; it is not the things manipulated. Delusions will not provide protein or even calories. If only a few people, for whatever reason, cease to participate in the great communal huffing and puffing that holds this balloon aloft, we will look up one morning and find the whole affair settling in great suffocating billows over us. It can only happen later if it does not happen sooner.

I have laid this argument out and looked it over, over, over. Where is the way out? What link can be broken? I have found none. I readily admit that the argument is a hybrid, half economic half sociological. It is not, for example, proper to a strictly economic argument to posit that the citizenry will not rise up in wrath to smite their oppressors, that they will instead fawn or huzzah according to their temperament. It is not an economic truth that when the 90 days are over and the State surveys the rubble, it will say not, "We goofed," but, "More!" I am not persuaded that my misestimate of American gullibility's being unduly low calls into question any other hunches. I am certainly not persuaded that it is grounds for concluding that my subsequent hunches overestimated American sense.

What can we do about it? I wish I knew.

Some things I have done: buy some rations and ammunition, keep the car gassed up and repaired, plan a route. If there is a sudden collapse, there will be no time to start preparing. (See the movie NO BLADE OF GRASS.) Don't extend yourself financially. Be ready to drop everything and get down to the bank (and keep no money where the institution can make you wait to withdraw). Get employed, if you can, and save fervently.

But as for advice on how to evade the freeze, what commodities to buy (gold? food?), all that—I have none. Does anyone?

*The labor theory of value, for example, stands only so long as one overlooks the clear difference in "value" of different kinds and degrees of labor.

**It is not implausible that "unfair price" might mean something in an emergency—but not from the causer of the emergency.

***Laborers are especially trapped. A worker can not very well raise or lower his inventory of labor. In the aggregate the supply of labor changes, but for the individual it's pretty much fixed—and he can't very easily even keep it off the market temporarily. A fallow worker starves.