Inflation and High ‘Costs’

March 31, 1952

From Sept. 3 to Oct. 1 last year there appeared in this space a series of articles called “Inflation for Beginners” which have since been made available to Newsweek readers in the form of a pamphlet. These articles sought to explain how and why: “Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit.”

There was nothing peculiar or particularly original about my explanation. It corresponded closely, in fact, with “orthodox” doctrine. It is supported overwhelmingly by theory, experience, and statistics. It may be pointed out once again, for example, that the doubling of retail prices since 1939 has been primarily caused by the increase in the supply of money and credit (currency plus bank deposits) from less than $65,000,000,000 at the end of 1939 to $188,000,000,000 today.

But this simple explanation still meets with considerable resistance. The Truman Administration denies or ignores it, because it places responsibility for inflation squarely on its own doorstep. Few of the academic economists are helpful. Most of them are attributing present inflation to a complicated and disparate assortment of factors and “pressures.” Labor leaders vaguely attribute inflation to the “greed” or “exorbitant profits” of manufacturers. And most businessmen have been similarly eager to pass the buck. The retailer throws the blame for higher prices on the exactions of the wholesaler, the wholesaler on the manufacturer, and the manufacturer on the raw-material supplier and on labor costs.

This last view is still widespread. Few manufacturers are students of money and banking; the total supply of currency and bank deposits is something that seems highly abstract to most of them and remote from their immediate experience. As one of them writes to me: “The thing that increases prices is costs.”

What he does not seem to realize is that a “cost” is simply another name for price. One of the consequences of the division of labor is that everybody’s price is somebody else’s cost, and vice versa. The price of pig iron is the steelmaker’s cost. The steelmaker’s price is the automobile manufacturer’s cost. The automobile manufacturer’s price is the doctor’s or the taxicab-operating company’s cost. And so on. Nearly all costs, it is true, ultimately resolve themselves into salaries or wages. But weekly salaries or hourly wages are the “price” that most of us get for our services.

Now inflation, which is an increase in the supply of money, lowers the value of the monetary unit. This is another way of saying that it raises both prices and “costs,” And “costs” do not necessarily go up sooner than prices do. Ham may go up before hogs, and hogs before corn. It is a mistake to conclude, with the old Ricardian economists, that prices are determined by costs of production. It would be just as true to say that costs of production are determined by prices. What hog raisers can afford to bid for corn, for example, depends on the price they are getting for hogs.

In the short run, both prices and costs are determined by the relationships of supply and demand—including, of course, the supply of money as well as goods. It is true that in the long run there is a constant tendency for prices to equal marginal costs of production. this is because, though what a thing has cost cannot determine its price, what it now costs or is expected to cost will determine how much of it, if any, will be made.

If these relationships were better understood, fewer editorial writers would attribute inflation to the so called “wage-price spiral.” In itself, a wage boost (above the “equilibrium” level) does not lead to inflation but to unemployment. The wage boost can, of course (and under present political pressures usually does), lead to more inflation indirectly by leading to an increase in the money supply to make the wage boost payable. But it is the increase in the money supply that causes the inflation. Not until we clearly recognize this will we know how to bring inflation to a halt.