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Inflation’s Moral Hazard

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Inflation’s Moral Hazard

An age of loose money not only destroys savings; it corrodes character. Summer 2009
Economy, finance, and budgets
Runaway inflation in Germany, which turned money into wallpaper, undermined the Weimar Republic and led to Hitler's rise.
Hulton Archive/Getty Images
Runaway inflation in Germany, which turned money into wallpaper, undermined the Weimar Republic and led to Hitler’s rise.

Information from the most diverse sources sometimes coalesces and provokes reflection on a subject to which one has not previously given sufficient thought. This happened to me recently with regard to the effect of monetary inflation on human character. With many observers predicting a substantial rise in inflation as a result of various government spending programs undertaken to reverse the current global downturn, the topic is anything but academic.

I was reading The Innocence of Edith Thompson, by Lewis Broad, a book about a notorious murder in 1920s London. Freddy Bywaters was a handsome young sailor, Edith Thompson an unsatisfactorily married woman. They had a torrid love affair, and Bywaters eventually stabbed Thompson’s husband to death as he walked home one evening from the theater with his wife. Thompson’s love letters to Bywaters, prosecutors claimed, were an incitement to murder—such an incitement that they rendered her a murderess herself. She was found guilty of the deed and hanged. Broad’s book—written in 1952, 31 years after the event—happens to mention Thompson’s comparative prosperity. She managed a millinery shop and earned enough to put her in the middle class: “six pounds per week,” as the author puts it, “or twelve pounds in our debased currency.” A doubling of prices in three decades called a debasement of the currency? What would Broad have written if he knew what was to come in the years ahead?

Then I began reading Ursa Major, a study of Doctor Johnson by C. E. Vulliamy. It was hostile to the great man; but from the point of view of inflation, what was interesting was Johnson’s pension from the crown. Worth 300 pounds per year when granted in 1762, Vulliamy informs us, it would have been worth 800 pounds at the time of Ursa Major’s publication in 1946.

But that 800 pounds, according to Broad’s book, would have been worth only 400 pounds as recently as 1921. If we put these two stories together, it means that 300 pounds in 1762 was the equivalent of 400 pounds in 1921; or, in other words, that in a century and a half, prices rose in Britain by about 33 percent, an overall rate so slow as to have been almost imperceptible year to year, even decade to decade. Such stability must have seemed more a fact of nature than a consequence of human behavior or policy, and therefore something that would last forever.

Of course, calculations of prices between different historical epochs can be inexact, if only because some things available to later ages were not available to earlier ones. What was the price of a chocolate bar in 1762? We can never know: bars of chocolate did not exist then.

Nevertheless, I can attest to a prolonged era of price stability from evidence in my own lifetime. When I was born, it cost one and a half times as much to send a letter as it did 100 years earlier. In my childhood, during the fifties, we still used the same coins, with the same denominations, that people had used during the Victorian era. The silver coins were still made of silver, not a worthless silvery metal. Occasionally, we would even come across pre-Victorian coins. Their continued use was not absurd: though prices had risen, they still bore some resemblance to what they had been in the earlier time. When my grandmother gave me a florin—one-tenth of a pound—I felt rich. It was enough, in any case, to buy a paperback book; between 50 and 60 times as much would be required now.

I also remember the vast white five-pound notes, as grandiose and almost as large as professional diplomas or nineteenth-century share certificates, that my father kept in a roll in his pocket, only 100 or 200 of which would have been needed in those days to buy a decent house. And it was still possible for a boy like me to buy something—albeit only a stick of gum—with the smallest coin of the realm, a farthing, worth one-960th of a pound. That something could be sold for such a tiny fraction of money might seem a sign of general poverty. But though the Britain of my youth lagged economically, it was far from poor.

The regime of relative price stability soon collapsed. During the sixties and seventies, the sums of money of which everyone spoke increased, first by a little and then by a lot (and how nonchalantly we now speak of trillions of dollars or euros!). All that had seemed solid, to paraphrase Marx, melted into air.

At the time, I gave no thought to the effects of this inflation, which tended to be discussed in purely economic terms—experts would ask, say, whether inflation was compatible with satisfactory economic growth. In a naive way, I assumed that since most people’s income tended to rise with inflation, there was nothing to worry about. I did not suffer personally because of it, nor did most of the people I knew. If a product once cost y and now cost 10y, what did it matter, so long as your income had gone up by ten times, too? Since people seemed better off, at least measured by what they could consume, one could even assume that incomes had risen faster than inflation.

Yet this was a crude way of looking at things, as my father’s fate should have instructed me. He sold his business in the sixties, at the end of the period of price stability that had reigned throughout his life, for what then seemed a large amount of money. He was a man who, for both temperamental and ideological reasons, held a deep contempt for financial speculation and wheeling and dealing, with the result that he did nothing as inflation inexorably eroded his savings. He grew poorer and poorer through the remaining 30 years of his life, and might have sunk into poverty had he not moved into a house that I owned. And this after reaching a level of wealth that, relatively speaking, was greater than I shall probably ever know.

For a while, I was angry about what seemed my father’s improvidence and lack of foresight. As the current financial crisis has conclusively demonstrated, however, not everyone is blessed with foresight, not even those whose livelihood depends primarily on the claim of possessing it. My father was born of a generation that saw money as a store of value, a far from dishonorable notion—and one that, when it reflected reality, helped give a lot of people peace of mind. And as I reach the age when inflation might cause me some embarrassment, even hardship, my sympathy with my father’s plight has grown. I am no longer young enough to fight another day, economically speaking: the destruction of my wealth by inflation would be final. In an aging population, more and more people are in my position, which helps explain why an age of prosperity can be an age of anxiety, even without a financial crisis.

Like my father, I am not particularly avaricious; on the other hand, I have no vocation for poverty and share the prejudice of most of mankind that a loss of capital and a sharp decline of income are much to be feared. In an era of price stability, a man of my disposition could judge with a degree of certainty how much money he would need for each year of his retirement. The calculation of how much principal he would require now, in order to yield that amount of money in interest each year in the future, was relatively simple and would yield financial tranquillity.

That kind of tranquillity about one’s financial future is more difficult for most of us to achieve now. President Reagan and Prime Minister Thatcher brought raging inflation under control in the U.S. and Britain during the eighties—at the cost of great short-term economic pain and considerable political and social strain—but they could not reverse the public’s loss of confidence in money as a store of value. People must today try to foresee not only how long they will live but also what is even less predictable: the reigning economic conditions of the next 40 years, assuming this to be the upper limit of their retirement period. And this, to quote Doctor Johnson in another context, “requires faculties which it has not pleased our Creator to give us.”

There seems to be no choice, then, but for everyone to have constant regard to his own pile, and to try to outwit the economic moth and rust that threaten to erode all but the largest fortunes: in short, he must speculate, or risk losing nearly everything. The question of whether it is best to hold shares, or bonds, or property, or gold, or some combination of them, is constantly before him. Further, as many who have taken tips from their brokers or bank will attest, funds’ managers and investors do not always have the same interests. A man trying to preserve a competence learns to trust neither himself nor others.

Inflation has overturned centuries of economic wisdom, or at least prejudice. When Polonius conferred his parting platitudes on Laertes, one was to “neither a lender nor a borrower be,” and this because a “loan oft loses both itself and friend.” A quarter of a millennium later, Mr. Micawber famously asserted that the secret of happiness was to live within one’s means; and while credit is obviously essential for economic growth, an intuitive difference exists between borrowing to consume beyond one’s means and borrowing to increase one’s means.

Inflation has blurred that intuitive difference. Many times I have received advice, from friends and banks, to borrow as much as I could so that I might buy the best and most expensive house possible. And for many years it seemed good advice, for what could be more advantageous than to buy an appreciating asset with depreciating currency, especially when my income was likely to appreciate faster than the currency depreciated? It was a painless way to become rich.

I did not take the advice—not entirely, anyway. I remained sufficiently a child of the regime of constant prices that I found it difficult to imagine how a sum that seemed vast now would seem trifling in just a few years: caution seemed wiser. Even so, I borrowed within what I thought to be my means, and thereby accumulated assets of a value that I could not have obtained by the steady buildup of savings. The curious result has been that at no point in my career could I have afforded to buy the real estate that I now own, whose value—even now, after a precipitate post-financial-crisis decline—greatly exceeds my cumulative income over the years. If my borrowing had been bolder, the value would exceed my earnings even more.

My situation is no different from that of millions of others, of course. And since we are all richer than we should otherwise be, is there anything, really, to complain about? The problem is that this “richer” represents a curious kind of wealth. I must live somewhere, after all, and everywhere else has appreciated in value, too. I don’t live any better in my house than I did before simply because it is worth three times what I paid for it. Its increase in value is thus of no use to me, unless I want to sell it to live in a less valuable house and invest the difference. An increase in the value of one’s house is therefore a bit like fool’s gold.

But for many years, people—in Britain, especially—have treated rising property values as if they were the real thing, and the government has supported this belief by allowing extremely easy credit. My bank gave me some good examples not long before the crunch.

I still remember the letter that the bank sent me when I was a student, pointing out with considerable asperity that I was almost three pounds overdrawn and asking when I would correct this serious irregularity. Nearly 40 years later, I briefly overdrew my account again—this time by much more—and wrote to the bank, explaining that I would clear the balance in a few days. Unusually, the bank called me: a banker wanted to see me, and would like to come to my house. I made an appointment and expected him with some trepidation.

When he arrived, I repeated that I would pay off the overdraft, and more, in less than a week’s time. “Oh, we don’t want you to do that,” he said. “I’ve come here to ask whether you want to borrow more money.”

“What for?”

“Well, a nice new car, or perhaps the holiday you’ve always dreamed of.”

I was astonished. The bank was encouraging me to indebt myself for an asset whose value would swiftly melt away—or for one of no resale value whatsoever. After rejecting this offer, I soon found myself receiving others—of large loans that would be advanced to me, as if by right, by a simple telephone call. Apart from home improvements, whose enduring monetary value would depend on the state of the property market, all the suggested uses to which I might want to put the lent money were for consumption in the here and now. It all suggested a giant pyramid scheme.

Some time later, I was thinking about buying another house, for which I would need a short-term loan. Passing my bank, and having a few minutes to spare, I entered and inquired about how I would arrange such a loan. Within five minutes, the bank had offered me a sum that was 20 percent larger than the single asset that it had evidence that I owned (another house)—whose value, in any case, was subject to fluctuation, including downward. I came away feeling that the bank was careless to the point of frivolity; it was treating money as if it were playing Monopoly, not exercising due diligence on behalf of its shareholders and depositors. Sure enough, the bank was nationalized two years later, in 2009, and its 3 million shareholders, who had enjoyed several fat years before the collapse, wound up virtually expropriated.

During those fat years, a man could sit at home watching television and imagine that he was growing richer thereby. I remember an eminent professor’s telling me, with a barely concealed exultation, that he was making nearly $1,000 per day, week after week, merely by owning a very large house in a fashionable area: an amount that, needless to say, dwarfed any savings he might salt away from his salary. The government could not have been better pleased, for the majority of the population, who owned their own homes, felt prosperous as never before and attributed their affluence to the government’s wise economic guidance.




Inflation is not a bogey for everyone—not for those who wish to restructure society, for example, or for those who want government control of ever more aspects of people’s lives. But for the rest of us, the consequences of its full-blown return are not likely to be good: for inflation is not an economic problem only, or even mainly, but one that afflicts the human soul.

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