A testing time for monetarism
From Professor F. A. Hayek, FBA
Sir, The question which Professor Pearce (June 5) raises is at the same time so important and so complex that it is hardly possible even to sketch an adequate answer within the same frame. I am still convinced that, as far as economic causation is concerned, the value of money is wholly determined by the magnitude of the supply of money in relation to the demand for holding it. In this sense I agree with Professor Milton Friedman that there is no such thing as a cost-push inflation. But politically it is unfortunately true that by pushing up wages the trade unions can make it "politically necessary" to increase the quantity of money, ie, create a condition in which government believes it must do so.
For this reason I am even convinced that trade union reform must precede monetary reform. It is this which makes the former so exceedingly urgent and is the chief reason why in both fields gradualism cannot help. If. as I believe to be true, with the present power of the trade unions no government that has the power over the supply of money can politically resist the pressure for more money, the urgently needed termination of inflation cannot succeed before the power of the trade unions is curbed. But time is becoming short and it will soon be necessary to proceed on a timetable if the necessary operation is to be completed.
The theoretician must always, and particularly if he lives abroad, hesitate to give advice on what must be a political decision. But if this Government, within its limited life, is to achieve the salvation of Britain, a radical procedure will soon be essential. As I see it, within the time available what is required can be achieved only if the Government, in the near future, obtains through a referendum popular instruction at once to rescind all the special privileges which have been granted to the trade unions by law, and is then ready immediately afterwards to terminate inflation instantly. Only this can make it possible for the beneficial effects of such a policy to manifest itself some time before the term of the present Government runs out.
From the technical point of view there is no serious difficulty about stopping inflation. As the former chairman of the Federal Reserve Board, Arthur Burns, has recently confirmed in a much noticed lecture, the monetary authority can always stop inflation "with little delay ". The difficulties are not economic but political and especially problems of government finance. Ending inflation demands that. government is deprived of the recourse to the printing press for financing its expenditure. Government must balance its budget and I admit that it is not humanly possible to do so overnight.
The central problem thus becomes how government can be offered a period up to two years or so during which it can reduce its expenditure so that it will be covered by revenue. But all borrowing in sterling at present would be likely to cause further inflation and impose an unbearable burden.
The only escape I can see is that government obtain the funds which will give it a period during which it can balance its budget by issuing a, chiefly internal, loan in terms of an indexed unit called, say, "solids". Large amounts could probably be raised cheaply, at perhaps three or even 2.5 per cent, if a public which no longer knows what to do with its savings were offered such an opportunity. It seems to me that the British Government, perhaps undeservedly, enjoys in the world still a reputation for honesty which may make a first experiment of this sort a great success. The "solids", in terms of which the loan would be issued would have to be defined as, and be redeemable with, so much of a bundle of other currencies as would at the time be required to buy on the world market a "basket" of a wide range of standard internationally traded raw materials in precisely stated quantitative combinations. Ultimately this unit might become, if necessary, the basis of a new British currency.
Slowness of procedure might at the time destroy all chances. If the present rightly directed efforts fail because of delay. it may be the loss of the last chance of a British recovery for generations. It is not too late yet, but it may be soon.
Yours faithfully,
F. A. HAYEK.
Urachstrasse 27, D-7800 Freiburg (Breisgau), Federal Republic of Germany.
June 7