The Cost of Depreciating Money

By a continuing process of inflation, govern­ments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

In Germany before the first World War, 40 billion marks of mortgage loans were outstanding —calculated to represent about one-sixth of the German national wealth. By 1923, when the mark had depreciated to a point where it took 42 billion of them to equal one U.S. cent, these loans were prac­tically worthless. In a word, infla­tion gave away to debtors the wealth of creditors. It destroyed the provident middle classes, wiped out the pool of loanable funds, and erased every sensible reason for saving — for laying aside any por­tion of income for lending at in­terest. Speculators in commodities, land, and foreign currencies of­fered fantastic rates of interest for borrowed funds, but little was forthcoming. People, to beat rising prices, spent their money as fast as it came in. They had to, for sur­vival. Thus the paradox that the more money the government printed the scarcer it became for would-be borrowers.

The German experience with ex­plosive inflation during and after World War I is not unique. It was repeated in a number of countries in World War II.

Since World War II, slow-burn­ing inflation has been the order of the day, afflicting almost the entire world. This is due mainly to politi­cal pressures to sustain full employment at constantly rising wage levels. One hears more and more competent observers projecting this drift indefinitely into the future, warning that "we are in a long-term cycle of inflation" or that "we shall experience a ris­ing price level for the rest of our lives." There may be interruptions, we are told, and the average rate of rise in prices will be modest —possibly no more than two or three per cent a year.

Two or three per cent a year, on the average, has seemed quite harmless to many political leaders and economists. It does not seem harmless to savers trying to accumulate resources for retirement, education of their children, and family emergencies. They have been alerted to their perils by not­ing how their past savings have depreciated in real value and by the many predictions that the fu­ture will hold more of the same. They want better returns, and gov­ernments, with greater or less re­luctance, have submitted to their demands and let interest rates rise, recognizing that a nation that sys­tematically steals away the citi­zens’ savings is inviting an uncon­trollable holocaust of inflation.

The Point of No Return

Progressive inflation has been a world-wide phenomenon, as the following table suggests. The table shows for 16 countries the depre­ciation of money since 1946 as measured by official cost of living indexes. If the depreciation is con­verted to an annual rate, compounded, as the third column of the table shows, the saver has a measure of his point of no return — the annual rate of interest which he would have had to receive, and reinvest at compound interest, to have the same amount of purchas­ing power now as he had in 1946.

Rates Of Interest And Depreciation Of Money

Note: depreciation computed from unrounded data. n.a. not available. *measured by rise in official cost of living or consumers’ price index. ++latest month available. +except for mortgage bond yield in Germany , commercial paper in Venezuela and Mexico , and commercial bank loan rate in Brazil and Chile . §1947. 1948.

Rates of interest available in 1946 were artificially depressed by "cheap money" policies in most countries, and did not give the saver compensation for the depreciation in store for him. Switzer­land, which offered 3.1 per cent on government bonds, was an excep­tion, and the fact that the conserv­ative investor in Switzerland has on the whole been better treated than elsewhere has something to do with the fact that interest rates in Switzerland today are the low­est in the world.

In most countries, the saver of ten years ago has suffered serious losses in purchasing power; rather more than the table would indicate since interest income is often sub­ject to taxation that waters down the rate and retards the working of compound interest. In the United States, for example, as­sume a capital sum invested ten years ago at 3.4 per cent, with all interest reinvested at the same rate. This sum would have grown enough in nominal value to keep up with the average rate of depre­ciation of the dollar only if the in­terest were free of income tax. A person in the 20 per cent income tax bracket would have required a taxable interest rate of 4.3 per cent; in a 40 per cent bracket 5.7 percent; in an 80 per cent bracket 17 per cent. And all this simply to hold even with the depreciation of the dollar and avoid actual loss.

A Sorry Chapter

This has been a sorry chapter for the lender of money at inter­est. Today’s higher rates help, but they will still leave the saver fall­ing behind in the race unless the price record of the next ten years is better than it has been over the past ten. Of this there is promise, for the rise in interest rates itself is a reflection of a greater sense of discretion by government central banks and treasuries in creating money. Politicians who want lower interest rates must get them the hard way — by curtailing govern­ment expenditures and income tax rates, stopping the upward price drift, and letting the loan capital of the people grow.

From the Monthly Letter of the First National City Bank of New York, De­cember 1956.