Friday, January 7, 2011

War and Inflation

An interesting article (via Manan Shukla) on the relationship between war and inflation. Simple economic analysis shows that prices should rise during warfare because government spending on war consumes resources that would otherwise be available to produce products for private consumption. The result is that private spending must decline in response to increased government spending or prices will rise to ration private demand. During WW 11 much of our private production was turned over to military production. We stopped building autos, for example, and we built tanks and engines for military aircraft. The government was forced to ration supplies such as gasoline which was need for warfare and it invoked price controls to fight off inflation. Consumers paid for WW 11 by the rationing of consumer products. They also paid for the war directly by purchasing saving bonds to finance military spending and by paying very high taxes on income.

Since WW 11 government has found ways to pay for warfare without rationing consumer production, and without raising taxes. Rationing and high taxes make the cost of warfare apparent and citizens are unwilling to pay the price for warfare unless they perceive a powerful threat to their safety. The Iraq war was financed with debt instead of taxes so it was relatively painless from a financial standpoint. Moreover, government demand for resources to expand military production did not require a reduction in consumption since we could import manufactured products to support consumption. The result is that two of the major constraints on a state that wants to conduct warfare were eliminated. The Vietnam war was also financed with debt instead of taxes and government spending on social programs was expanded by Johnson's "Great Society" programs. The result was inflation which became apparent in the Nixon administration which led him invoke wage and price controls.

The Vietnam war also taught our politicians another lesson. The use of the draft to expand military operations led to resistance, especially among college students who were subject to the draft. The media also did a good job of reporting on the war and popular support for the war eroded as the war progressed. The elimination of the draft and cheerleading for the war in the media, especially among cable networks like Fox, has diminished the last remaining impediments to the military state. The recession has tamed inflation, but since the war has been funded with debt, it will rear its ugly head when we return to a full-employment economy. We are already seeing some signals for price inflation during our downturn. The producer price index (PPI) for finished goods is up at an annual rate of 5.5%; the PPI for intermediate goods is up 8.8% and the PPI for raw materials is up 60%.

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