Peterson's u2018Law': An Economist's Foray Into the Nature of Money and the Declining Value Thereof


Originally published in Challenge, November 1959

Textbooks on economics usually define money in terms of four functions: medium of exchange, unit of account, store of value, and standard for credit transactions. Now, because of an economic law to be presented to the public for the first time, such a definition must be dismissed as ivory tower thinking — in the same vein as the business cycle theory that the raising and lowering of ladies’ hemlines govern increases and decreases in economic activity.

What textbooks ought to say is: money is a medium of exchange if used in increasing amounts, a diminishing unit of account, a shrinking store of value and a declining standard for credit transactions. This definition is much the superior, for it ties money and inflation together, organically, as it were, and realistically, as it is. Money is, after all, what money does.

Yet, most textbook writers treat inflation, if they treat it at all, as an afterthought in a separate chapter or perhaps in an appendix. To them it is a special condition, a phenomenon of the times, something which if condemned roundly and often enough will pass on and leave us be.

Perhaps the textbook writers have not been doing their history lesson as they should; or maybe they believe this is a dawn of a new day and human nature can be changed, and so-called “monetary stability” can be achieved. But history bespeaks of no such millennium in human affairs. History tells us money, i.e. the monetary unit, in the long run, must increasingly be worth less, buy less, store less, and beget less credit.

Regardless of what finance ministers, central bankers and heads of state may say to the contrary, prices and the public debt will rise. Moreover, experience shows that the currency gymnastics of multiplication (more money) and division (less value) accelerate in direct proportion to the agitation against inflation, which in turn increases in direct proportion to the size of the public debt.

The new scientific law at hand should prove of inestimable value in monetary and fiscal management, corporate accounting, and economic calculation in general. With some deference to Sir Thomas Gresham (Gresham’s Law: bad money drives good money out of circulation) and Prof. C. Northcote Parkinson (Parkinson’s Law: bureaucracy tends to expand), this law is hereby launched, however immodestly, as Peterson’s Law. To restate the law:

History shows that money will multiply in volume and divide in value over the long run. Or expressed differently, the purchasing power of currency will vary inversely with the magnitude of the public debt.

The reason for the law is quite simple. Wealth is money, it is reasoned; so multiply money and, presto, you multiply wealth. This reasoning is most likely to manifest itself when complaints about a “shortage” of money — or of liquidity, to use the presently more sophisticated term — persists, and when national debts are at high levels. Peterson’s law, then, has its roots in psychology, ergo, in human nature.

Empirical proof of the law is abundant. Take any currency of any era in the ancient, medieval and modern worlds, regardless of the political economy involved, and observe the inexorable monetary multiplication of volume and division of value over the years. Note, too, that the higher the public debt, the louder the condemnation of the process, the more persistently do price levels rise.

Examine the case of the English penny, originally struck of sterling silver. From 1275 to 1816, the weight of this coin dropped from 22 grains troy to 7.27 grains. Lest the reader suspect that silver is so inherently constricted in supply that its price would naturally rise with population growth, it should be noted that the London price of gold, from 1250 to 1950, rose from 17 shillings per fine ounce to 250 shillings per fine ounce.

Or look at the modern French franc. Between World War I and World War II it lost approximately 90 per cent of its value, and between World War II and the present it lost another 90 per cent. (That is 10 per cent figured one way but 99 per cent figured another.)

Devaluations multiply not only currency but ciphers as well, which strain human calculations (e.g., 6,500 francs for a double room and bath at a good Parisian hotel; 14,000 francs for a night on the town). To ease the problem of astronomical arithmetic, the French government has thoughtfully issued a currency edict that, effective January 1, 1960, the last two zeros will be dropped from the stated value of all paper money in France, so the 100-franc note officially becomes — voil — a “heavy” one-franc note, although it had been that in effect for quite some time.

Eroded by time

By now you may be getting the idea that public debts were made to be increased and currencies made to be devalued, and this is precisely the point of the law at hand. Consider: Originally the pound, lira and peso referred to certain monetary weights; now all have been eroded by time, their original meanings lost in the dustbin of history.

Of course, there are some sustained periods of history when remarkable currency stability existed — for example, the French franc stayed put for 100 years, from 1814 to 1914; the Dutch guilder did almost as well, surviving from 1816 to 1914; and the pound sterling persisted undisturbed from 1821 to 1914.

Such phenomena of currency stability are not to be construed as a flouting of Peterson’s law. The 19th century was the century of the gold standard and witnessed little public debt and, therefore, precious little agitation and practically no countermeasures against inflation. Besides, the franc, guilder and pound eventually did come to a sorry pass. Peterson’s law held all right.

Lost time made up

Moreover, since World War I and especially since World War II, monetary multiplication and division have made up for lost time. Dr. Franz Pick, the New York currency authority, finds that but 14 years after the end of World War II, only seven of the 85 currency units of the world have lasted more than 20 years without a legal devaluation. The average age of all currencies is a little more than seven years. The year 1957, for example, saw the official multiplication and division of the U.S.S.R. ruble, the Polish zloty, the Spanish peseta and the Ghana pound; in 1958 the East German mark, the Egyptian pound, the Chilean peso, the New Taiwan dollar and, or course, that hardy perennial, the French franc (now happily hardening under the fiscal sanity of De Gaulle). These, bear in mind, are the occasional de jure devaluations; the de facto devaluations go on continuously.

This, then, is an age of inflation. But what age wasn’t? What age hasn’t witnessed its currencies clipped on the Procrustean bed of Peterson’s law? What is interesting about the moment of this age is the din of agitation and talk of countermeasures against inflation in the land of that supposed Gibraltar of currencies — the U.S. dollar. The din bodes of ill for the monetary status quo.

Consider the Niagara of papers, pamphlets, books, public addresses, and newspaper and magazine articles and editorials on the subject of inflation-inflation-inflation, reiterated and reiterated until one’s head begins to swim. Too, rarely has inflation been called by so many different names. But would not inflation under any other name be just as thorny?

Flight from the dollar

Meanwhile, with the deficit for the 1959 federal budget at roughly $12 billion, the flight from the U.S. dollar is on. Gold outflow is at a record level since World War II — $2.2 billion during 1958, with $492,200,000 more through June 30, 1959. In 1958, for the first time in history, Congress twice raised the statutory debt limit in one year. Still another raise was requested and granted in 1959. Increasingly the Treasury finds the public too wary to buy government long-term securities and is thus predisposed to dispose of them at the commercial banks, which Chairman William McChesney Martin of the Federal Reserve Board declares to be “the high road of monetary inflation.”

Hedging against inflation is rampant. Workers and unions secure escalator clauses. Dow-Jones stock averages have hit new records. Farm acreage commands the richest prices in history. Some knowing buyers hedge with rare books and French Impressionist paintings. Saving atrophies, and the stock market and race track hustle, which probably account for Treasury Secretary Anderson’s statement earlier this year, “If we ever reach the point where people believe that to speculate is safe but to save is to gamble, then we are indeed in trouble.” A Toronto investment firm offers to hold gold bars for Americans as an inflation hedge (possession of gold, except in teeth, jewelry, etc., is illegal in the U.S.). Inflation has even hit crime. The Michigan legislature has raised from $50 to $100 the amount of money you must steal to commit a felony rather than a misdemeanor in that state.

Learned investigations and conferences on inflation mushroom, and money is being studied as never before (presaging greater monetary multiplication and division, you may be sure).

It is the Temporary National Economic Committee of the late 1930s all over again, and then some. Mountains of hearings, papers, findings and reports roll from the presses. Labor blames management. Management blames labor. Democrats blame Republicans. Republicans blame Democrats. The people blame government. Government blames the people.

How investigations churn! Public tears are shed for inflation’s “innocent victims.” But as the late Prof. Sumner Slichter of Harvard, a student of inflation, noted in a Japanese publication, the Nihon Keizai Shimbun of Tokyo:

Conspicuous by its absence is any protest against creeping inflation by the alleged victims. The people who are supposed to suffer from creeping inflation do not indulge in any of the customary methods of protest — they do not march on Washington, they do not picket the White House or the halls of Congress or the headquarters of trade unions. Their most conspicuous action is to vote for candidates whom President Eisenhower describes as u2018spenders.’

Still, Prof. Slichter’s “alleged” victims may well have been victimized, as trillions of dollars in monetary claims — bonds, savings accounts, insurance policies, pensions, and so on, have gone down the drain of Peterson’s law during the past 20 years the world over.

Many Congressmen ask for stand-by price and wage controls, and admonish the people with “moral suasion” to exercise spending restraint.

But Peterson’s law, like the tide that wetted King Canute’s feet, will prevail in the end. The investigations will go around in circles. The people will exercise no restraint. The government will exercise no restraint. The public debt, handmaiden to inflation, will wing onward and upward; prices and wages, with or without federal review, will continue to rise; money continues to multiply in volume and divide in value. And as for the stand-by controls, if tried — well, no government with all its quite persuasive machinery of coercion, before or since Diocletian, has been able to fix the price of a loaf of bread.

Peterson’s law is a purely scientific discovery — a fact of history, a part of human nature. Lorelei may be on the rocks, and our sailors are human. The law makes no moral judgments. It stands removed from politics. It poses no solutions. After all, it is not the business of the scientist to shut off the tap water. Enough for him to tell us the tub is overflowing.

January 2, 2007