One can say without exaggeration that inflation is an indispensable means of militarism, Ludwig von Mises wrote. Without it, the repercussions of war on welfare become obvious much more quickly and penetratingly; war weariness would set in much earlier.
This explains why American politicians have always resorted to the legalized counterfeiting of central banking to finance wars, the most expensive of all government programs. If citizens had a clearer picture of the true costs, they would be more inclined to oppose non-defensive intervention and to force all wars to hastier conclusions.
Government can finance war (and everything else) by only three methods: taxes, debt, and the printing of money. Taxes are the most visible and painful, followed by debt finance, which crowds out private borrowing, drives up interest rates, and imposes the double burden of principal and interest. Money creation, on the other hand, makes war seem costless to the average citizen. But of course there is no such thing as a free lunch.
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As a general rule, the longer a war lasts, the more centrally planned and government-controlled the entire economy becomes. And it remains so to some degree after the war has ended. War is the health of the state, as Randolph Bourne famously declared, and the growth of the state means a decline in liberty and prosperity.
As Robert Higgs wrote in Crisis and Leviathan, among the effects of World War I were massive government collusion with organized special-interest groups; the de facto nationalization of the ocean shipping and railroad industries; the increased federal intrusion in labor markets, capital markets, communications, and agriculture; and enduring changes in constitutional doctrines regarding conscription and governmental suppression of free speech.
Inflationary war finance inevitably leads to calls for price controls, which inflict even greater damage on the private enterprise system by generating shortages of goods and services, which are falsely blamed on capitalism. The state uses this excuse to grant itself even greater central-planning powers. Inflating the currency as a method of war finance is often a first step in the adoption of what is essentially economic fascism.
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Paper and printing were invented in China, but American politicians were the first to use government paper money. It was adopted by the colonial government of Massachusetts in 1690. As Murray N. Rothbard wrote, the Massachusetts government was accustomed to launching plunder expeditions against the prosperous French colony in Quebec. The loot was typically used to pay mercenary soldiers, but when one of the expeditions failed and the soldiers threatened mutiny, the Massachusetts government printed 7,000 British pounds in paper notes to pay them. The government promised to redeem the paper money in gold or silver, but took 40 years to do so. Meanwhile, the public was so suspicious of the notes that they depreciated by 40 percent in the first year.
By 1740, every colony except for Virginia had followed Massachusetts’ lead in issuing fiat paper money. The results were dramatic inflation, boom-and-bust cycles, and depreciated currency.
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During the Revolution, a form of centralized banking was adopted when the Continental Congress issued the Continental in 1775. Because it was not backed by anything of value, the Continental depreciated so severely that it was virtually worthless by 1781. Not worth a Continental became a popular slang.
Some of the states attempted to deal with the inflation caused by the massive printing of Continentals with price-control laws. The predictable effect: shortages so severe that George Washington’s army almost starved in a field in Pennsylvania. The situation became so desperate that the Continental Congress issued a resolution on June 4, 1778 urging all the states to abolish their price-control laws: Whereas it hath been found by experience that limitations upon the prices of commodities are not only ineffectual for the purpose proposed, but likewise productive of very evil consequences — resolved, that it be recommended to the several states to repeal or suspend all laws limiting, regulating or restraining the Price of any Article. Within three months, the army was fairly well provided for as a direct result of this change in policy, write Robert Schuettinger and Eamonn Butler in Forty Centuries of Wage and Price Controls: How Not to Fight Inflation.
Despite the economic calamities caused by America’s first foray into centralized control of the money supply, at the end of the Revolutionary War the nation’s first central bank — the Bank of North America — was created, with defense contractor/congressman Robert Morris implanted as its president. Centralized banking might have been ruinous for the general public, but political insiders like Morris profited handsomely. The bank was given a monopoly license to issue paper currency, and it used most of its newly created money for loans to the central government. In so doing, it inflated its currency so rapidly that within one year the market lost all confidence in the bank and it was privatized.
Alexander Hamilton was the real founding father of central banking, as the Federal Reserve Board declares in one of its publications. His Bank of the United States (BUS), established in 1791 after a momentous debate between Hamilton and Jefferson over its constitutionality, was partly intended to finance sudden emergencies like war, in Hamilton’s own words. He rejected Washington and Jefferson’s foreign policy of commercial relations with all nations, entangling alliances with none. Instead, he advocated a permanent military establishment complete with a large navy and standing army that would pursue imperial glory. As historian Clinton Rossiter explains, Hamilton’s overriding purpose was to build the foundations of a new empire.