2 - The rise of inflation

Summary

After having an inflation rate averaging near to zero during the gold standard, and dating back to the inception of the United States, the march towards a statutory zero-inflation-rate target in the country began with the march into Vietnam. This war arose from the tensions stemming from the First and Second World Wars. In the Korean War the United States had continued its long rivalry by fighting directly against China, and then it confronted the Soviet Union in the decades-long Cold War. The Vietnam War perpetuated these conflicts, with the United States fighting both Chinese and Soviet military assets across southeast Asia.

Inflation was high during both the First and Second World Wars. It rose again during the Korean War. It comes as no surprise that the subsequent Vietnam War once more involved high inflation for the United States. How do wars cause inflation?

The answer is short and simple: the government finances the war by printing money. To understand how the printing of money covers government budget deficits during wartime, we need to investigate the “monetary regime” that exists at the time of war. US history provides ample opportunity to demonstrate the effect of war on inflation, and the effect of the US involvement in the Vietnam War precipitated an inflection point in the world's monetary regime history.

The first US war-induced inflation took place even before the Constitution was enacted. The American Revolutionary War and the Articles of Confederation led to money printing to finance that war, because the US federal government had no power to raise taxes. The Continental currency became worthless, the monetary regime collapsed and the United States was forced to default on its debt. As Peter Bernholz (2016: 55) writes: “During the American War of Independence against Britain the war efforts of the emerging United States were to a large degree financed by issuing a new paper money, the Continental Currency.”

Bernholz attributes this to the inability of the confederated states to raise taxes or offer such financial help. Bernholz plots (2016: 56, fig. 4.4) a price index that has been computed for that period, along with the stock of Continental currency and the currency price of gold.