James F. Davis

The cause and effect of government policies on the economic well being of the majority of a country's citizens should be a major focus in teaching macroeconomics. One of the first to do this in the 20th century was Andrew D. White, a history professor, an ambassador who spoke five languages, and the first president of Cornell University.

White's body of research included collecting and analyzing the treasury papers of the French revolutionary government of 1789 to 1799. Based on his primary research, he gave a series of lectures at Cornell on the economic effects of their financial policy and later expanded these lectures into a book Fiat Money Inflation in France: How it Came, What it Brought, and How it Ended. It is a truly remarkable bit of scholarship and analysis based on original records.

The new French revolutionary government seized power in 1789 and confiscated approximately one-third of the entire real estate of France without compensation to the owners. They took the choicest properties, namely all church assets and the most productive aristocratic farms and enterprises. Then the government created a paper currency, backed by the massive amounts of confiscated assets. They sold these assets to raise more money.

Understanding the fundamental effects of a government creating paper money and the reasons why such results occur, may be helpful to the reader in analyzing what is going on in today's world and in predicting the probable long-term effects of similar policies being followed today. Below is a summary of what White learned about the first great modern effort to use the creation and printing of paper money to promote economic prosperity.

The French leaders believed that issuing paper money would bind the interest of the citizens to the public good. It enabled the leadership to allocate resources to what they believed was in the public good rather than let the people decide. At first this decision appeared to bring prosperity, but ultimately it brought disaster.

Notwithstanding the fact that the paper currency was a direct obligation of the state and backed by valuable and productive assets, there was a steady depreciation in the paper money's value. When the government increased the amount of money in circulation without a corresponding increase of assets (wealth) being created, the currency lost value.

At first producers were delighted with inflation, as they refrained from bringing their products to market in order to obtain the higher prices that inflation brought. But the withholding of merchandise meant purchases became less in amount and payment less secure. Insecurity spread and enterprise stagnated.

Wages never increased as fast as inflation, even though wage and price controls were established and laws passed requiring the indexing of wages to inflation. Fines, imprisonment, and even death sentences were given to those that did not comply. Despite the severe penalties, the government could not stop the depreciation in the value of the paper currency.

The loss of the currency's value hit the least affluent the hardest, that is, those people living on salaries, wages, and fixed incomes. Paper money was and still is largely in the hands of employees and people of modest means, so they were and are always hurt the most by the devaluation of currency. People of more substantial means generally had and have the ability to put more of their wealth into objects of permanent value and are less affected by inflation.

As the economy deteriorated, a progressive tax system was implemented to soak the rich. It made things worse for employees because it took an even bigger portion of their salary as inflation grew. These were the very people the government was trying to help.

With the depreciation of the currency, the cost of goods rose faster than salaries, so fewer items were affordable enough to be purchased by the populace. Also, with fewer buyers, manufactures had to cut back on production, and lay off more people, further compounding the problem.

The government continued to print money and sell government property to pay for their bureaucracy and bills (deficits). With each new issue of money, the value of the currency decreased, that is, it followed the financial laws of nature.

The people that benefited the most from these policies were the politically connected and speculators, such as brokers of securities, land and products. They were the ones who were most able to purchase assets with borrowed money, therefore allowing them to repay loans with currency of lesser value.

Perhaps the most significant effect on the French government's paper money policy was a wholesale demoralization of the society. Gambling throughout the country greatly increased. Inflation encouraged people not to save because the currency lost its value if they did save.

There was even less money for investment in new enterprises and the resulting creation of jobs, which would enable an expanding working class the means of providing for their families. A progressive tax was a further disincentive to create or expand businesses as the State would get a larger share of any success and the entrepreneur would get all the losses if the enterprise failed.

Values, essential to any civilization maintaining and improving the human condition, broke down. Morality, integrity, humanity, self-denial, hard work, and thrift were undermined. National honor and patriotism were destroyed by cynicism.

Paper money managed to transform prosperity into famine. Brutality, cruelty, and chaos became commonplace in what historians now call France's "Regime of Terror."

The result of France's economic collapse was a dictator, Napoleon. He did straighten out the financial mess, a fact largely ignored by historians. At his first cabinet meeting, Napoleon declared, "I will pay cash or I will pay nothing" to his finance minister's request to print more money. By the time Waterloo came and Napoleon was thrown from power, France, despite the heavy expenses of war, was no longer in severe economic distress, because the government had virtually no debt. The natural laws of "cause and effect" revealed by this and other history is the best way of avoiding the repetition of past mistakes. Government leaders would be wise to read White's classic work and to avoid instituting policies that have caused so much suffering in the past.