In one sense fiat is a factor even in the absence of controls. On every piece of paper money in your pocket are two phrases. One is “In God we trust.” The other, sadly much more significant these days, says “This note is legal tender for all debts, public and private.” What that means is that the creditor must accept payment in such notes whether he likes to or not. A creditor who lent dollars payable in gold of specified weight and fineness might otherwise refuse payment in notes redeemable in nothing.
Habit, or the rigidity of our social system, slows down changes in the purchasing power of money but does not determine its value. If by some magic you could cut the value of all money in half overnight, not all prices could double the next day because it would take time to adjust to the new price level. Until wages and prices were raised many people simply would be unable to pay twice as much as before for rent and food. Others, for a while, would accept money at the old value by force of habit. Ultimately the basic factors would prevail.
Internationally, so long as our Government continued able and willing to meet all central bank demands for gold—or its IMF equivalent—at $35 to the ounce, the inherent value of our money was assured. But foreign claims on our gold so far exceeded our reserves that maintenance of a reasonable balance of payments was imperative. This meant both that we must not price our exports out of foreign markets, nor unduly indulge our tastes for foreign goods and foreign travel. When for the first time since 1893 our imports for 1971 threatened to exceed our exports, the jig was up.
The Nixon Administration sought to stabilize the buying power of the dollar by balancing the budget and slowing down the money printing press. Interest rates and unemployment increased sharply. And prices continued to rise. To lower interest rates the Federal Reserve bought government securities—with printing press money. That was inflationary. To combat unemployment the Administration budgeted a huge deficit and proposed tax cuts. Those moves too were inflationary. To counter those effects the President invoked the wage and price freeze.
The situation recalls Victor Hugo’s story. You may remember, the Good Lord created a mouse.
“What ho!” he cried. “I’ve made a mistake.” So he created a cat to correct it. President Nixon’s freeze is the cat. We can all join in praying that it does not grow into a man-eating tiger.
Basically the problem arises out of our desire as a people to do inflationary things without having inflation. So far no one has invented a pill to make that possible.