Land Speculation and Inflation

There are as many different theories of the basic cause of inflation as there are for depressions. But since today's business cycle seems to involve a constant tension between periods of inflation and periods of unemployment/recession, the two phenomena clearly are related.

George said almost nothing in Progress and Poverty about inflation; in his day industrial depression was a much more serious problem. After the Great Depression of the 1930s, however, governments began using macroeconomic "pump-priming" to hold off economic downturns, or blunt their severity. This took the form of deficit spending by government, decreased interest rates, or both. But, of course, this amounted to injecting more money into the economy, which brought the risk of inflation. In the modern world inflation is generally seen as the flipside danger to recession. The conventional macroeconomic wisdom is that the economy cannot be stimulated too much without risking excessive inflation and the economy cannot be slowed down too quickly (via higher interest rates, tax increases, etc.) lest it bring on a recession.

Why talk of the risk of inflation? Cannot the government avoid inflation by simply choosing not to print more money? Not exactly. That is because almost all countries today use a fractional-reserve banking system, in which the great majority of money is loaned into existence by banks (and paid back out of existence when loans are retired.) The bills and coins issued by the government are really only counters useful in day-to-day transactions, but only a small fraction of the total amount of money.

In a fractional reserve banking system, banks are allowed to loan out more money than they actually have on deposit. The process can be influenced (by the government and/or the central bank) in two basic ways: either by adjusting interest rates (1) or by raising or lowering the portion of their deposits that banks must hold in reserve. These tools can influence the supply of money, but they cannot determine it because banks are free to decide how much money they will lend, within the limits of the basic reserve requirement.

Land isn't the Only Thing Bought with Borrowed Money

What does this have to do with land speculation? Remember that in a modern economy, the vast majority of real estate is acquired with borrowed money. However, credit is not only important for acquiring land and buildings. Credit is also vital to daily business operations. Businesses routinely borrow money, for example, to purchase inventories. If the profit on the items sold is greater than the interest charged on the loan, then the business is better off borrowing. Such short-term business loans are considered to be "self-liquidating." Their risk is quite low, and they facilitate the flow of commerce. (2)

Recall, too, that because of the basic nature of land as a factor of production, land value takes an ever-greater portion of aggregate wealth as the economy grows. This means that an ever-greater portion of loans must go to the acquisition of land. And, since the higher speculative value of land pushes people to build more expensive buildings, this means that an ever-greater portion of loans also goes to buildings. These are long-term loans. Banks do not have unlimited funds to loan. Money committed to long-term loans for land and buildings is not available for short-term business loans.

These sort-term business loans are essential to the smooth running of the economy. If less loanable funds are available, the cost of doing business goes up, and the economy slows. But, the supply of these short-term loans is inexorably restricted, as more and more loanable funds go toward buying land and buildings. Recession looms. The irresistible incentive for the Federal Reserve is to allow the money supply to increase, by keeping interest rates and reserve requirements low. This can offset the reduced supply of funds businesses need for day-to-day operations. But not indefinitely, and not without limit: since the central bank cannot control banks' money-lending decisions, it cannot be sure that inflation won't run out of control.

The fact that inflation and unemployment are seen as inextricably linked that we seem unable to reduce one without risking the other shows that they are symptoms of the same underlying problem.

Many people note the intimate role of money and banking in economic cycles and asssume that the financial system is at the root of the problem. Undoubtedly, the financial system has a long history of "ratcheting up" the volatility of the speculative land market. This was painfully clear in the Great Depression, and again in the 2000s, after many depression-era banking regulations had been eliminated. However, although the Glass-Steagall act and other regulations served to soften boom/bust cycles, it did not eliminate them. And, land price bubbles have recurred throughout history, under many different banking and monetary systems. Unfortunately, the primary role of land values in economic cycles has been obscured by the mainstream economics establishment, which has persistently denied land's role as a distinct factor of production.


  1. The Central Bank does this by raising or lowering the prime rate (the interest on short-term loans from the Federal Reserve to banks). This effectively increases the supply of money available for loan, and hence, increases the spply of money. In recent years, however, interest rates were lowered to nearly zero, and the Federal Reserve continued to stimulate the money supply via "quantitative easing" in which the Fed directly bought financial assets from commercial banks and other private institutions.    (Go back)
  2. See Mason affney, "Money, Credit and Crisis" in Georgist Journal #106, Autumn, 2006    (Go back)