Transcriber’s Note: Italic text is enclosed in _underscores_; boldface
text is enclosed in ~tildes~.
BY THE SAME AUTHOR
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A TRACT
ON MONETARY REFORM
[Illustration]
MACMILLAN AND CO., LIMITED
LONDON · BOMBAY · CALCUTTA · MADRAS
MELBOURNE
THE MACMILLAN COMPANY
NEW YORK · BOSTON · CHICAGO
DALLAS · SAN FRANCISCO
THE MACMILLAN CO. OF CANADA, LTD.
TORONTO
A TRACT
ON
MONETARY REFORM
BY
JOHN MAYNARD KEYNES
FELLOW OF KING’S COLLEGE, CAMBRIDGE
MACMILLAN AND CO., LIMITED
ST. MARTIN’S STREET, LONDON
1923
COPYRIGHT
PRINTED IN GREAT BRITAIN
PREFACE
We leave Saving to the private investor, and we encourage him to place
his savings mainly in titles to money. We leave the responsibility
for setting Production in motion to the business man, who is mainly
influenced by the profits which he expects to accrue to himself in
terms of money. Those who are not in favour of drastic changes in the
existing organisation of society believe that these arrangements,
being in accord with human nature, have great advantages. But they
cannot work properly if the money, which they assume as a stable
measuring-rod, is undependable. Unemployment, the precarious life of
the worker, the disappointment of expectation, the sudden loss of
savings, the excessive windfalls to individuals, the speculator, the
profiteer--all proceed, in large measure, from the instability of the
standard of value.
It is often supposed that the costs of production are threefold,
corresponding to the rewards of labour, enterprise, and accumulation.
But there is a fourth cost, namely risk; and the reward of risk-bearing
is one of the heaviest, and perhaps the most avoidable, burden
on production. This element of risk is greatly aggravated by the
instability of the standard of value. Currency Reforms, which led to
the adoption by this country and the world at large of sound monetary
principles, would diminish the wastes of _Risk_, which consume at
present too much of our estate.
Nowhere do conservative notions consider themselves more in place than
in currency; yet nowhere is the need of innovation more urgent. One
is often warned that a scientific treatment of currency questions is
impossible because the banking world is intellectually incapable of
understanding its own problems. If this is true, the order of Society,
which they stand for, will decay. But I do not believe it. What we have
lacked is a clear analysis of the real facts, rather than ability to
understand an analysis already given. If the new ideas, now developing
in many quarters, are sound and right, I do not doubt that sooner or
later they will prevail. I dedicate this book, humbly and without
permission, to the Governors and Court of the Bank of England, who
now and for the future have a much more difficult and anxious task
entrusted to them than in former days.
J. M. KEYNES.
_October 1923._
CONTENTS
PAGE
PREFACE v
CHAPTER I
THE CONSEQUENCES TO SOCIETY OF CHANGES IN THE VALUE OF MONEY 1
I. As Affecting Distribution 5
1. The Investor 5
2. The Business Man 18
3. The Earner 27
II. As Affecting Production 32
CHAPTER II
PUBLIC FINANCE AND CHANGES IN THE VALUE OF MONEY 41
1. Inflation as a Method of Taxation 41
2. Currency Depreciation _versus_ Capital Levy 63
CHAPTER III
THE THEORY OF MONEY AND THE EXCHANGES 74
1. The Quantity Theory re-stated 74
2. The Theory of Purchasing Power Parity 87
3. The Seasonal Fluctuation of the Exchanges 106
4. The Forward Market in Exchanges 115
CHAPTER IV
ALTERNATIVE AIMS IN MONETARY POLICY 140
1. Devaluation _versus_ Deflation 142
2. Stability of Prices _versus_ Stability of Exchange 154
3. The Restoration of a Gold Standard 163
CHAPTER V
POSITIVE SUGGESTIONS FOR THE FUTURE REGULATION OF MONEY 177
1. Great Britain 178
2. The United States 197
3. Other Countries 204
INDEX 207
[I have utilised, mainly in the first chapter and in parts
of the second and third, the material, much revised and
re-written, of some articles which were published during
1922 in the Reconstruction Supplements of the _Manchester
Guardian Commercial_.--J. M. K.]
CHAPTER I
THE CONSEQUENCES TO SOCIETY OF CHANGES IN THE VALUE OF MONEY
Money is only important for what it will procure. Thus a change in
the monetary unit, which is uniform in its operation and affects all
transactions equally, has no consequences. If, by a change in the
established standard of value, a man received and owned twice as much
money as he did before in payment for all rights and for all efforts,
and if he also paid out twice as much money for all acquisitions and
for all satisfactions, he would be wholly unaffected.
It follows, therefore, that a change in the value of money, that is to
say in the level of prices, is important to Society only in so far as
its incidence is unequal. Such changes have produced in the past, and
are producing now, the vastest social consequences, because, as we all
know, when the value of money changes, it does _not_ change equally for
all persons or for all purposes. A man’s receipts and his outgoings are
not all modified in one uniform proportion. Thus a change in prices and
rewards, as measured in money, generally affects different classes
unequally, transfers wealth from one to another, bestows affluence here
and embarrassment there, and redistributes Fortune’s favours so as to
frustrate design and disappoint expectation.
The fluctuations in the value of money since 1914 have been on a scale
so great as to constitute, with all that they involve, one of the most
significant events in the economic history of the modern world. The
fluctuation of the standard, whether gold, silver, or paper, has not
only been of unprecedented violence, but has been visited on a society
of which the economic organisation is more dependent than that of any
earlier epoch on the assumption that the standard of value would be
moderately stable.
During the Napoleonic Wars and the period immediately succeeding them
the extreme fluctuation of English prices within a single year was 22
per cent; and the highest price level reached during the first quarter
of the nineteenth century, which we used to reckon the most disturbed
period of our currency history, was less than double the lowest and
with an interval of thirteen years. Compare with this the extraordinary
movements of the past nine years. To recall the reader’s mind to the
exact facts, I refer him to the table on the next page.
I have not included those countries--Russia, Poland, and Austria--where
the old currency has long been bankrupt. But it will be observed
that, even apart from the countries which have suffered revolution
or defeat, no quarter of the world has escaped a violent movement. In
the United States, where the gold standard has functioned unabated, in
Japan, where the war brought with it more profit than liability, in the
neutral country of Sweden, the changes in the value of money have been
comparable with those in the United Kingdom.
INDEX NUMBERS OF WHOLESALE PRICES EXPRESSED AS A PERCENTAGE OF 1913 (1).
+-----------------------------------+--------------------------------+
|Monthly Average. |U.S.A. (3). |
| |United Kingdom (2). | |Canada. |
| | |France. | | |Japan. |
| | | |Italy. | | | |Sweden. |
| | | | |Germany.| | | | |India.|
+-------+-----+----- +-----+--------+-----+----- +-----+----- +------+
|1913 | 100 | 100 | 100 | 100| 100 | 100 | 100 | 100 | .. |
|1914 | 100 | 102 | 96 | 106| 98 | 100 | 95 | 116 | 100 |
|1915 | 127 | 140 | 133 | 142| 101 | 109 | 97 | 145 | 112 |
|1916 | 160 | 189 | 201 | 153| 127 | 134 | 117 | 185 | 128 |
|1917 | 206 | 262 | 299 | 179| 177 | 175 | 149 | 244 | 147 |
|1918 | 227 | 340 | 409 | 217| 194 | 205 | 196 | 339 | 180 |
|1919 | 242 | 357 | 364 | 415| 206 | 216 | 239 | 330 | 198 |
|1920 | 295 | 510 | 624 | 1,486| 226 | 250 | 260 | 347 | 204 |
|1921 | 182 | 345 | 577 | 1,911| 147 | 182 | 200 | 211 | 181 |
|1922 | 159 | 327 | 562 | 34,182| 149 | 165 | 196 | 162 | 180 |
|1923[A]| 159 | 411 | 582 | 765,000| 157 | 167 | 192 | 166 | 179 |
+-------+-----+----- +-----+--------+-----+----- +-----+----- +------+
(1) These figures are taken from the _Monthly Bulletin of Statistics_
of the League of Nations. (2) _Statist_ up to 1919; thereafter the
median of the _Economist_, _Statist_, and Board of Trade Index Numbers.
(3) Bureau of Labour Index Number (revised).
[A] First half-year.
From 1914 to 1920 all these countries experienced an expansion in
the supply of money to spend relatively to the supply of things to
purchase, that is to say _Inflation_. Since 1920 those countries which
have regained control of their financial situation, not content with
bringing the Inflation to an end, have contracted their supply of money
and have experienced the fruits of _Deflation_. Others have followed
inflationary courses more riotously than before. In a few, of which
Italy is one, an imprudent desire to deflate has been balanced by the
intractability of the financial situation, with the happy result of
comparatively stable prices.
Each process, Inflation and Deflation alike, has inflicted great
injuries. Each has an effect in altering the _distribution_ of wealth
between different classes, Inflation in this respect being the worse of
the two. Each has also an effect in overstimulating or retarding the
_production_ of wealth, though here Deflation is the more injurious.
The division of our subject thus indicated is the most convenient for
us to follow,--examining first the effect of changes in the value of
money on the distribution of wealth with most of our attention on
Inflation, and next their effect on the production of wealth with most
of our attention on Deflation. How have the price changes of the past
nine years affected the productivity of the community as a whole, and
how have they affected the conflicting interests and mutual relations
of its component classes? The answer to these questions will serve to
establish the gravity of the evils, into the remedy for which it is the
object of this book to inquire.
I.--CHANGES IN THE VALUE OF MONEY, AS AFFECTING DISTRIBUTION
For the purpose of this inquiry a triple classification of Society
is convenient--into the Investing Class, the Business Class, and the
Earning Class. These classes overlap, and the same individual may earn,
deal, and invest; but in the present organisation of society such a
division corresponds to a social cleavage and an actual divergence of
interest.
1. _The Investing Class._
Of the various purposes which money serves, some essentially depend
upon the assumption that its real value is nearly constant over
a period of time. The chief of these are those connected, in a
wide sense, with contracts for the _investment of money_. Such
contracts--namely, those which provide for the payment of fixed sums
of money over a long period of time--are the characteristic of what it
is convenient to call the _Investment System_, as distinct from the
property system generally.
Under this phase of capitalism, as developed during the nineteenth
century, many arrangements were devised for separating the management
of property from its ownership. These arrangements were of three
leading types: (1) Those in which the proprietor, while parting with
the management of his property, retained his ownership of it--_i.e._
of the actual land, buildings, and machinery, or of whatever else
it consisted in, this mode of tenure being typified by a holding
of ordinary shares in a joint-stock company; (2) those in which he
parted with the property temporarily, receiving a fixed sum of _money_
annually in the meantime, but regained his property eventually, as
typified by a lease; and (3) those in which he parted with his real
property permanently, in return either for a perpetual annuity fixed in
terms of money, or for a terminable annuity and the repayment of the
principal in money at the end of the term, as typified by mortgages,
bonds, debentures, and preference shares. This third type represents
the full development of _Investment_.
Contracts to receive fixed sums of money at future dates (made without
provision for possible changes in the real value of money at those
dates) must have existed as long as money has been lent and borrowed.
In the form of leases and mortgages, and also of permanent loans
to Governments and to a few private bodies, such as the East India
Company, they were already frequent in the eighteenth century. But
during the nineteenth century they developed a new and increased
importance, and had, by the beginning of the twentieth, divided
the propertied classes into two groups--the “business men” and the
“investors”--with partly divergent interests. The division was not
sharp as between individuals; for business men might be investors
also, and investors might hold ordinary shares; but the division was
nevertheless real, and not the less important because it was seldom
noticed.
By this system the active business class could call to the aid of their
enterprises not only their own wealth but the savings of the whole
community; and the professional and propertied classes, on the other
hand, could find an employment for their resources, which involved them
in little trouble, no responsibility, and (it was believed) small risk.
For a hundred years the system worked, throughout Europe, with an
extraordinary success and facilitated the growth of wealth on an
unprecedented scale. To save and to invest became at once the duty and
the delight of a large class. The savings were seldom drawn on, and,
accumulating at compound interest, made possible the material triumphs
which we now all take for granted. The morals, the politics, the
literature, and the religion of the age joined in a grand conspiracy
for the promotion of saving. God and Mammon were reconciled. Peace on
earth to men of good means. A rich man could, after all, enter into
the Kingdom of Heaven--if only he saved. A new harmony sounded from
the celestial spheres. “It is curious to observe how, through the wise
and beneficent arrangement of Providence, men thus do the greatest
service to the public, when they are thinking of nothing but their own
gain”[1]; so sang the angels.
[1] _Easy Lessons on Money Matters for the Use of Young
People._ Published by the Society for Promoting Christian
Knowledge. Twelfth Edition, 1850.
The atmosphere thus created well harmonised the demands of expanding
business and the needs of an expanding population with the growth of
a comfortable non-business class. But amidst the general enjoyment of
ease and progress, the extent, to which the system depended on the
stability of the money to which the investing classes had committed
their fortunes, was generally overlooked; and an unquestioning
confidence was apparently felt that this matter would look after
itself. Investments spread and multiplied, until, for the middle
classes of the world, the gilt-edged bond came to typify all that was
most permanent and most secure. So rooted in our day has been the
conventional belief in the stability and safety of a money contract
that, according to English law, trustees have been encouraged to embark
their trust funds exclusively in such transactions, and are indeed
forbidden, except in the case of real estate (an exception which is
itself a survival of the conditions of an earlier age), to employ them
otherwise.[2]
[2] German trustees were not released from a similar obligation
until 1923, by which date the value of trust funds invested
in titles to money had entirely disappeared.
As in other respects, so also in this, the nineteenth century relied
on the future permanence of its own happy experiences and disregarded
the warning of past misfortunes. It chose to forget that there is
no historical warrant for expecting money to be represented even by
a constant quantity of a particular metal, far less by a constant
purchasing power. Yet Money is simply that which the State declares
from time to time to be a good legal discharge of money contracts. In
1914 gold had not been the English standard for a century or the sole
standard of any other country for half a century. There is no record
of a prolonged war or a great social upheaval which has not been
accompanied by a change in the legal tender, but an almost unbroken
chronicle in every country which has a history, back to the earliest
dawn of economic record, of a progressive deterioration in the real
value of the successive legal tenders which have represented money.
Moreover, this progressive deterioration in the value of money through
history is not an accident, and has had behind it two great driving
forces--the impecuniosity of Governments and the superior political
influence of the debtor class.
The power of taxation by currency depreciation is one which has been
inherent in the State since Rome discovered it. The creation of
legal-tender has been and is a Government’s ultimate reserve; and no
State or Government is likely to decree its own bankruptcy or its own
downfall, so long as this instrument still lies at hand unused.
Besides this, as we shall see below, the benefits of a depreciating
currency are not restricted to the Government. Farmers and debtors and
all persons liable to pay fixed money dues share in the advantage.
As now in the persons of business men, so also in former ages these
classes constituted the active and constructive elements in the
economic scheme. Those secular changes, therefore, which in the past
have depreciated money, assisted the new men and emancipated them
from the dead hand; they benefited new wealth at the expense of old,
and armed enterprise against accumulation. The tendency of money to
depreciate has been in past times a weighty counterpoise against
the cumulative results of compound interest and the inheritance
of fortunes. It has been a loosening influence against the rigid
distribution of old-won wealth and the separation of ownership from
activity. By this means each generation can disinherit in part its
predecessors’ heirs; and the project of founding a perpetual fortune
must be disappointed in this way, unless the community with conscious
deliberation provides against it in some other way, more equitable and
more expedient.
At any rate, under the influence of these two forces--the financial
necessities of Governments and the political influence of the debtor
class--sometimes the one and sometimes the other, the progress of
inflation has been _continuous_, if we consider long periods, ever
since money was first devised in the sixth century B.C. Sometimes the
standard of value has depreciated of itself; failing this, debasements
have done the work.
Nevertheless it is easy at all times, as a result of the way we use
money in daily life, to forget all this and to look on money as itself
the absolute standard of value; and when, besides, the actual events
of a hundred years have not disturbed his illusions, the average man
regards what has been normal for three generations as a part of the
permanent social fabric.
The course of events during the nineteenth century favoured such ideas.
During its first quarter, the very high prices of the Napoleonic Wars
were followed by a somewhat rapid improvement in the value of money.
For the next seventy years, with some temporary fluctuations, the
tendency of prices continued to be downwards, the lowest point being
reached in 1896. But while this was the tendency as regards direction,
the remarkable feature of this long period was the relative _stability_
of the price level. Approximately the _same_ level of price ruled in or
about the years 1826, 1841, 1855, 1862, 1867, 1871, and 1915. Prices
were also level in the years 1844, 1881, and 1914. If we call the index
number of these latter years 100, we find that, for the period of close
on a century from 1826 to the outbreak of war, the maximum fluctuation
in either direction was 30 points, the index number never rising above
130 and never falling below 70. No wonder that we came to believe in
the stability of money contracts over a long period. The metal _gold_
might not possess all the theoretical advantages of an artificially
regulated standard, but it could not be tampered with and had proved
reliable in practice.
At the same time, the investor in Consols in the early part of the
century had done very well in three different ways. The “security” of
his investment had come to be considered as near absolute perfection
as was possible. Its capital value had uniformly appreciated, partly
for the reason just stated, but chiefly because the steady fall in the
rate of interest increased the number of years’ purchase of the annual
income which represented the capital.[3] And the annual money income
had a purchasing power which on the whole was increasing. If, for
example, we consider the seventy years from 1826 to 1896 (and ignore
the great improvement immediately after Waterloo), we find that the
capital value of Consols rose steadily, with only temporary set-backs,
from 79 to 109 (in spite of Goschen’s conversion from a 3 per cent
rate to a 2¾ per cent rate in 1889 and a 2½ per cent rate effective
in 1903), while the purchasing power of the annual dividends, even
after allowing for the reduced rates of interest, had increased 50
per cent. But Consols, too, had added the virtue of stability to that
of improvement. Except in years of crisis Consols never fell below 90
during the reign of Queen Victoria; and even in ’48, when thrones were
crumbling, the mean price of the year fell but 5 points. Ninety when
she ascended the throne, they reached their maximum with her in the
year of Diamond Jubilee. What wonder that our parents thought Consols a
good investment!
[3] If (for example) the rate of interest falls from 4½ per
cent to 3 per cent, 3 per cent Consols rise in value from
66 to 100.
Thus there grew up during the nineteenth century a large, powerful,
and greatly respected class of persons, well-to-do individually and
very wealthy in the aggregate, who owned neither buildings, nor land,
nor businesses, nor precious metals, but titles to an annual income in
legal-tender money. In particular, that peculiar creation and pride
of the nineteenth century, the savings of the middle class, had been
mainly thus embarked. Custom and favourable experience had acquired for
such investments an unimpeachable reputation for security.
Before the war these medium fortunes had already begun to suffer some
loss (as compared with the summit of their prosperity in the middle
’nineties) from the rise in prices and also in the rate of interest.
But the monetary events which have accompanied and have followed the
war have taken from them about one-half of their real value in England,
seven-eighths in France, eleven-twelfths in Italy, and virtually the
whole in Germany and in the succession states of Austria-Hungary and
Russia.
The loss to the typical English investor of the pre-war period is
sufficiently measured by the loss to the investor in Consols. Such an
investor, as we have already seen, was steadily improving his position,
apart from temporary fluctuations, up to 1896, and in this and the
following year two maxima were reached simultaneously--both the capital
value of an annuity and also the purchasing power of money. Between
1896 and 1914, on the other hand, the investor had already suffered a
serious loss--the capital value of his annuity had fallen by about a
third, and the purchasing power of his income had also fallen by nearly
a third. This loss, however, was incurred gradually over a period of
nearly twenty years from an exceptional maximum, and did not leave
him appreciably worse off than he had been in the early ’eighties or
the early ’forties. But upon the top of this came the further swifter
loss of the war period. Between 1914 and 1920 the capital value of the
investor’s annuity again fell by more than a third, and the purchasing
power of his income by about two-thirds. In addition, the standard rate
of income tax rose from 7½ per cent in 1914 to 30 per cent in 1921.[4]
Roughly estimated in round numbers, the change may be represented thus
in terms of an index of which the base year is 1914:
[4] Since 1896 there has been the further burden of the Death
Duties.
+------+--------------+----------------+----------------+-------------+
| | Purchasing | Do. after | Money price | Purchasing |
| | Power of the | deduction of | of the capital | Power of |
| | Income of | Income Tax | value of | the capital |
| | Consols.[5] | at the | Consols. | value of |
| | | standard rate. | | Consols. |
+------+--------------+----------------+----------------+-------------+
| 1815 | 61 | 59 | 92 | 56 |
| 1826 | 85 | 90 | 108 | 92 |
| 1841 | 85 | 90 | 122 | 104 |
| 1869 | 87 | 89 | 127 | 111 |
| 1883 | 104 | 108 | 138 | 144 |
| 1896 | 139 | 145 | 150 | 208 |
| 1914 | 100 | 100 | 100 | 100 |
| 1920 | 34 | 26 | 64 | 22 |
| 1921 | 53 | 39 | 56 | 34 |
| 1922 | 62 | 50 | 76 | 47 |
+------+--------------+----------------+----------------+-------------+
[5] Without allowance for the reduction of the interest from 3
to 2½ per cent.
The second column well illustrates what a splendid investment
gilt-edged stocks had been through the century from Waterloo to Mons,
even if we omit altogether the abnormal values of 1896–97. Our table
shows how the epoch of Diamond Jubilee was the culminating moment in
the prosperity of the British middle class. But it also exhibits with
the precision of figures the familiar bewailed plight of those who try
to live on the income of the same trustee investments as before the
war. The owner of consols in 1922 had a real income, one half of what
he had in 1914 and one third of what he had in 1896. The whole of the
improvement of the nineteenth century had been obliterated, and his
situation was not quite so good as it had been after Waterloo.
Some mitigating circumstances should not be overlooked. Whilst the
war was a period of the dissipation of the community’s resources
as a whole, it was a period of saving for the individuals of the
saving class, who with their larger holdings of the securities of the
Government now have an increased aggregate money claim on the receipts
of the Exchequer. Also, the investing class, which has lost money,
overlaps, both socially and by the ties of family, with the business
class, which has made money, sufficiently to break in many cases the
full severity of the loss. Moreover, in England, there has been a
substantial recovery from the low point of 1920.
But these things do not wash away the significance of the facts. The
effect of the war, and of the monetary policy which has accompanied
and followed it, has been to take away a large part of the real value
of the possessions of the investing class. The loss has been so rapid
and so intermixed in the time of its occurrence with other worse losses
that its full measure is not yet separately apprehended. But it has
effected, nevertheless, a far-reaching change in the relative position
of different classes. Throughout the Continent the pre-war savings of
the middle class, so far as they were invested in bonds, mortgages, or
bank deposits, have been largely or entirely wiped out. Nor can it be
doubted that this experience must modify social psychology towards
the practice of saving and investment. What was deemed most secure
has proved least so. He who neither spent nor “speculated,” who made
“proper provision for his family,” who sang hymns to security and
observed most straitly the morals of the edified and the respectable
injunctions of the worldly-wise,--he, indeed, who gave fewest pledges
to Fortune has yet suffered her heaviest visitations.
What moral for our present purpose should we draw from this? Chiefly, I
think, that it is not safe or fair to combine the social organisation
developed during the nineteenth century (and still retained) with a
_laisser-faire_ policy towards the value of money. It is not true that
our former arrangements have worked well. If we are to continue to draw
the voluntary savings of the community into “investments,” we must
make it a prime object of deliberate State policy that the standard of
value, in terms of which they are expressed, should be kept stable;
adjusting in other ways (calculated to touch all forms of wealth
equally and not concentrated on the relatively helpless “investors”)
the redistribution of the national wealth, if, in course of time, the
laws of inheritance and the rate of accumulation have drained too great
a proportion of the income of the active classes into the spending
control of the inactive.
2. _The Business Class._
It has long been recognised, by the business world and by economists
alike, that a period of rising prices acts as a stimulus to enterprise
and is beneficial to business men.
In the first place there is the advantage which is the counterpart
of the loss to the investing class which we have just examined. When
the value of money falls, it is evident that those persons who have
engaged to pay fixed sums of money yearly out of the profits of active
business must benefit, since their fixed money outgoings will bear a
smaller proportion than formerly to their money turnover. This benefit
persists not only during the transitional period of change, but also,
so far as old loans are concerned, when prices have settled down at
their new and higher level. For example, the farmers throughout Europe,
who had raised by mortgage the funds to purchase the land they farmed,
now find themselves almost freed from the burden at the expense of the
mortgagees.
But during the period of change, while prices are rising month by
month, the business man has a further and greater source of windfall.
Whether he is a merchant or a manufacturer, he will generally buy
before he sells, and on at least a part of his stock he will run the
risk of price changes. If, therefore, month after month his stock
appreciates on his hands, he is always selling at a better price than
he expected and securing a windfall profit upon which he had not
calculated. In such a period the business of trade becomes unduly easy.
Any one who can borrow money and is not exceptionally unlucky must make
a profit, which he may have done little to deserve. The continuous
enjoyment of such profits engenders an expectation of their renewal.
The practice of borrowing from banks is extended beyond what is normal.
If the market expects prices to rise still further, it is natural that
stocks of commodities should be held speculatively for the rise, and
for a time the mere expectation of a rise is sufficient, by inducing
speculative purchases, to produce one.
Take, for example, the _Statist_ index number for raw materials month
by month from April, 1919, to March, 1920:
April, 1919 100
May 108
June 112
July 117
August 120
September 121
October 127
November 131
December 135
January, 1920 142
February 150
March 146
It follows from this table that a man, who borrowed money from his
banker and used the proceeds to purchase raw materials selected at
random, stood to make a profit in every single month of this period
with the exception of the last, and would have cleared 46 per cent on
the average of the year. Yet bankers were not charging at this time
above 7 per cent for their advances, leaving a clear profit of between
30 and 40 per cent per annum, without the exercise of any particular
skill, to any person lucky enough to have embarked on these courses.
How much more were the opportunities of persons whose business position
and expert knowledge enabled them to exercise intelligent anticipation
as to the probable course of prices of particular commodities! Yet any
dealer in or user of raw materials on a large scale who knew his trade
was thus situated. The profits of certain kinds of business to the man
who has a little skill or some luck are certain in such a period to
be inordinate. Great fortunes may be made in a few months. But apart
from all such, the steady-going business man, who would be pained and
insulted at the thought of being designated speculator or profiteer,
may find windfall profits dropping into his lap which he has neither
sought nor desired.
Economists draw an instructive distinction between what are termed the
“money” rate of interest and the “real” rate of interest. If a sum of
money worth 100 in terms of commodities at the time when the loan is
made is lent for a year at 5 per cent interest, and is only worth 90
in terms of commodities at the end of the year, the lender receives
back, including his interest, what is only worth 94½. This is expressed
by saying that while the _money_ rate of interest was 5 per cent, the
_real_ rate of interest had actually been negative and equal to _minus_
5½ per cent. In the same way, if at the end of the period the value of
money had risen and the capital sum lent had come to be worth 110 in
terms of commodities, while the _money_ rate of interest would still be
5 per cent the _real_ rate of interest would have been 15½ per cent.
Such considerations, even though they are not explicitly present to the
minds of the business world, are far from being academic. The business
world may speak, and even think, as though the money rate of interest
could be considered by itself, without reference to the real rate. But
it does not act so. The merchant or manufacturer, who is calculating
whether a 7 per cent bank rate is so onerous as to compel him to
curtail his operations, is very much influenced by his anticipations
about the prospective price of the commodity in which he is interested.
Thus, when prices are rising, the business man who borrows money is
able to repay the lender with what, in terms of real value, not only
represents no interest, but is even less than the capital originally
advanced; that is, the real rate of interest falls to a negative value,
and the borrower reaps a corresponding benefit. It is true that, in so
far as a rise of prices is foreseen, attempts to get advantage from
this by increased borrowing force the money rates of interest to move
upwards. It is for this reason, amongst others, that a high bank rate
should be associated with a period of rising prices, and a low bank
rate with a period of falling prices. The apparent abnormality of the
money rate of interest at such times is merely the other side of the
attempt of the real rate of interest to steady itself. Nevertheless in
a period of rapidly changing prices, the money rate of interest seldom
adjusts itself adequately or fast enough to prevent the real rate from
becoming abnormal. For it is not the _fact_ of a given rise of prices,
but the _expectation_ of a rise compounded of the various possible
price-movements and the estimated probability of each, which affects
money rates; and in countries where the currency has not collapsed
completely, there has seldom or never existed a sufficient general
confidence in a further rise or fall of prices to cause the short-money
rate of interest to rise above 10 per cent per annum, or to fall below
1 per cent.[6] A fluctuation of this order is not sufficient to balance
a movement of prices, up or down, of more than (say) 5 per cent per
annum,--a rate which the actual price movement has frequently exceeded.
[6] The merchant, who borrows money in order to take advantage
of a prospective high real rate of interest, has to act
in advance of the rise in prices, and is calculating on a
probability, not upon a certainty, with the result that
he will be deterred by a movement in the money rate of
interest of much less magnitude than the contrary movement
in the real rate of interest, upon which indeed he is
reckoning, yet is not reckoning with certainty.
Germany has recently provided an illustration of the extraordinary
degree in which the money rate of interest can rise in its endeavour
to keep up with the real rate, when prices have continued to rise for
so long and with such violence that, rightly or wrongly, every one
believes that they will continue to rise further. Yet even there the
money rate of interest has never risen high enough to keep pace with
the rise of prices. In the autumn of 1922, the full effects were just
becoming visible of the long preceding period during which the real
rate of interest in Germany had reached a high negative figure, that
is to say during which any one who could borrow marks and turn them
into assets would have found at the end of any given period that the
appreciation in the mark-value of the assets was far greater than
the interest he had to pay for borrowing them. By this means great
fortunes were snatched out of general calamity; and those made most
who had seen first, that the right game was to borrow and to borrow
and to borrow, and thus secure the difference between the real rate
of interest and the money rate. But after this had been good business
for many months, every one began to take a hand, with belated results
on the money rate of interest. At that time, with a nominal Reichsbank
rate of 8 per cent, the effective gilt-edged rate for short loans had
risen to 22 per cent per annum. During the first half of 1923, the
rate of the Reichsbank itself rose to 24 per cent, and subsequently
to 30, and finally 108 per cent, whilst the market rate fluctuated
violently at preposterous figures, reaching at times 3 per cent _per
week_ for certain types of loan. With the final currency collapse of
July-September 1923, the open market rate was altogether demoralised,
and reached figures of 100 per cent per month. In face, however, of the
rate of currency depreciation, even such figures were inadequate, and
the bold borrower was still making money.
In Hungary, Poland, and Russia--wherever prices were expected to
collapse yet further--the same phenomenon was present, exhibiting
as through a microscope what takes place everywhere when prices are
expected to rise.
On the other hand, when prices are falling 30 to 40 per cent between
the average of one year and that of the next, as they were in Great
Britain and in the United States during 1921, even a bank rate of 1
per cent would have been oppressive to business, since it would have
corresponded to a very high rate of real interest. Any one who could
have foreseen the movement even partially would have done well for
himself by selling out his assets and staying out of business for the
time being.
But if the depreciation of money is a source of gain to the business
man, it is also the occasion of opprobrium. To the consumer the
business man’s exceptional profits appear as the cause (instead of the
consequence) of the hated rise of prices. Amidst the rapid fluctuations
of his fortunes he himself loses his conservative instincts, and begins
to think more of the large gains of the moment than of the lesser, but
permanent, profits of normal business. The welfare of his enterprise
in the relatively distant future weighs less with him than before,
and thoughts are excited of a quick fortune and clearing out. His
excessive gains have come to him unsought and without fault or design
on his part, but once acquired he does not lightly surrender them, and
will struggle to retain his booty. With such impulses and so placed,
the business man is himself not free from a suppressed uneasiness.
In his heart he loses his former self-confidence in his relation to
society, in his utility and necessity in the economic scheme. He fears
the future of his business and his class, and the less secure he feels
his fortune to be the tighter he clings to it. The business man, the
prop of society and the builder of the future, to whose activities and
rewards there had been accorded, not long ago, an almost religious
sanction, he of all men and classes most respectable, praiseworthy and
necessary, with whom interference was not only disastrous but almost
impious, was now to suffer sidelong glances, to feel himself suspected
and attacked, the victim of unjust and injurious laws,--to become, and
know himself half-guilty, a profiteer.
No man of spirit will consent to remain poor if he believes his betters
to have gained their goods by lucky gambling. To convert the business
man into the profiteer is to strike a blow at capitalism, because it
destroys the psychological equilibrium which permits the perpetuance
of unequal rewards. The economic doctrine of normal profits,
vaguely apprehended by every one, is a necessary condition for the
justification of capitalism. The business man is only tolerable so long
as his gains can be held to bear some relation to what, roughly and in
some sense, his activities have contributed to society.
This, then, is the second disturbance to the existing economic order
for which the depreciation of money is responsible. If the fall in the
value of money discourages investment, it also discredits enterprise.
Not that the business man was allowed, even during the period of boom,
to retain the whole of his exceptional profits. A host of popular
remedies vainly attempted to cure the evils of the day; which remedies
themselves--subsidies, price and rent fixing, profiteer hunting, and
excess profits duties--eventually became not the least part of the
evils.
In due course came the depression, with falling prices, which operate
on those who hold stocks in a manner exactly opposite to rising
prices. Excessive losses, bearing no relation to the efficiency of
the business, took the place of windfall gains; and the effort of
every one to hold as small stocks as possible brought industry to a
standstill, just as previously their efforts to accumulate stocks had
over-stimulated it. Unemployment succeeded Profiteering as the problem
of the hour. But whilst the cyclical movement of trade and credit has,
in the good-currency countries, partly reversed, for the time being at
least, the great rise of 1920, it has, in the countries of continuing
inflation, made no more than a ripple on the rapids of depreciation.
3. _The Earner._
It has been a commonplace of economic text-books that wages tend to
lag behind prices, with the result that the real earnings of the
wage-earner are diminished during a period of rising prices. This
has often been true in the past, and may be true even now of certain
classes of labour which are ill-placed or ill-organised for improving
their position. But in Great Britain, at any rate, and in the United
States also, some important sections of labour were able to take
advantage of the situation not only to obtain money wages equivalent
in purchasing power to what they had before, but to secure a real
improvement, to combine this with a diminution in their hours of work
(and, so far, of the work done), and to accomplish this (in the case
of Great Britain) at a time when the total wealth of the community as
a whole had suffered a decrease. This reversal of the usual course has
not been due to an accident and is traceable to definite causes.
The organisation of certain classes of labour--railwaymen, miners,
dockers, and others--for the purpose of securing wage increases is
better than it was. Life in the army, perhaps for the first time in
the history of wars, raised in many respects the conventional standard
of requirements,--the soldier was better clothed, better shod, and
often better fed than the labourer, and his wife, adding in war time a
separation allowance to new opportunities to earn, had also enlarged
her ideas.
But these influences, while they would have supplied the motive,
might have lacked the means to the result if it had not been for
another factor--the windfalls of the profiteer. The fact that the
business man had been gaining, and gaining notoriously, considerable
windfall profits in excess of the normal profits of trade, laid him
open to pressure, not only from his employees but from public opinion
generally; and enabled him to meet this pressure without financial
difficulty. In fact, it was worth his while to pay ransom, and to share
with his workmen the good fortune of the day.
Thus the working classes improved their _relative_ position in the
years following the war, as against all other classes except that of
the “profiteers.” In some important cases they improved their absolute
position--that is to say, account being taken of shorter hours,
increased money wages, and higher prices, some sections of the working
classes secured for themselves a higher real remuneration for each unit
of effort or work done. But we cannot estimate the _stability_ of this
state of affairs, as contrasted with its desirability, unless we know
the source from which the increased reward of the working classes was
drawn. Was it due to a permanent modification of the economic factors
which determine the distribution of the national product between
different classes? Or was it due to some temporary and exhaustible
influence connected with inflation and with the resulting disturbance
in the standard of value?
A violent disturbance of the standard of value obscures the true
situation, and for a time one class can benefit at the expense
of another surreptitiously and without producing immediately the
inevitable reaction. In such conditions a country can without knowing
it expend in current consumption those savings which it thinks it is
investing for the future; and it can even trench on existing capital or
fail to make good its current depreciation. When the value of money is
greatly fluctuating, the distinction between capital and income becomes
confused. It is one of the evils of a depreciating currency that it
enables a community to live on its capital unawares. The increasing
_money_ value of the community’s capital goods obscures temporarily a
diminution in the real quantity of the stock.
The period of depression has exacted its penalty from the working
classes more in the form of unemployment than by a lowering of real
wages, and State assistance to the unemployed has greatly moderated
even this penalty. Money wages have followed prices downwards. But
the depression of 1921–22 did not reverse or even greatly diminish
the relative advantage gained by the working classes over the middle
class during the previous years. In 1923 British wage rates stood at an
appreciably higher level above the pre-war rates than did the cost of
living, if allowance is made for the shorter hours worked.
In Germany and Austria also, but in a far greater degree than in
England or in France, the change in the value of money has thrown the
burden of hard circumstances on the middle class, and hitherto the
labouring class have by no means supported their full proportionate
share. If it be true that university professors in Germany have some
responsibility for the atmosphere which bred war, their class has paid
the penalty. The effects of the impoverishment, throughout Europe,
of the middle class, out of which most good things have sprung, must
slowly accumulate in a decay of Science and Art.
* * * * *
We conclude that Inflation redistributes wealth in a manner very
injurious to the investor, very beneficial to the business man, and
probably, in modern industrial conditions, beneficial on the whole
to the earner. Its most striking consequence is its _injustice_ to
those who in good faith have committed their savings to titles to
money rather than to things. But injustice on such a scale has further
consequences. The above discussion suggests that the diminution in the
production of wealth which has taken place in Europe since the war
has been, to a certain extent, at the expense, not of the consumption
of any class, but of the accumulation of capital. Moreover, Inflation
has not only diminished the capacity of the investing class to save
but has destroyed the atmosphere of confidence which is a condition
of the willingness to save. Yet a growing population requires, for
the maintenance of the same standard of life, a proportionate growth
of capital. In Great Britain for many years to come, regardless of
what the birth-rate may be from now onwards (and at the present time
the number of births per day is nearly double the number of deaths),
upwards of 250,000 new labourers will enter the labour market annually
in excess of those going out of it. To maintain this growing body of
labour at the same standard of life as before, we require not merely
growing markets but a growing capital equipment. In order to keep our
standards from deterioration, the national capital must grow as fast
as the national labour supply, which means new savings of at least
£250,000,000[7] per annum at present. The favourable conditions for
saving which existed in the nineteenth century, even though we smile at
them, provided a proportionate growth between capital and population.
The disturbance of the pre-existing balance between classes, which in
its origins is largely traceable to the changes in the value of money,
may have destroyed these favourable conditions.
[7] That is to say, it costs not less than £1000 in new capital
outlay to equip a working man with organisation and
appliances, which will render his labour efficient, and to
house and supply himself and his family. Indeed this is
probably an underestimate.
On the other hand Deflation, as we shall see in the second section
of the next chapter, is liable, in these days of huge national debts
expressed in legal-tender money, to overturn the balance so far the
other way in the interests of the _rentier_, that the burden of
taxation becomes intolerable on the productive classes of the community.
II.--CHANGES IN THE VALUE OF MONEY, AS AFFECTING PRODUCTION.
If, for any reason right or wrong, the business world _expects_ that
prices will fall, the processes of production tend to be inhibited; and
if it expects that prices will rise, they tend to be over-stimulated. A
fluctuation in the measuring-rod of value does not alter in the least
the wealth of the world, the needs of the world, or the productive
capacity of the world. It ought not, therefore, to affect the character
or the volume of what is produced. A movement of _relative_ prices,
that is to say of the comparative prices of different commodities,
_ought_ to influence the character of production, because it is an
indication that various commodities are not being produced in the
exactly right proportions. But this is not true of a change, as such,
in the _general_ price level.
The fact that the expectation of changes in the _general_ price
level affects the processes of production, is deeply rooted in the
peculiarities of the existing economic organisation of society, partly
in those described in the preceding sections of this chapter, partly
in others to be mentioned in a moment. We have already seen that a
change in the general level of prices, that is to say a change in
the measuring-rod, which fixes the obligation of the borrowers of
money (who make the decisions which set production in motion) to the
lenders (who are inactive once they have lent their money), effects a
redistribution of real wealth between the two groups. Furthermore, the
active group can, if they foresee such a change, alter their action in
advance in such a way as to minimise their losses to the other group
or to increase their gains from it, if and when the expected change
in the value of money occurs. If they expect a fall, it may pay them,
as a group, to damp production down, although such enforced idleness
impoverishes society as a whole. If they expect a rise, it may pay
them to increase their borrowings and to swell production beyond the
point where the real return is just sufficient to recompense society
as a whole for the effort made. Sometimes, of course, a change in the
measuring-rod, especially if it is unforeseen, may benefit one group
at the expense of the other disproportionately to any influence it
exerts on the volume of production; but the tendency, in so far as the
active group anticipate a change, will be as I have described it.[8]
This is simply to say that the intensity of production is largely
governed in existing conditions by the anticipated real profit of the
_entrepreneur_. Yet this criterion is the right one for the community
as a whole only when the delicate adjustment of interests is not upset
by fluctuations in the standard of value.
[8] The interests of the salaried and wage-earning classes
will, in so far as their salaries and wages tend to be
steadier in money-value than in real-value, coincide with
those of the inactive capitalist group. The interests
of the consumer will, in so far as he can vary the
distribution of his floating resources between cash and
goods purchased in advance of consumption, coincide with
those of the active capitalist group; and his decisions,
made in his own interests, may serve to reinforce the
effect of those of the latter. But that the interests of
the same individual will often be those of one of the
groups in one of his capacities and of the other in another
of his capacities, does not save the situation or affect
the argument. For his losses in one capacity depend only
infinitesimally on him personally refraining from action
in his other capacity. The facts, that a man is a cannibal
at home and eaten abroad, do not cancel out to render him
innocuous and safe.
But there is a further reason, connected with the above but
nevertheless distinct, why modern methods of production require a
stable standard,--a reason springing to a certain extent out of the
character of the social organisation described above, but aggravated
by the technical methods of present-day productive processes. With the
development of international trade, involving great distances between
the place of original production and the place of final consumption,
and with the increased complication of the technical processes of
manufacture, the amount of _risk_ which attaches to the undertaking
of production and the length of time through which this risk must be
carried are much greater than they would be in a comparatively small
self-contained community. Even in agriculture, whilst the risk to
the consumer is diminished by drawing supplies from many different
sources, which average the fluctuations of the seasons, the risk to the
agricultural producer is increased, since, when his crop falls below
his expectations in volume, he may fail to be compensated by a higher
price. This increased risk is the price which producers have to pay for
the other advantages of a high degree of specialisation and for the
variety of their markets and their sources of supply.
The provision of adequate facilities for the carrying of this risk at a
moderate cost is one of the greatest of the problems of modern economic
life, and one of those which so far have been least satisfactorily
solved. The business of keeping the productive machine in continuous
operation (and thereby avoiding unemployment) would be greatly
simplified if this risk could be diminished or if we could devise a
better means of insurance against it for the individual _entrepreneur_.
A considerable part of the risk arises out of fluctuations in the
_relative_ value of a commodity compared with that of commodities in
general during the interval which must elapse between the commencement
of production and the time of consumption. This part of the risk is
independent of the vagaries of money, and must be tackled by methods
with which we are not concerned here. But there is also a considerable
risk directly arising out of instability in the value of money. During
the lengthy process of production the business world is incurring
outgoings in terms of _money_--paying out in money for wages and
other expenses of production--in the expectation of recouping this
outlay by disposing of the product for _money_ at a later date. That
is to say, the business world as a whole must always be in a position
where it stands to gain by a rise of price and to lose by a fall of
price. Whether it likes it or not, the technique of production under a
_régime_ of money-contract forces the business world always to carry
a big speculative position; and if it is reluctant to carry this
position, the productive process must be slackened. The argument is
not affected by the fact that there is some degree of specialisation
of function within the business world, in so far as the professional
speculator comes to the assistance of the producer proper by taking
over from him a part of his risk.
Now it follows from this, not merely that the _actual occurrence_ of
price changes profits some classes and injures others (which has been
the theme of the first section of this chapter), but that a _general
fear_ of falling prices may inhibit the productive process altogether.
For if prices are expected to fall, not enough risk-takers can be
found who are willing to carry a speculative “bull” position, and this
means that _entrepreneurs_ will be reluctant to embark on lengthy
productive processes involving a money outlay long in advance of money
recoupment,--whence unemployment. The _fact_ of falling prices injures
_entrepreneurs_; consequently the _fear_ of falling prices causes them
to protect themselves by curtailing their operations; yet it is upon
the aggregate of their individual estimations of the risk, and their
willingness to run the risk, that the activity of production and of
employment mainly depends.
There is a further aggravation of the case, in that an expectation
about the course of prices tends, if it is widely held, to be
cumulative in its results up to a certain point. If prices are
expected to rise and the business world acts on this expectation,
that very fact causes them to rise for a time and, by verifying the
expectation, reinforces it; and similarly, if it expects them to fall.
Thus a comparatively weak initial impetus may be adequate to produce a
considerable fluctuation.
Three generations of economists have recognised that certain influences
produce a progressive and continuing change in the value of money, that
others produce in it an oscillatory movement, and that the latter act
cumulatively in their initial stages but produce the conditions for
a reaction after a certain point. But their investigations into the
oscillatory movements have been chiefly confined, until lately, to the
question what kind of cause is responsible for the initial impetus.
Some have been fascinated by the idea that the initial cause is always
the same and is astronomically regular in the times of its appearance.
Others have maintained, more plausibly, that sometimes one thing
operates and sometimes another.
It is one of the objects of this book to urge that the best way to cure
this mortal disease of individualism is to provide that there shall
never exist any confident expectation either that prices generally
are going to fall or that they are going to rise; and also that there
shall be no serious risk that a movement, if it does occur, will be
a big one. If, unexpectedly and accidentally, a moderate movement
were to occur, wealth, though it might be redistributed, would not be
diminished thereby.
To procure this result by removing all possible influences towards
an initial movement, whether such influences are to be found in the
skies only or everywhere, would seem to be a hopeless enterprise. The
remedy would lie, rather, in so controlling the standard of value that,
whenever something occurred which, left to itself, would create an
expectation of a change in the general level of prices, the controlling
authority should take steps to counteract this expectation by setting
in motion some factor of a contrary tendency. Even if such a policy
were not wholly successful, either in counteracting expectations
or in avoiding actual movements, it would be an improvement on the
policy of sitting quietly by, whilst a standard of value, governed by
chance causes and deliberately removed from central control, produces
expectations which paralyse or intoxicate the government of production.
* * * * *
We see, therefore, that rising prices and falling prices each have
their characteristic disadvantage. The Inflation which causes the
former means Injustice to individuals and to classes,--particularly
to investors; and is therefore unfavourable to saving. The Deflation
which causes falling prices means Impoverishment to labour and to
enterprise by leading _entrepreneurs_ to restrict production, in their
endeavour to avoid loss to themselves; and is therefore disastrous to
employment. The counterparts are, of course, also true,--namely that
Deflation means Injustice to borrowers, and that Inflation leads to
the over-stimulation of industrial activity. But these results are not
so marked as those emphasised above, because borrowers are in a better
position to protect themselves from the worst effects of Deflation than
lenders are to protect themselves from those of Inflation, and because
labour is in a better position to protect itself from over-exertion in
good times than from under-employment in bad times.
Thus Inflation is unjust and Deflation is inexpedient. Of the two
perhaps Deflation is, if we rule out exaggerated inflations such as
that of Germany, the worse; because it is worse, in an impoverished
world, to provoke unemployment than to disappoint the _rentier_.
But it is not necessary that we should weigh one evil against the
other. It is easier to agree that both are evils to be shunned. The
Individualistic Capitalism of to-day, precisely because it entrusts
saving to the individual investor and production to the individual
employer, _presumes_ a stable measuring-rod of value, and cannot be
efficient--perhaps cannot survive--without one.
For these grave causes we must free ourselves from the deep distrust
which exists against allowing the regulation of the standard of value
to be the subject of _deliberate decision_. We can no longer afford to
leave it in the category of which the distinguishing characteristics
are possessed in different degrees by the weather, the birth-rate, and
the Constitution,--matters which are settled by natural causes, or
are the resultant of the separate action of many individuals acting
independently, or require a Revolution to change them.