ALTERNATIVE AIMS IN MONETARY POLICY
Our first two chapters, on the evils proceeding from instability in the
purchasing power of money and on the part played by the exigencies of
Public Finance, have indicated the practical importance of our subject
to the welfare of society. In the third chapter an attempt has been
made to lay a foundation of theory upon which to raise constructions.
We can now turn, in this and the following chapter, to _Remedies_.
The instability of money has been compounded, in most countries except
the United States, of two elements: the failure of the national
currencies to remain stable in terms of what was supposed to be the
standard of value, namely gold; and the failure of gold itself to
remain stable in terms of purchasing power. Attention has been mainly
concentrated (_e.g._ by the Cunliffe Committee) on the first of these
two factors. It is often assumed that the restoration of the gold
standard, that is to say, of the convertibility of each national
currency at a fixed rate in terms of gold, must be, in any case, our
objective; and that the main question of controversy is whether
national currencies should be restored to their pre-war gold value or
to some lower value nearer to the present facts; in other words, the
choice between _Deflation_ and _Devaluation_.
This assumption is hasty. If we glance at the course of prices during
the last five years, it is obvious that the United States, which has
enjoyed a gold standard throughout, has suffered as severely as many
other countries, that in the United Kingdom the instability of gold has
been a larger factor than the instability of the exchange, that the
same is true even of France, and that in Italy it has been nearly as
large. On the other hand, in India, which has suffered violent exchange
fluctuations, the standard of value, as we shall see below, has been
more stable than in any other country.
We should not, therefore, by fixing the exchanges get rid of our
currency troubles. It is even possible that this step might weaken our
control. The problem of stabilisation has several sides, which we must
consider one by one:
1. Devaluation _versus_ Deflation. Do we wish to fix the standard of
value, whether or not it be gold, near the existing value? Or do we
wish to restore it to the pre-war value?
2. Stability of Prices _versus_ Stability of Exchange. Is it more
important that the value of a national currency should be stable in
terms of purchasing power, or stable in terms of the currency of
certain foreign countries?
3. The Restoration of a Gold Standard. In the light of our answers
to the first two questions, is a gold standard, however imperfect in
theory, the best available method for attaining our ends in practice?
Having decided between these alternative aims, we can proceed, in the
next chapter, to some constructive suggestions.
I. _Devaluation_ versus _Deflation_.
The policy of reducing the ratio between the volume of a country’s
currency and its requirements of purchasing power in the form of money,
so as to increase the exchange value of the currency in terms of gold
or of commodities, is conveniently called _Deflation_.
The alternative policy of stabilising the value of the currency
somewhere near its present value, without regard to its pre-war value,
is called _Devaluation_.
Up to the date of the Genoa Conference of April 1922, these two
policies were not clearly distinguished by the public, and the sharp
opposition between them has been only gradually appreciated. Even now
(October 1923) there is scarcely any European country in which the
authorities have made it clear whether their policy is to stabilise the
value of their currency or to raise it. Stabilisation at the existing
level has been recommended by International Conferences;[40] and the
actual value of many currencies tends to fall rather than to rise. But,
to judge from other indications, the heart’s desire of the State Banks
of Europe, whether they pursue it successfully, as in Czecho-Slovakia,
or unsuccessfully, as in France, is to _raise_ the value of their
currencies. In only one country so far have practical steps been taken
to _fix_ the exchange, namely in Austria.
[40] Whilst the Conference of Genoa (April 1922) affirmed the
doctrine in general, representatives of the countries
chiefly affected were united in declaring that it must
not be applied to them in particular. Signor Peano, M.
Picard, and M. Theunis, speaking on behalf of Italy,
France, and Belgium, announced, each for his own country,
that they would have nothing to do with devaluating, and
were determined to restore their respective currencies
to their pre-war values. Reform is not likely to come by
joint, simultaneous action. The experts of Genoa recognised
this when they “ventured to suggest” that “a considerable
service will be rendered by that country which first
decides boldly to set the example of securing immediate
stability in terms of gold” by devaluation.
The simple arguments against Deflation fall under two heads.
In the first place, Deflation is not _desirable_, because it effects,
what is always harmful, a change in the existing Standard of Value,
and redistributes wealth in a manner injurious, at the same time, to
business and to social stability. Deflation, as we have already seen,
involves a transference of wealth from the rest of the community
to the _rentier_ class and to all holders of titles to money; just
as inflation involves the opposite. In particular it involves a
transference from all borrowers, that is to say from traders,
manufacturers, and farmers, to lenders, from the active to the
inactive.
But whilst the oppression of the taxpayer for the enrichment of the
_rentier_ is the chief lasting result, there is another, more violent,
disturbance during the period of transition. The policy of gradually
raising the value of a country’s money to (say) 100 per cent above its
present value in terms of goods--I repeat here the arguments of Chapter
I.--amounts to giving notice to every merchant and every manufacturer,
that for some time to come his stock and his raw materials will
steadily depreciate on his hands, and to every one who finances his
business with borrowed money that he will, sooner or later, lose 100
per cent on his liabilities (since he will have to pay back in terms of
commodities twice as much as he has borrowed). Modern business, being
carried on largely with borrowed money, must necessarily be brought to
a standstill by such a process. It will be to the interest of every one
in business to go out of business for the time being; and of every one
who is contemplating expenditure to postpone his orders so long as he
can. The wise man will be he who turns his assets into cash, withdraws
from the risks and the exertions of activity, and awaits in country
retirement the steady appreciation promised him in the value of his
cash. A probable expectation of Deflation is bad enough; a certain
expectation is disastrous. For the mechanism of the modern business
world is even less adapted to fluctuations in the value of money
upwards than it is to fluctuations downwards.
In the second place, in many countries, Deflation, even were it
desirable, is not _possible_; that is to say, Deflation in sufficient
degree to restore the currency to its pre-war parity. For the burden
which it would throw on the taxpayer would be insupportable. I need
add nothing on this to what I have already written in the second
chapter above. This practical impossibility might have rendered the
policy innocuous, if it were not that, by standing in the way of the
alternative policy, it prolongs the period of uncertainty and severe
seasonal fluctuation, and even, in some cases, can be carried into
effect sufficiently to cause much interference with business. The fact,
that the restoration of their currencies to the pre-war parity is still
the declared official policy of the French and Italian Governments, is
preventing, in those countries, any rational discussion of currency
reform. All those--and in the financial world they are many--who
have reasons for wishing to appear “correct,” are compelled to talk
foolishly. In Italy, where sound economic views have much influence
and which may be nearly ripe for currency reform, Signor Mussolini has
threatened to raise the lira to its former value. Fortunately for the
Italian taxpayer and Italian business, the lira does not listen even to
a dictator and cannot be given castor oil. But such talk can postpone
positive reform; though it may be doubted if so good a politician would
have propounded such a policy, even in bravado and exuberance, if he
had understood that, expressed in other but equivalent words, it was
as follows: “My policy is to halve wages, double the burden of the
National Debt, and to reduce by 50 per cent the prices which Sicily can
get for her exports of oranges and lemons.”
One single country--Czechoslovakia--has made the experiment on a modest
but sufficient scale. Comparatively free from the burden of internal
debt, and free also from serious budgetary deficits, Czechoslovakia was
able in the course of 1922, in pursuance of the policy of her Finance
Minister, Dr. Alois Rasin, to employ the proceeds of certain foreign
loans to improve the exchange value of the Czech crown to nearly three
times the rate which had been touched in the previous year. The policy
has cost her an industrial crisis and serious unemployment. To what
purpose? I do not know. Even now the Czech crown is not worth a sixth
of its pre-war parity; and it remains unstabilised, fluttering before
the breath of the seasons and the wind of politics. Is, therefore, the
process of appreciation to continue indefinitely? If not, when and at
what point is stabilisation to be effected? Czechoslovakia was better
placed than any country in Europe to establish her economic life on the
basis of a sound and fixed currency. Her finances were in equilibrium,
her credit good, her foreign resources adequate, and no one could have
blamed her for devaluating the crown, ruined by no fault of hers and
inherited from the Habsburg Empire. Pursuing a misguided policy in a
spirit of stern virtue, she preferred the stagnation of her industries
and a still fluctuating standard.[41]
[41] I cannot criticise the work, in his second term of
office (1922), of Dr. Rasin, now fallen by the hand of
an assassin, without reference to his great achievement
during his first term (1919) in rescuing his country’s
currency from the surrounding chaos. The stamping of the
Austrian notes and the levy on holders of titles to money
which accompanied it was the only drastic, courageous, and
successful measure of finance carried through anywhere in
Europe at that epoch; the story of it from Dr. Rasin’s
own pen can be read in his _The Financial Policy of
Czecho-Slovakia_. Before he had finished other influences
became dominant. But, when in 1922 this austere and
disinterested Minister returned to office, he missed, in my
judgment, his opportunity. He could have completed his task
by establishing the currency on a fixed and stable basis,
instead of which he used his great authority to disorder
trade by a futile process of Deflation.
* * * * *
If the restoration of many European currencies to their pre-war parity
with gold is neither desirable nor possible, what are the forces or the
arguments which have established this undesirable impossibility as the
avowed policy of most of them? The following are the most important:
1. _To leave the gold value of a country’s currency at the low level
to which war has driven it is an injustice to the_ rentier _class and
to others whose income is fixed in terms of currency, and practically
a breach of contract; whilst to restore its value would meet a debt of
honour._
The injury done to pre-war holders of fixed interest-bearing stocks is
beyond dispute. Real justice, indeed, might require the restoration
of the purchasing power, and not merely the gold value, of their
money incomes, a measure which no one in fact proposes; whilst nominal
justice has not been infringed, since these investments were not in
gold bullion but in the legal tender of the realm. Nevertheless, if
this class of investors could be dealt with separately, considerations
of equity and the expedience of satisfying reasonable expectation would
furnish a strong case.
But this is not the actual situation. The vast issues of War Loans have
swamped the pre-war holdings of fixed interest-bearing stocks, and
society has largely adjusted itself to the new situation. To restore
the value of pre-war holdings by Deflation means enhancing at the
same time the value of war and post-war holdings, and thereby raising
the total claims of the _rentier_ class not only beyond what they are
entitled to, but to an intolerable proportion of the total income of
the community. Indeed justice, rightly weighed, comes down on the
other side. Much the greater proportion of the money contracts still
outstanding were entered into when money was worth more nearly what
it is worth now than what it was worth in 1913. Thus, in order to do
justice to a minority of creditors, a great injustice would be done to
a great majority of debtors.
This aspect of the matter has been admirably argued by Professor Irving
Fisher.[42] We forget, he says, that not all contracts require the
same adjustment in order to secure justice, and that while we are
debating whether we ought to deflate to secure ideal justice for those
who made contracts on old price levels, new contracts are constantly
being made at the new price levels. An estimate of the volume of
contracts now outstanding, classified according to their age, would
show that some contracts are a day old, some are a month old, some are
a year old, some are a decade old, and some are a century old, the
great mass, however, being of very recent origin. Consequently the
average, or centre of gravity, of the total existing indebtedness is
probably always somewhat near the present. Before the war, Professor
Fisher estimated, very roughly, that contracts in the United States
were on the average about one year old.
[42] In his article “Devaluation versus Deflation,” published
in the eleventh _Manchester Guardian_ Reconstruction
Supplement (Dec. 7, 1922).
When, therefore, the depreciation of the currency has lasted long
enough for society to adjust itself to the new values, Deflation is
even worse than Inflation. Both are “unjust” and disappoint reasonable
expectation. But whereas Inflation, by easing the burden of national
debt and stimulating enterprise, has a little to throw into the other
side of the balance, Deflation has nothing.
2. _The restoration of a currency to its pre-war gold value enhances a
country’s financial prestige and promotes future confidence._
Where a country can hope to restore its pre-war parity at an early
date, this argument cannot be neglected. This might be said of Great
Britain, Holland, Sweden, Switzerland, and (perhaps) Spain, but of
no other European country. The argument cannot be extended to those
countries which, even if they could raise somewhat the value of their
legal-tender money, could not possibly restore it to its old value.
It is of the essence of the argument that the _exact_ pre-war parity
should be recovered. It would not make much difference to the financial
prestige of Italy whether she stabilised the lira at 100 to the £
sterling or at 60; and it would be much better for her prestige to
stabilise it definitely at 100 than to let it fluctuate between 60 and
100.
This argument is limited, therefore, to those countries the gold value
of whose currencies is within (say) 5 or 10 per cent of their former
value. Its force in these cases depends, I think, upon what answer
we give to the problem discussed below, namely, whether we intend
to pin ourselves in the future, as in the past, to an unqualified
gold standard. If we still prefer such a standard to any available
alternative, and if future “confidence” in our currency is to depend
not on the stability of its purchasing power but on the fixity of its
gold-value, then it may be worth our while to stand the racket of
Deflation to the extent of 5 or 10 per cent. This view is in accordance
with that expressed by Ricardo in analogous circumstances a hundred
years ago.[43] If, on the other hand, we decide to aim for the future
at stability of the price level rather than at a fixed parity with
gold, in that case _cadit quaestio_.
[43] See below, p. 153.
In any case this argument does not affect our main conclusion, that
the right policy for countries of which the currency has suffered a
prolonged and severe depreciation is to _devaluate_, and to fix the
value of the currency at that figure in the neighbourhood of the
existing value to which commerce and wages are adjusted.
3. _If the gold value of a country’s currency can be increased,
labour will profit by a reduced cost of living, foreign goods will be
obtainable cheaper, and foreign debts fixed in terms of gold_ (e.g. _to
the United States) will be discharged with less effort._
This argument, which is pure delusion, exercises quite as much
influence as the other two. If the franc is worth more, wages, it is
argued, which are paid in francs, will surely buy more, and French
imports, which are paid for in francs, will be so much cheaper. No!
If francs are worth more they will buy more labour as well as more
goods,--that is to say, wages will fall; and the French exports, which
pay for the imports, will, measured in francs, fall in value just as
much as the imports. Nor will it make in the long run any difference
whatever in the amount of goods the value of which England will have
to transfer to America to pay her dollar debts, whether in the end
sterling settles down at four dollars to the pound, or at its pre-war
parity. The burden of this debt depends on the value of gold, in terms
of which it is fixed, not on the value of sterling. It is not easy, it
seems, for men to apprehend that their money is a mere intermediary,
without significance in itself, which flows from one hand to another,
is received and is dispensed, and disappears when its work is done from
the sum of a nation’s wealth.
* * * * *
In concluding this section, let me quote on the issue between Deflation
and Devaluation two classic authorities, Gibbon and Ricardo, the one
to represent the imposing but false wisdom of the would-be upright
statesman, the other to speak in clear tones the voice of instructed
reason.
In the eleventh chapter of _The Decline and Fall_, Gibbon deems
incredible a story of how in A.D. 274 Aurelian’s deflationary zeal to
restore the integrity of the coin excited an insurrection which caused
the death of 7000 soldiers. “We might naturally expect,” he says, “that
the reformation of the coin should have been an action equally popular
with the destruction of those obsolete accounts, which by the emperor’s
order were burnt in the forum of Trajan. In an age when the principles
of commerce were so imperfectly understood, the most desirable end
might perhaps be effected by harsh and injudicious means; but a
temporary grievance of such a nature can scarcely excite and support
a serious civil war. The repetition of intolerable taxes, imposed
either on the land or on the necessaries of life, may at last provoke
those who will not or who cannot relinquish their country. But the case
is far otherwise in every operation which, by whatsoever expedients,
restores the just value of money.”
Rome may have understood the principles of commerce imperfectly in
the third century and not perfectly in the twentieth; but that does
not save her citizens from experiencing their applications. Signor
Mussolini might peruse with interest the annals of Aurelian, who,
“ignorant or impatient of the restraints of civil institutions,”
fell by the hand of an assassin within a year of his deflation of
the currency, “regretted by the army, detested by the Senate, but
universally acknowledged as a warlike and fortunate prince, the useful
though severe reformer of a degenerate State.”
Ricardo, speaking in the House of Commons on the 12th of June 1822,[44]
gave his opinion that: “If in the year 1819 the value of the currency
had stood at 14s. for the pound note, which was the case in the year
1813, he should have thought that, on a balance of all the advantages
and disadvantages of the case, it would have been as well to fix the
currency at the then value, according to which most of the existing
contracts had been made; but when the currency was within 5 per cent of
its par value, he thought they had made the best selection in recurring
to the old standard.”
[44] The great debate of June 11 and 12, 1822, on Mr. Western’s
Motion concerning the Resumption of Cash Payments, well
illustrates, more particularly in the speeches of the
opener, Mr. Western, and of the opposer, Mr. Huskisson, the
regularity of the evils which follow a deflationary raising
of the standard, and the unchanging antithesis between the
temperaments of deflationists and devaluers, though I doubt
if any present-day deflationists could make a speech at the
same time so able and so unfair as Mr. Huskisson’s.
The same is repeated in his _Protection to Agriculture_[45] where he
approves the restoration of the old standard when gold was £4 : 2s. per
standard ounce, but adds that, if it had been £5 : 10s., “no measure
could have been more inexpedient than to make so violent a change in
all subsisting engagements.”
[45] Works, p. 468.
II. _Stability of Prices_ versus _Stability of Exchange_.
Since, subject to the qualification of Chapter III., the rate of
exchange of a country’s currency with the currency of the rest of
the world (assuming for the sake of simplicity that there is only
one external currency) depends on the relation between the internal
price level and the external price level, it follows that the exchange
cannot be stable unless _both_ internal _and_ external price levels
remain stable. If, therefore, the external price level lies outside our
control, we must submit either to our own internal price level or to
our exchange being pulled about by external influences. If the external
price level is unstable, we cannot keep _both_ our own price level
_and_ our exchanges stable. And we are compelled to choose.
In pre-war days, when almost the whole world was on a gold standard,
we had all plumped for stability of exchange as against stability of
prices, and we were ready to submit to the social consequences of a
change of price level for causes quite outside our control, connected,
for example, with the discovery of new gold mines in foreign countries
or a change of banking policy abroad. But we submitted, partly because
we did not dare trust ourselves to a less automatic (though more
reasoned) policy, and partly because the price fluctuations experienced
were in fact moderate. Nevertheless, there were powerful advocates of
the other choice. In particular, the proposals of Professor Irving
Fisher for a Compensated Dollar, amounted, unless all countries adopted
the same plan, to putting into practice a preference for stability of
internal price level over stability of external exchange.
The right choice is not necessarily the same for all countries. It
must partly depend on the relative importance of foreign trade in the
economic life of the country. Nevertheless, there does seem to be in
almost every case a presumption in favour of the stability of prices,
if only it can be achieved. Stability of exchange is in the nature of
a convenience which adds to the efficiency and prosperity of those
who are engaged in foreign trade. Stability of prices, on the other
hand, is profoundly important for the avoidance of the various evils
described in Chapter I. Contracts and business expectations, which
presume a stable exchange, must be far fewer, even in a trading country
such as England, than those which presume a stable level of internal
prices. The main argument to the contrary seems to be that exchange
stability is an easier aim to attain, since it only requires that the
same standard of value should be adopted at home and abroad; whereas an
internal standard, so regulated as to maintain stability in an index
number of prices, is a difficult scientific innovation, never yet put
into practice.
There has been an interesting example recently of a country which,
more perhaps by chance than by design, has secured the advantages
of a relatively stable level of internal prices at the expense of a
fluctuating exchange, namely India. Public attention is so much fixed
on the exchange as the test of the success of a financial policy, that
the Government of India, under severe reproaches for what has happened,
have not defended themselves as effectively as they might. During the
boom of 1919–20, when world prices were soaring, the exchange value of
the rupee was allowed to rise by successive stages, with the result
that the highest level reached by the Indian index number in 1920
exceeded by only 12 per cent the average figure for 1919, whereas for
England the figure was 29 per cent. The Report of the Indian Currency
Committee, on which the Government of India acted somewhat clumsily
without enough allowance for rapidly changing conditions, was avowedly
influenced by the importance in such a country as India, especially in
the political circumstances of that time, of avoiding a violent upward
movement of internal prices. The most just criticism of the Government
of India’s action, in the light of after-events, is that they went too
far in attempting to raise the rupee so high as 2s. 8d.,--a rate not
contemplated by the Currency Committee. Prices outside India never rose
so high as to justify an exchange exceeding 2s. 3d. on the criterion of
keeping Indian prices stable at the 1919 level. On the other hand, when
world prices collapsed, the rupee exchange was allowed to fall with
them, again with the result that the lowest point touched by the Indian
index number in 1921 was only 16 per cent below the highest in 1920,
whereas for England the figure was 50 per cent. The following table
gives the details:
+--------------+----------+------------+-----------------------------+
| | | | Value of Rupee in Sterling. |
| | Indian | English +--------------+--------------+
| | Prices. |Prices.[46] | Purchasing | Actual |
| | | | Power Parity.| Exchange. |
+--------------+----------+------------+--------------+--------------+
| Average 1919 | 100 | 100 | 100 | 100 |
| Highest 1920 | 112 | 129 | 115 | 152 |
| Lowest 1921 | 95 | 65 | 69 | 72 |
| Average 1922 | 90 | 64 | 71 | 74 |
+--------------+----------+------------+--------------+--------------+
[46] _Statist._
If the Government of India had been successful in stabilising the
rupee-sterling exchange, they would necessarily have subjected India to
a disastrous price fluctuation comparable to that in England. Thus the
unthinking assumption, in favour of the restoration of a fixed exchange
as the one thing to aim at, requires more examination than it sometimes
receives.
Especially is this the case if the prospect that a majority of
countries will adopt the same standard is still remote. When by
adopting the gold standard we could achieve stability of exchange
with almost the whole world, whilst any other standard would have
appeared as a solitary eccentricity, the solid advantages of certainty
and convenience supported the conservative preference for gold.
Nevertheless, even so, the convenience of traders and the primitive
passion for solid metal might not, I think, have been adequate
to preserve the dynasty of gold, if it had not been for another,
half-accidental circumstance; namely, that for many years past gold had
afforded not only a stable exchange but, on the whole, a stable price
level also. In fact, the choice between stable exchanges and stable
prices had not presented itself as an acute dilemma. And when, prior to
the development of the South African mines, we seemed to be faced with
a continuously falling price level, the fierceness of the bimetallic
controversy testified to the discontent provoked as soon as the
existing standard appeared seriously incompatible with the stability of
prices.
Indeed, it is doubtful whether the pre-war system for regulating the
international flow of gold would have been capable of dealing with such
large or sudden divergencies between the price levels of different
countries as have occurred lately. The fault of the pre-war régime,
under which the rates of exchange between a country and the outside
world were fixed, and the internal price level had to adjust itself
thereto (_i.e._ was chiefly governed by external influences), was that
it was too slow and insensitive in its mode of operation. The fault
of the post-war régime, under which the price level mainly depends on
internal influences (_i.e._ internal currency and credit policy) and
the rates of exchange with the outside world have to adjust themselves
thereto, is that it is too rapid in its effect and over-sensitive, with
the result that it may act violently for merely transitory causes.
Nevertheless, when the fluctuations are large and sudden, a quick
reaction is necessary for the maintenance of equilibrium; and the
necessity for quick reaction has been one of the factors which have
rendered the pre-war method inapplicable to post-war conditions, and
have made every one nervous of proclaiming a final fixation of the
exchange.
We are familiar with the causal chain along which the pre-war method
reached its result. If gold flowed out of the country’s central
reserves, this modified discount policy and the creation of credit,
thus affecting the demand for, and hence the price of, the class of
goods most sensitive to the ease of credit, and gradually, through the
price of these goods, spreading its influence to the prices of goods
generally, including those which enter into international trade, until
at the new level of price foreign goods began to look dear at home and
domestic goods cheap abroad, and the adverse balance was redressed. But
this process might take months to work itself out. Nowadays, the gold
reserves might be dangerously depleted before the compensating forces
had time to operate. Moreover, the movement of the rate of interest
up or down sometimes had more effect in attracting foreign capital
or encouraging investment abroad than in influencing home prices.
Where the disequilibrium was purely seasonal, this was an unqualified
advantage; for it was much better that foreign funds should ebb and
flow between the slack and the busy seasons than that prices should
go up and down. But where it was due to more permanent causes, the
adjustment even before the war might be imperfect; for the stimulus to
foreign loans, whilst restoring the balance for the time being, might
obscure the real seriousness of the situation, and enable a country
to live beyond its resources for a considerable time at the risk of
ultimate default.
Compare with this the instantaneous effects of the post-war method. If
at the existing rate of exchange the amount of sterling offered in the
exchange market during the course of the morning exceeds the amount
of dollars offered, there is no gold available for export at a fixed
price to bridge the gulf. Consequently the dollar rate of exchange must
move until at the new rate the offerings of each of the two currencies
in exchange for one another exactly balance in amount. But it is the
inevitable result of this that within half an hour the relative prices
of commodities entering into English-American trade, such as cotton
and electrolytic copper, have adjusted themselves accordingly. Unless
the American prices move to meet them half-way, the English prices
immediately rise correspondent to the movement of the exchange.
This means that relative prices can be knocked about by the most
fleeting influences of politics and of sentiment, and by the periodic
pressure of seasonal trades. But it also means that the post-war method
is a most rapid and powerful corrective of real disequilibria in the
balance of international payments arising from whatever causes, and
a wonderful preventive in the way of countries which are inclined to
spend abroad beyond their resources.
Thus when there are violent shocks to the pre-existing equilibrium
between the internal and external price-levels, the pre-war method is
likely to break down in practice, simply because it cannot bring about
the re-adjustment of internal prices _quick enough_. Theoretically,
of course, the pre-war method must be able to make itself effective
sooner or later, provided the movement of gold is allowed to continue
without restriction, until the inflation or deflation of prices has
taken place to the necessary extent. But in practice there is usually a
limit to the rate and to the amount by which the actual currency or the
metallic backing for it can be allowed to flow abroad. If the supply of
money or credit is reduced faster than social and business arrangements
allow prices to fall, intolerable inconveniences result. Perhaps some
of the incidents of debasement of the coinage which are sprinkled
through the currency history of the late Middle Ages were really due to
a similar cause. Prior to the discovery of the New World the precious
metals were, over a long period, becoming progressively scarcer in
Europe through natural wastage in the absence of adequate new supplies,
and the drain to the East; with the result that from time to time the
price level in England (for example) would be established on too high a
level in relation to European prices. The resulting tendency of silver
to flow abroad, being accentuated perhaps by some special temporary
cause, would give rise to complaints of a “scarcity of currency,”
which really means an outflow of money faster than social organisation
permits prices to fall. No doubt some of the debasements were helped
by the fact that they profited incidentally a necessitous Exchequer.
But they may have been, nevertheless, the best available expedient
for meeting the currency problem.[47] We shall look on Edward III.’s
debasements of sterling money with a more tolerant eye if we regard
them as a method of carrying into effect a preference for stability
of internal prices over stability of external exchanges, celebrating
that monarch as an enlightened forerunner of Professor Irving Fisher in
advocacy of the “compensated dollar,” only more happy than the latter
in his opportunities to carry theory into practice.
[47] Cf. Hawtrey, _Currency and Credit_, chap. xvii.
The reader should notice, further, the different parts played by
discount policy under the one régime and under the other. With the
pre-war method discount policy is a vital part of the process for
restoring equilibrium between internal and external prices. With the
post-war method it is not equally indispensable, since the fluctuation
of the exchanges can bring about equilibrium without its aid;--though
it remains, of course, as an instrument for influencing the internal
price level and through this the exchanges, if we desire to establish
either the one or the other at a different level from that which would
have prevailed otherwise.
III. _The Restoration of a Gold Standard._
Our conclusions up to this point are, therefore, that, when stability
of the internal price level and stability of the external exchanges
are incompatible, the former is generally preferable; and that on
occasions when the dilemma is acute, the preservation of the former at
the expense of the latter is, fortunately perhaps, the line of least
resistance.
The restoration of the gold standard (whether at the pre-war parity or
at some other rate) certainly will not give us complete stability of
internal prices and can only give us complete stability of the external
exchanges if all other countries also restore the gold standard. The
advisability of restoring it depends, therefore, on whether, on the
whole, it will give us the best working compromise obtainable between
the two ideals.
The advocates of gold, as against a more scientific standard, base
their cause on the double contention, that in practice gold has
provided and will provide a reasonably stable standard of value, and
that in practice, since governing authorities lack wisdom as often
as not, a managed currency will, sooner or later, come to grief.
Conservatism and scepticism join arms--as they often do. Perhaps
superstition comes in too; for gold still enjoys the prestige of its
smell and colour.
The considerable success with which gold maintained its stability of
value in the changing world of the nineteenth century was certainly
remarkable. I have applauded it in the first chapter. After the
discoveries of Australia and California it began to depreciate
dangerously, and before the exploitation of South Africa it began to
appreciate dangerously. Yet in each case it righted itself and retained
its reputation.
But the conditions of the future are not those of the past. We have
no sufficient ground for expecting the continuance of the special
conditions which preserved a sort of balance before the war. For what
are the underlying explanations of the good behaviour of gold during
the nineteenth century?
In the first place, it happened that progress in the discovery of
gold mines roughly kept pace with progress in other directions--a
correspondence which was not altogether a matter of chance, because
the progress of that period, since it was characterised by the gradual
opening up and exploitation of the world’s surface, not unnaturally
brought to light _pari passu_ the remoter deposits of gold. But this
stage of history is now almost at an end. A quarter of a century
has passed by since the discovery of an important deposit. Material
progress is more dependent now on the growth of scientific and
technical knowledge, of which the application to gold-mining may be
intermittent. Years may elapse without great improvement in the methods
of extracting gold; and then the genius of a chemist may realise past
dreams and forgotten hoaxes, transmuting base into precious like
Subtle, or extracting gold from sea-water as in the Bubble. Gold is
liable to be either too dear or too cheap. In either case, it is too
much to expect that a succession of accidents will keep the metal
steady.
But there was another type of influence which used to aid stability.
The value of gold has not depended on the policy or the decisions of
a single body of men; and a sufficient proportion of the supply has
been able to find its way, without any flooding of the market, into the
Arts or into the hoards of Asia for its marginal value to be governed
by a steady psychological estimation of the metal in relation to other
things. This is what is meant by saying that gold has “intrinsic value”
and is free from the dangers of a “managed” currency. The _independent
variety_ of the influences determining the value of gold has been in
itself a steadying influence. The arbitrary and variable character
of the proportion of gold reserves to liabilities maintained by many
of the note-issuing banks of the world, so far from introducing an
incalculable factor, was an element of stability. For when gold was
relatively abundant and flowed towards them, it was absorbed by their
allowing their ratio of gold reserves to rise slightly; and when it
was relatively scarce, the fact that they had no intention of ever
utilising their gold reserves for any practical purpose, permitted
most of them to view with equanimity a moderate weakening of their
proportion. A great part of the flow of South African gold between the
end of the Boer War and 1914 was able to find its way into the central
gold reserves of European and other countries with the minimum effect
on prices.
But the war has effected a great change. Gold itself has become a
“managed” currency. The West, as well as the East, has learnt to hoard
gold; but the motives of the United States are not those of India.
Now that most countries have abandoned the gold standard, the supply
of the metal would, if the chief user of it restricted its holdings
to its real needs, prove largely redundant. The United States has not
been able to let gold fall to its “natural” value, because it could
not face the resulting depreciation of its standard. It has been
driven, therefore, to the costly policy of burying in the vaults of
Washington what the miners of the Rand have laboriously brought to the
surface. Consequently gold now stands at an “artificial” value, the
future course of which almost entirely depends on the policy of the
Federal Reserve Board of the United States. The value of gold is no
longer the resultant of the chance gifts of Nature and the judgment
of numerous authorities and individuals acting independently. Even if
other countries gradually return to a gold basis, the position will
not be greatly changed. The tendency to employ some variant of the
gold-exchange standard and the probably permanent disappearance of gold
from the pockets of the people are likely to mean that the strictly
_necessary_ gold reserves of the Central Banks of the gold-standard
countries will fall considerably short of the available supplies. The
actual value of gold will depend, therefore, on the policy of three or
four of the most powerful Central Banks, whether they act independently
or in unison. If, on the other hand, pre-war conventions about the use
of gold in reserves and in circulation were to be restored--which is,
in my opinion, the much less probable alternative--there might be, as
Professor Cassel has predicted, a serious shortage of gold leading to a
progressive appreciation in its value.
Nor must we neglect the possibility of a partial demonetisation of gold
by the United States through a closing of its mints to further receipts
of gold. The present policy of the United States in accepting unlimited
imports of gold can be justified, perhaps, as a temporary measure,
intended to preserve tradition and to strengthen confidence through
a transitional period. But, looked at as a permanent arrangement, it
could hardly be judged otherwise than as a foolish expense. If the
Federal Reserve Board intends to maintain the value of the dollar at
a level which is irrespective of the inflow or outflow of gold, what
object is there in continuing to accept at the mints gold which is not
wanted, yet costs a heavy price? If the United States mints were to be
closed to gold, everything, except the actual price of the metal, could
continue precisely as before.
Confidence in the future stability of the value of gold depends
therefore on the United States being foolish enough to go on accepting
gold which it does not want, and wise enough, having accepted it, to
maintain it at a fixed value. This double event might be realised
through the collaboration of a public understanding nothing with a
Federal Reserve Board understanding everything. But the position is
precarious; and not very attractive to any country which is still in a
position to choose what its future standard is to be.
This discussion of the prospects of the stability of gold has partly
answered by anticipation the second principal argument in favour of the
restoration of an unqualified gold standard, namely that this is the
only way of avoiding the dangers of a “managed” currency.
It is natural, after what we have experienced, that prudent people
should desiderate a standard of value which is independent of Finance
Ministers and State Banks. The present state of affairs has allowed
to the ignorance and frivolity of statesmen an ample opportunity of
bringing about ruinous consequences in the economic field. It is felt
that the general level of economic and financial education amongst
statesmen and bankers is hardly such as to render innovations feasible
or safe; that, in fact, a chief object of stabilising the exchanges is
to strap down Ministers of Finance.
These are reasonable grounds of hesitation. But the experience on which
they are based is by no means fair to the capacities of statesmen and
bankers. The non-metallic standards, of which we have experience, have
been anything rather than scientific experiments coolly carried out.
They have been a last resort, involuntarily adopted, as a result of war
or inflationary taxation, when the State finances were already broken
or the situation out of hand. Naturally in these circumstances such
practices have been the accompaniment and the prelude of disaster. But
we cannot argue from this to what can be achieved in normal times. I
do not see that the regulation of the standard of value is essentially
more difficult than many other objects of less social necessity which
we attain successfully.
If, indeed, a providence watched over gold, or if Nature had provided
us with a stable standard ready-made, I would not, in an attempt after
some slight improvement, hand over the management to the possible
weakness or ignorance of Boards and Governments. But this is not the
situation. We have no ready-made standard. Experience has shown that
in emergencies Ministers of Finance cannot be strapped down. And--most
important of all--in the modern world of paper currency and bank credit
there is no escape from a “managed” currency, whether we wish it or
not;--convertibility into gold will not alter the fact that the value
of gold itself depends on the policy of the Central Banks.
It is worth while to pause a moment over the last sentence. It differs
significantly from the doctrine of gold reserves which we learnt and
taught before the war. We used to assume that no Central Bank would be
so extravagant as to keep more gold than it required or so imprudent
as to keep less. From time to time gold would flow out into the
circulation or for export abroad; experience showed that the quantity
required on these occasions bore some rough proportion to the Central
Bank’s liabilities; a decidedly higher proportion than this would be
fixed on to provide for contingencies and to inspire confidence; and
the creation of credit would be regulated largely by reference to the
maintenance of this proportion. The Bank of England, for example,
would allow itself to be swayed by the tides of gold, permitting
the inflowing and outflowing streams to produce their “natural”
consequences unchecked by any ideas as to preventing the effect on
prices. Already before the war, the system was becoming precarious by
reason of its artificiality. The “proportion” was by the lapse of time
losing its relation to the facts and had become largely conventional.
Some other figure, greater or less, would have done just as well.[48]
The War broke down the convention; for the withdrawal of gold from
actual circulation destroyed one of the elements of reality lying
behind the convention, and the suspension of convertibility destroyed
the other. It would have been absurd to regulate the bank rate by
reference to a “proportion” which had lost all its significance; and
in the course of the past ten years a new policy has been evolved. The
bank rate is now employed, however incompletely and experimentally,
to regulate the expansion and deflation of credit in the interests of
business stability and the steadiness of prices. In so far as it is
employed to procure stability of the dollar exchange, where this is
inconsistent with stability of internal prices, we have a relic of
pre-war policy and a compromise between discrepant aims.
[48] _Vide_, for what I wrote about this in 1914, _The Economic
Journal_, xxiv. p. 621.
Those who advocate the return to a gold standard do not always
appreciate along what different lines our actual practice has been
drifting. If we restore the gold standard, are we to return also to the
pre-war conceptions of bank-rate, allowing the tides of gold to play
what tricks they like with the internal price-level, and abandoning the
attempt to moderate the disastrous influence of the credit-cycle on the
stability of prices and employment? Or are we to continue and develop
the experimental innovations of our present policy, ignoring the “bank
ratio” and, if necessary, allowing unmoved a piling up of gold reserves
far beyond our requirements or their depletion far below them?
In truth, the gold standard is already a barbarous relic. All of us,
from the Governor of the Bank of England downwards, are now primarily
interested in preserving the stability of business, prices, and
employment, and are not likely, when the choice is forced on us,
deliberately to sacrifice these to the out-worn dogma, which had its
value once, of £3 : 17 : 10½ per ounce. Advocates of the ancient
standard do not observe how remote it now is from the spirit and the
requirements of the age. A regulated non-metallic standard has slipped
in unnoticed. _It exists._ Whilst the economists dozed, the academic
dream of a hundred years, doffing its cap and gown, clad in paper rags,
has crept into the real world by means of the bad fairies--always so
much more potent than the good--the wicked Ministers of Finance.
For these reasons enlightened advocates of the restoration of gold,
such as Mr. Hawtrey, do not welcome it as the return of a “natural”
currency, and intend, quite decidedly, that it shall be a “managed”
one. They allow gold back only as a constitutional monarch, shorn of
his ancient despotic powers and compelled to accept the advice of a
Parliament of Banks. The adoption of the ideas present in the minds of
those who drafted the Genoa Resolutions on Currency is an essential
condition of Mr. Hawtrey’s adherence to gold. He contemplates “the
practice of continuous co-operation among central banks of issue” (Res.
3), and an international convention, based on a gold exchange standard,
and designed “with a view to preventing undue fluctuations in the
purchasing power of gold” (Res. 11).[49] But he is _not_ in favour of
resuming the gold standard irrespective of “whether the difficulties
in regard to the future purchasing power of gold have been provided
against or not.” “It is not easy,” he admits, “to promote international
action, and should it fail, the wisest course for the time being
might be to concentrate on the stabilisation of sterling in terms of
commodities, rather than tie the pound to a metal, the vagaries of
which cannot be foreseen.”[50]
[49] _Monetary Reconstruction_, p. 132.
[50] _Loc. cit._ p. 22.
It is natural to ask, in face of advocacy of this kind, why it is
necessary to drag in gold at all. Mr. Hawtrey lays no stress on the
obvious support for his compromise, namely the force of sentiment and
tradition, and the preference of Englishmen for shearing a monarch of
his powers rather than of his head. But he adduces three other reasons:
(1) that gold is required as a liquid reserve for the settlement
of international balances of indebtedness; (2) that it enables an
experiment to be made without cutting adrift from the old system; and
(3) that the vested interests of gold producers must be considered.
These objects, however, are so largely attained by my own suggestions
in the following chapter, that I need not dwell on them here.
On the other hand, I see grave objections to reinstating gold in the
pious hope that international co-operation will keep it in order. With
the existing distribution of the world’s gold, the reinstatement of
the gold standard means, inevitably, that we surrender the regulation
of our price level and the handling of the credit cycle to the Federal
Reserve Board of the United States. Even if the most intimate and
cordial co-operation is established between the Board and the Bank of
England, the preponderance of power will still belong to the former.
The Board will be in a position to disregard the Bank. But if the Bank
disregard the Board, it will render itself liable to be flooded with,
or depleted of, gold, as the case may be. Moreover, we can be confident
beforehand that there will be much suspicion amongst Americans (for
that is their disposition) of any supposed attempt on the part of
the Bank of England to dictate their policy or to influence American
discount rates in the interests of Great Britain. We must also be
prepared to incur our share of the vain expense of bottling up the
world’s redundant gold.
It would be rash in present circumstances to surrender our freedom of
action to the Federal Reserve Board of the United States. We do not
yet possess sufficient experience of its capacity to act in times of
stress with courage and independence. The Federal Reserve Board is
striving to free itself from the pressure of sectional interests; but
we are not yet certain that it will wholly succeed. It is still liable
to be overwhelmed by the impetuosity of a cheap money campaign. A
suspicion of British influence would, so far from strengthening the
Board, greatly weaken its resistance to popular clamour. Nor is it
certain, quite apart from weakness or mistakes, that the simultaneous
application of the same policy will always be in the interests of
both countries. The development of the credit cycle and the state of
business may sometimes be widely different on the two sides of the
Atlantic.
Therefore, since I regard the stability of prices, credit, and
employment as of paramount importance, and since I feel no confidence
that an old-fashioned gold standard will even give us the modicum of
stability that it used to give, I reject the policy of restoring the
gold standard on pre-war lines. At the same time I doubt the wisdom of
attempting a “managed” gold standard jointly with the United States, on
the lines recommended by Mr. Hawtrey, because it retains too many of
the disadvantages of the old system without its advantages, and because
it would make us too dependent on the policy and on the wishes of the
Federal Reserve Board.