By Author [ A  B  C  D  E  F  G  H  I  J  K  L  M  N  O  P  Q  R  S  T  U  V  W  X  Y  Z |  Other Symbols ]
  By Title [ A  B  C  D  E  F  G  H  I  J  K  L  M  N  O  P  Q  R  S  T  U  V  W  X  Y  Z |  Other Symbols ]
  By Language
all Classics books content using ISYS

Download this book: [ ASCII ]

Look for this book on Amazon

We have new books nearly every day.
If you would like a news letter once a week or once a month
fill out this form and we will give you a summary of the books for that week or month by email.

Title: A Tract on Monetary Reform
Author: Keynes, John Maynard
Language: English
As this book started as an ASCII text book there are no pictures available.
Copyright Status: Not copyrighted in the United States. If you live elsewhere check the laws of your country before downloading this ebook. See comments about copyright issues at end of book.

*** Start of this Doctrine Publishing Corporation Digital Book "A Tract on Monetary Reform" ***

Transcriber’s Note: Italic text is enclosed in _underscores_; boldface
text is enclosed in ~tildes~.



  Pp. viii + 263. 1913.

  ~7s. 6d.~ net.


  Pp. vii + 279. 1919.

  ~8s. 6d.~ net.


  Pp. xi + 466. 1921.

  ~18s.~ net.


  Pp. viii + 223. 1922.

  ~7s. 6d.~ net.
















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._



  PREFACE                                                              v



     I. As Affecting Distribution                                      5

          1. The Investor                                              5

          2. The Business Man                                         18

          3. The Earner                                               27

    II. As Affecting Production                                       32



     1. Inflation as a Method of Taxation                             41

     2. Currency Depreciation _versus_ Capital Levy                   63


  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


  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



     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.]



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.


 |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.


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

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

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

        [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

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

 |      |  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

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

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.


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.



I. _Inflation as a Method of Taxation_

A Government can live for a long time, even the German Government or
the Russian Government, by printing paper money. That is to say, it can
by this means secure the command over real resources,--resources just
as real as those obtained by taxation. The method is condemned, but
its efficacy, up to a point, must be admitted. A Government can live
by this means when it can live by no other. It is the form of taxation
which the public find hardest to evade and even the weakest Government
can enforce, when it can enforce nothing else. Of this character have
been the progressive and catastrophic inflations practised in Central
and Eastern Europe, as distinguished from the limited and oscillatory
inflations, experienced for example in Great Britain and the United
States, which have been examined in the preceding chapter.

The Quantity Theory of Money states that the amount of cash which the
community requires, _assuming certain habits of business and of banking
to be established_, and assuming also a given level and distribution
of wealth, depends on the level of prices. If the consumption and
production of actual goods are unaltered but prices and wages are
doubled, then twice as much cash as before is required to do the
business. The truth of this, properly explained and qualified, it
is foolish to deny. The Theory infers from this that the _aggregate
real value_ of all the paper money in circulation remains more
or less the same, irrespective of the _number of units_ of it in
circulation, provided the habits and prosperity of the people are not
changed,--_i.e._ the community retains in the shape of cash the command
over a more or less constant amount of real wealth, which is the same
thing as to say that the total quantity of money in circulation has a
more or less fixed purchasing power.[9]

        [9] See also Chapter III., Section I.

Let us suppose that there are in circulation 9,000,000 currency notes,
and that they have altogether a value equivalent to 36,000,000 gold
dollars.[10] Suppose that the Government prints a further 3,000,000
notes, so that the amount of currency is now 12,000,000; then, in
accordance with the above theory, the 12,000,000 notes are still only
equivalent to $36,000,000. In the first state of affairs, therefore,
each note = $4, and in the second state of affairs each note = $3.
Consequently the 9,000,000 notes originally held by the public are now
worth $27,000,000 instead of $36,000,000, and the 3,000,000 notes newly
issued by the Government are worth $9,000,000. Thus by the process of
printing the additional notes the Government has transferred from the
public to itself an amount of resources equal to $9,000,000, just as
successfully as if it had raised this sum in taxation.

       [10] It will simplify the argument to ignore the fact that
            the value of gold in terms of commodities is itself a
            fluctuating one, and to treat the value of a currency in
            terms of gold as a rough measure of its value in terms of
            “real resources” generally.

On whom has the tax fallen? Clearly on the holders of the original
9,000,000 notes, whose notes are now worth 25 per cent less than they
were before. The inflation has amounted to a tax of 25 per cent on all
holders of notes in proportion to their holdings. The burden of the tax
is well spread, cannot be evaded, costs nothing to collect, and falls,
in a rough sort of way, in proportion to the wealth of the victim. No
wonder its superficial advantages have attracted Ministers of Finance.

Temporarily, the yield of the tax is even a little better for the
Government than by the above calculation. For the new notes can be
passed off at first at the same value as though there were still only
9,000,000 notes altogether. It is only after the new notes get into
circulation and people begin to spend them that they realise that the
notes are worth less than before.

What is there to prevent the Government from repeating this process
over and over again? The reader must observe that the aggregate note
issue is still worth $36,000,000. If, therefore, the Government now
prints a further 4,000,000 notes, there will be 16,000,000 notes
altogether, which by the same argument as before are worth $2.25 each
instead of $3, and by issuing the 4,000,000 notes the Government has,
just as before, transferred an amount of resources equal to $9,000,000
from the public to itself. The holders of notes have again suffered a
tax of 25 per cent in proportion to their holdings.

Like other forms of taxation, these exactions, if overdone and out of
proportion to the wealth of the community, must diminish its prosperity
and lower its standards, so that at the lower standard of life the
aggregate value of the currency may fall and still be enough to go
round. But this effect cannot interfere very much with the efficacy of
taxing by inflation. Even if the aggregate real value of the currency
falls for these reasons to a half or two-thirds of what it was before,
which represents a tremendous lowering of the standards of life, this
only means that the quantity of notes which the Government must issue
in order to obtain a given result must be raised proportionately. It
remains true that by this means the Government can still secure for
itself a large share of the available surplus of the community.

Has the public in the last resort no remedy, no means of protecting
itself against these ingenious depredations? It has only one
remedy,--to change its habits in the use of money. The initial
assumption on which our argument rested was that the community did
_not_ change its habits in the use of money.

Experience shows that the public generally is very slow to grasp the
situation and embrace the remedy. Indeed, at first there may be a
change of habit in the wrong direction, which actually facilitates the
Government’s operations. The public is so much accustomed to thinking
of money as the ultimate standard, that, when prices begin to rise,
believing that the rise must be temporary, they tend to hoard their
money and to postpone purchases, with the result that they hold in
monetary form a _larger_ aggregate of real value than before. And,
similarly, when the fall in the real value of the money is reflected
in the exchanges, foreigners, thinking that the fall is abnormal and
temporary, purchase the money for the purpose of hoarding it.

But sooner or later the second phase sets in. The public discover that
it is the holders of notes who suffer taxation and defray the expenses
of government, and they begin to change their habits and to economise
in their holding of notes. They can do this in various ways:--(1)
instead of keeping some part of their ultimate reserves in money they
can spend this money on durable objects, jewellery or household goods,
and keep their reserves in this form instead; (2) they can reduce the
amount of till-money and pocket-money that they keep and the average
length of time for which they keep it,[11] even at the cost of great
personal inconvenience; and (3) they can employ foreign money in many
transactions where it would have been more natural and convenient to
use their own.

       [11] In Moscow the unwillingness to hold money except for the
            shortest possible time reached at one period a fantastic
            intensity. If a grocer sold a pound of cheese, he ran off
            with the roubles as fast as his legs could carry him to
            the Central Market to replenish his stocks by changing
            them into cheese again, lest they lost their value before
            he got there; thus justifying the prevision of economists
            in naming the phenomenon “velocity of circulation”! In
            Vienna, during the period of collapse, mushroom exchange
            banks sprang up at every street corner, where you could
            change your krone into Zurich francs within a few minutes
            of receiving them, and so avoid the risk of loss during the
            time it would take you to reach your usual bank. It became
            a seasonable witticism to allege that a prudent man at a
            café ordering a bock of beer should order a second bock at
            the same time, even at the expense of drinking it tepid,
            lest the price should rise meanwhile.

By these means they can get along and do their business with an amount
of notes having an aggregate real value substantially less than
before. For example, the notes in circulation become worth altogether
$20,000,000 instead of $36,000,000, with the result that the next
inflationary levy by the Government, falling on a smaller amount, must
be at a greater rate in order to yield a given sum.

When the public take alarm faster than they can change their habits,
and, in their efforts to avoid loss, run down the amount of real
resources, which they hold in the form of money, _below_ the working
minimum, seeking to supply their daily needs for cash by borrowing,
they get penalised, as in Germany in 1923, by prodigious rates of
money-interest. The rates rise, as we have seen in the previous
chapter, until the rate of interest on money equals or exceeds the
anticipated rate of the depreciation of money. Indeed it is always
likely, when money is rapidly depreciating, that there will be
recurrent periods of scarcity of currency, because the public, in their
anxiety not to hold too much money, will fail to provide themselves
even with the minimum which they will require in practice.

Whilst economists have sometimes described these phenomena in terms of
an increase in the velocity of circulation due to loss of confidence
in the currency; nevertheless there are not, I think, many passages in
economic literature where the matter is clearly analysed. Professor
Cannan’s article on “The Application of the Apparatus of Supply and
Demand to Units of Currency” (_Economic Journal_, December 1921) is
one of the most noteworthy. He points out that the common assumption
that “the elasticity of demand for money is unity” is equivalent to
the assertion that a mere variation in the quantity of money does
not affect the willingness and habits of the public as holders of
purchasing power in that form. But in extreme cases this assumption
does not hold; for if it did, there would be no limit to the sums which
the Government could extract from the public by means of inflation.
It is, therefore, unsafe to assume that the elasticity of demand is
necessarily unity. Professor Lehfeldt followed this up in a subsequent
issue of the _Economic Journal_ (December 1922) by a calculation of
the actual elasticity of demand for money in some recent instances.
He found that between July 1920 and April 1922, the elasticity of
demand for money fell to an average of about ·73 in Austria, ·67 in
Poland, and ·5 in Germany. Thus in the last stages of inflation the
prodigious increase in the velocity of circulation may have as much,
or more, effect in raising prices and depreciating the exchanges than
the increase in the volume of notes. The note-issuing authorities often
cry out against what they regard as the unfair and anomalous fact of
the notes falling in value _more_ than in proportion to their increased
volume. Yet it is nothing of the kind; it is merely the result of the
one method to evade a crushing burden left open to the public, who
discover for themselves, sooner than the financiers, that the law of
unit elasticity in their demand for money can be escaped.

Nevertheless, it is evident that so long as the public use money at
all, the Government can continue to raise resources by inflation.
Moreover, the conveniences of using money in daily life are so great
that the public are prepared, rather than forego them, to pay the
inflationary tax, provided it is not raised to a prohibitive level.
Like other conveniences of life the use of money is taxable, and,
although for various reasons this particular form of taxation is
highly inexpedient, a Government can get resources by a _continuous_
practice of inflation, even when this is foreseen by the public
generally, unless the sums they seek to raise in this way are very
grossly excessive. Just as a toll can be levied on the use of roads or
a turnover tax on business transactions, so also on the use of money.
The higher the toll and the tax, the less traffic on the roads, and
the less business transacted, so also the less money carried. But
some traffic is so indispensable, some business so profitable, some
money-payments so convenient, that only a very high levy will stop
completely all traffic, all business, all payments. A Government has
to remember, however, that even if a tax is not prohibitive it may be
unprofitable, and that a medium, rather than an extreme, imposition
will yield the greatest gain.

Suppose that the rate of inflation is such that the value of the money
falls by half every year, and suppose that the cash used by the public
for retail purchases in shops is turned over 100 times a year (_i.e._
stays in one pocket for half a week on the average); then this is
only equivalent to a turnover tax of ½ per cent on each transaction.
The public will gladly pay such a tax rather than suffer the trouble
and inconvenience of barter with trams and tradesmen. Even if the
value of the money falls by half every month, the public, by keeping
their pocket-money so low that they turn it over once a day on the
average instead of only twice a week, can still keep the tax down to
the equivalent of less than 2 per cent on each transaction, or more
precisely 4d. in the £. Even such a terrific rate of depreciation as
this is not sufficient, therefore, to counterbalance the advantages
of using money rather than barter in the trifling business of daily
life. This is the explanation why, even in Germany and in Russia, the
Government’s notes remained current for many retail transactions.

For certain other purposes, however, to which money is put in a modern
community, the inflationary tax becomes prohibitive at a much earlier
stage. As a store of value, for example, money is rapidly discarded, as
soon as further depreciation is confidently anticipated. As a unit of
account, for contracts and for balance sheets, it quickly becomes worse
than useless, although for such purposes the privilege of the current
money as legal-tender for the discharge of debts stands in the way of
its being discarded as soon as it ought to be.

In the last phase, when the use of the legal-tender money has been
discarded for all purposes except trifling out-of-pocket expenditure,
inflationary taxation has at last defeated itself. For in that case the
total value of the note issue, which is sufficient to meet the public’s
minimum requirements, amounts to a figure relatively so trifling that
the amount of resources which the government can hope to raise by yet
further inflation--without pushing it to a point at which the money
will be discarded even for out-of-pocket trifles--is correspondingly
small. Thus at last, unless it is employed with some measure of
moderation, this potent instrument of governmental exaction breaks in
the hands of those that use it, and leaves them at the same time with
the rest of their fiscal system in total ruins;--out of which, in the
ebb and flow of the economic life of nations, may emerge once more a
reformed and admirable system. The chervonetz of Moscow and the krone
of Vienna are already stabler units than the franc or the lira.

All these matters can be illustrated from the recent experiences of
Germany, Austria, and Russia. The following tables show the gold value
of the note issues of these countries at various dates:

 |                | Volume of Note  |   Number of    |  Value of Note  |
 |    GERMANY.    |Issue in Milliard|  Paper Marks   |Issue in Milliard|
 |                |  Paper Marks.   | = 1 Gold Mark. |   Gold Marks.   |
 | December 1920  |          81     |           17   |      4·8        |
 | December 1921  |         122     |           46   |      2·7        |
 | March 1922     |         140     |           65   |      2·2        |
 | June 1922      |         180     |           90   |      2·0        |
 | September 1922 |         331     |          349   |      0·9        |
 | December 1922  |       1,293     |        1,778   |      0·7        |
 | February 1923  |       2,266     |       11,200   |      0·2        |
 | March 1923     |       4,956     |        4,950   |      1·0        |
 | June 1923      |      17,000     |       45,000   |      0·4        |
 | August 1923    |     116,000     |    1,000,000   |      0·116      |

 |                | Volume of Note  |   Number of    |  Value of Note  |
 |    AUSTRIA.    |Issue in Milliard|  Paper Krone   |Issue in Million |
 |                |  Paper Krone.   |= 1 Gold Krone. |   Gold Krone.   |
 | June 1920      |         17      |         27     |       620       |
 | December 1920  |         30      |         70     |       430       |
 | December 1921  |        174      |        533     |       326       |
 | March 1922     |        304      |      1,328     |       229       |
 | June 1922      |        550      |      2,911     |       189       |
 | September 1922 |      2,278      |     14,473     |       157       |
 | December 1922  |      4,080      |     14,473     |       282       |
 | March 1923     |      4,238      |     14,363     |       295       |
 | August 1923    |      5,557      |     14,369     |       387       |

 |                | Volume of Note  |   Number of    |  Value of Note  |
 |    RUSSIA.     |Issue in Milliard|Paper Roubles[B]|Issue in Million |
 |                | Paper Roubles.  |= 1 Gold Rouble.|  Gold Roubles.  |
 | January 1919   |           61    |          103   |       592       |
 | January 1920   |          225    |        1,670   |       134       |
 | January 1921   |        1,169    |       26,000   |        45       |
 | January 1922   |       17,539    |      172,000   |       102[C]    |
 | March 1922     |       48,535    |    1,060,000   |        46       |
 | May 1922       |      145,635    |    3,800,000   |        38[D]    |
 | July 1922      |      320,497    |    4,102,000   |        78       |
 | October 1922   |      815,486    |    6,964,000   |       117       |
 | January 1923   |    2,138,711    |   15,790,000   |       135       |
 | June 1923      |    8,050,000    |   97,690,000   |        82[E]    |

        [B] “Gosplan” figures for 1923, Moscow Economic Institute
            figures previously.

        [C] The increase is due to the reintroduction of the use of
            money in State transactions as a result of the New Economic

        [D] Lowest point reached.

        [E] The decrease may be attributed to the introduction of the
            chervonetz (see p. 57 below).

The characteristics of each phase emerge clearly. The tables show,
first of all, how quickly, during the period of collapse, the rate
of the depreciation of the value of the money outstrips the rate of
the inflation of its volume. During the collapse of the German mark
beginning with December 1920, the rate of depreciation proceeded
for some time roughly twice as fast as that of the inflation, and
eventually by June 1923, when the volume of the note-issue had
increased 200-fold compared with December 1920, the value of a paper
mark had fallen 2500-fold. The figures given above for Austria begin
at a rather later stage of the _débâcle_. But if we equate Austria in
June 1920 to Germany in December 1920, the progress of events between
that date and September 1922 is roughly comparable to that in Germany
between December 1920 and May 1923. The figures for Russia between
January 1919 and the early part of 1923 also exhibit the same general

These tables all commence after a considerable depreciation had
already occurred and the gold-value of the aggregate note-issue had
fallen considerably below the normal.[12] Nevertheless their earliest
entries still belong to the period when an eventual recovery was still
widely anticipated and the general public had not at all appreciated
what they were in for. They indicate that as the situation develops
from this point onwards and the use of money is discarded except for
retail transactions, the aggregate value of the note-issue falls by
about four-fifths. As the result of extreme panic or depression a
further fall may occur for a time; but, unless the money is discarded
altogether, a minimum is reached eventually from which the least
favourable circumstance will cause a sharp recovery.

       [12] The pre-war currency of Germany was estimated at about 6
            milliard gold marks (£300,000,000), or nearly £5 per head.

The temporary recovery in Germany after the collapse of February 1923
exhibited how a point may come when, if the money is to continue in
use at all, a bottom is reached and a technical position is created in
which some recovery is possible. When the gold value of the currency
has fallen to a very low figure, it is easy for the Government, if
it has any external resources at all, to give sufficient support to
prevent the exchange from falling further for the time being. And since
by that time the public will have carried their attempts to economise
the use of money to a pitch of inconvenience which it is impracticable
to continue, even a moderate weakening in the degree of their distrust
of the future value of the money will lead to some increase in their
use of it; with the result that the aggregate value of the note issue
will tend to recover. By February 1923 these conditions existed in
Germany in a high degree. The German Government was able within two
months, in the face of most adverse political conditions, to double the
exchange-value of the mark whilst simultaneously more than doubling
the note circulation. Even so the gold value of the note issue was
only brought back to what it had been six months earlier; and if even
a moderate degree of confidence had been restored, it might have been
possible to bring the value of the note circulation of Germany up to
(say) 2 milliard gold marks (£100,000,000) at least, which is probably
about the lowest figure at which it can stand permanently, unless every
one is to put himself to intolerable inconvenience in his efforts to
hold as little money as possible. Incidentally the Government is able
during the period of recovery to obtain, once more, through the issue
of notes the command over a considerable amount of real resources.

In Austria, where, at the date of writing, the exchange has been
stabilised for a year, the same phenomenon has been apparent with
the growth of confidence, the gold value of the note issue having
been raised to nearly two and a half times the low point reached in
September 1922. The fact of stabilisation, with foreign aid, has,
by increasing confidence, permitted this increase of the note issue
without imperilling the stabilisation, and will probably permit in
course of time a substantial further increase.

Even in Russia a sort of equilibrium seems to have been reached. There
the last phase had appeared by the middle of 1922, when a tenfold
inflation in six months[13] had brought the aggregate value of the
note issue below £4,000,000, which clearly could not be adequate
for the transaction of the business of Russia even in its present
condition. A point had been reached when the use of paper roubles
was being dispensed with altogether. At about that date I had the
opportunity of discussion at Genoa with some of the Soviet financiers.
They have always been more self-conscious and deliberate than others
in their monetary policy. They maintained at that time that, with the
help of legal compulsion to employ paper roubles for certain types of
transaction, these roubles could always be maintained in circulation
up to a certain _minimum_ real value, however certain the public might
be as to their ultimate worthlessness. According to this calculation,
it would always be possible to raise (say) £3,000,000 to £4,000,000
per annum by this method, even though the paper rouble regularly fell
in value at the rate of a tenfold or a hundredfold a year (one or more
noughts being struck off the monetary unit annually for convenience of
calculation). During the year following they did, in fact, decidedly
better than this, and, by reducing the rate of inflation to a figure
not much in excess of 100 per cent per three months, were able to raise
the aggregate value of the note issue to more than double the lowest
point reached. The equivalent of something like £15,000,000 seems to
have been raised during the year (April 1922–April 1923) by this means
towards the expenses of government, at the cost of having to strike
only one nought off the monetary unit for the whole year![14] At the
same time, in order to furnish a reliable store of value and a basis
for foreign trade, the Soviet Government introduced in December 1922 a
new currency unit (the chervonetz, or gold ducat), freely convertible
on sterling-exchange standard principles, alongside the paper rouble,
which was still indispensable as an instrument of taxation. So far this
new bank note has kept respectable. By August 1923 its circulation had
risen to nearly 16,000,000 having a value of about £16,000,000, and its
exchange value had kept steady, the State Bank undertaking to convert
the chervonetz on a parity with the £ sterling.[15] Thus by the middle
of 1923 the aggregate value of the Russian note issues, good and bad
money together, had risen to the substantial figure of £25,000,000, as
compared with barely £4,000,000 at the date of the Genoa Conference
in May 1922, thus indicating the return of confidence and the
re-inauguration of a monetary _régime_. Russia provides an instructive
example (at least for the moment) of a sound money for substantial
transactions alongside small change for daily life, the progressive
depreciation on which merely represents a quite supportable rate of
turn-over tax.

       [13] Recent experience everywhere seems to show that it is
            possible to inflate 100 per cent every three months without
            entirely killing the use of money in retail transactions,
            but that a greater rate of inflation than this can only be
            indulged in at the peril of total collapse.

       [14] The Soviet Government have always regarded monetary
            inflation quite frankly as an instrument of taxation,
            and have themselves calculated that the purchasing power
            secured to the State by this means has amounted in the past
            to the following sums:

              1918                      525 million gold roubles
              1919                      380    „     „      „
              1920                      186    „     „      „
              1921                      143    „     „      „
              1922 (Jan. to March)       58    „     „      „
                      or (say) £130,000,000 altogether.

       [15] So far the chervonetz has generally sold at a small
            premium, the rates being:

              March 15, 1923      ch. 1 = £1·07
              April 17, 1923      ch. 1 = £1·05
              June 15, 1923       ch. 1 = £0·94
              July 27, 1923       ch. 1 = £1·05

The collapse of the currency in Germany which was the chief
contributory cause to the fall of Dr. Cuno’s Government in August 1923,
was due, not so much to taxing by inflation--for that had been going
on for years--as to an increase in the _rate_ of inflation to a level
almost prohibitive for daily transactions and quite destructive of
the legal-tender money as a unit of account. We have seen that what
concerns the use of money in the retail transactions of daily life
is the _rate_ of depreciation, rather than the absolute amount of
depreciation as compared with some earlier date.

In the middle of 1922 I estimated, very roughly, that the German
Government had then been obtaining for some time past the equivalent of
something between £75,000,000 and £100,000,000 per annum by means of
printing money. Up to that time, however, a substantial proportion of
these receipts had been contributed through the purchase of mark-notes
by speculative foreigners. Nevertheless the German public itself
had probably paid upwards of £50,000,000 per annum in this form of
taxation. Since the German note issue was still worth £240,000,000 so
lately as December 1920 (see the table on p. 51) and had not fallen
below £100,000,000 even in the middle of 1922, the rate of depreciation
represented by the above, whilst sufficiently disastrous to the mark
as a store of value or as a unit of account, had been by no means
prohibitive to its continued use in daily life. In the latter half of
1922, however, the public learnt to make enough further economies in
the use of the mark as money to reduce the value of the total note
issue to about £60,000,000. The first effect of the Ruhr occupation
was, as we have seen above (p. 54), to bring down the note issue below
the minimum to which the public could adjust their habits, which
resulted in the temporary recovery of March 1923. Nevertheless by the
middle of 1923 the public was able to get along with a note issue worth
about £20,000,000. All this time the German Government had continued
to raise resources equivalent to round about £1,000,000 a week by
note-printing--which meant a depreciation of 5 per cent a week even
if the public had been unable to reduce any further the value of the
aggregate note issue, and came in practice to about 10 per cent a week
allowing for their yet further economies in the use of mark-currency.

But the expenses of the Ruhr resistance, coupled with the complete
breakdown of other sources of taxation, had led, by May and June 1923,
to the Government’s raising the equivalent of, first, £2,000,000
and then £3,000,000 a week by note-printing. On a note issue, of
which the total value had sunk by that time to about £20,000,000,
this was pushing inflationary taxation to a preposterous and suicidal
point. The social disorganisation, resulting from a rapid movement
to do without the mark altogether, quickly resulted in Dr. Cuno’s
fall.[16] The climax was reached when, in Dr. Cuno’s last days, the
Government doubled the note issue in a week and raised the equivalent
of £3,000,000 in that period out of a note issue worth about £4,000,000
altogether,--a performance far transcending the wildest extravagances
of the Soviet.

       [16] It is necessary to admit that Dr. Cuno’s failure to control
            incompetence at the Treasury and at the Reichsbank was
            bound to bring this about. During this catastrophic period
            those responsible for the financial policy of Germany did
            not do a single wise thing, or show the least appreciation
            of what was happening. The profits of note-printing were
            not even monopolised by the Government, and Herr Havenstein
            continued to allow the German banks to share in them, by
            discounting their bills at the Reichsbank at a rate of
            discount far below the rate of depreciation. Only at the
            end of August 1923 did the Reichsbank begin to require that
            borrowers should make good on repayment a percentage of
            the loss due to the depreciation of the borrowed marks (as
            reckoned by the dollar exchange) during the currency of the

By the time this book is published, Dr. Cuno’s successors may have
solved, or failed to solve, the problem facing them. However this may
be, the restoration of a serviceable unit of account seems to be the
first step. This is a necessary preliminary to the escape of the German
financial system from the vicious circle in which it now moves. The
Government cannot introduce a sound money, because, in the absence
of other revenue, the printing of an unsound money is the only way by
which it can live. Yet a serviceable unit of account is a pre-requisite
of the collection of the normal sources of revenue. The best course,
therefore, is to remain content for a little longer with an unsound
money as a source of revenue, but to introduce immediately a steady
unit of account (the relation of which to the unsound money could be
officially fixed daily or weekly) as a preliminary to the restoration
of the normal sources of revenue.

The recent history of German finance can be summarised thus. Reliance
on inflationary taxation, whilst extremely productive to the exchequer
in its earliest stages especially whilst the foreign speculator
was still buying paper marks, gradually broke down the mark as a
serviceable unit of account, one of the effects of which was to render
unproductive the greater part of the rest of the revenue-collecting
machinery--most taxes being necessarily assessed at some interval of
time before they are collected. The failure of the rest of the revenue
rendered the Treasury more and more dependent on inflation, until
finally the use of legal-tender money had been so far abandoned by the
public that even the inflationary tax ceased to be productive and the
Government was threatened by literal bankruptcy. At this stage, the
fiscal organisation of the country had been so thoroughly destroyed
and its social and economic organisation so grievously disordered, as
in Russia eighteen months earlier, that it was a perplexing problem to
devise ways and means by which the Government could live during the
transitional period whilst the normal machinery for collecting revenue
was being re-created, especially in face of the struggle with France
proceeding at the same time. Nevertheless the problem is not insoluble;
many suggestions could be made; and a way out will doubtless be found
at length.

       *       *       *       *       *

It is common to speak as though, when a Government pays its way by
inflation, the people of the country avoid taxation. We have seen that
this is not so. What is raised by printing notes is just as much taken
from the public as is a beer-duty or an income-tax. What a Government
spends the public pay for. There is no such thing as an uncovered
deficit. But in some countries it seems possible to please and content
the public, for a time at least, by giving them, in return for the
taxes they pay, finely engraved acknowledgements on water-marked
paper. The income-tax receipts, which we in England receive from the
Surveyor, we throw into the wastepaper basket; in Germany they call
them bank-notes and put them into their pocket-books; in France they
are termed Rentes and are locked up in the family safe.

II. _Currency Depreciation_ versus _Capital Levy_

We have seen in the preceding section the extent to which a Government
can make use of currency inflation for the purpose of securing income
to meet its outgoings. But there is a second way in which inflation
helps a Government to make both ends meet, namely by reducing the
burden of its pre-existing liabilities in so far as they have been
fixed in terms of money. These liabilities consist, in the main, of the
internal debt. Every step of depreciation obviously means a reduction
in the real claims of the _rentes_-holders against their Government.

It would be too cynical to suppose that, in order to secure the
advantages discussed in this section, Governments (except, possibly,
the Russian Government) depreciate their currencies _on purpose_.
As a rule, they are, or consider themselves to be, driven to it
by their necessities. The requirements of the Treasury to meet
sudden exceptional outgoings--for a war or to pay the consequences
of defeat--are likely to be the original occasion of, at least
_temporary_, inflation. But the most cogent reason for _permanent_
depreciation, that is to say _Devaluation_, or the policy of fixing
the value of the currency permanently at the low level to which a
temporary emergency has driven it, is generally to be found in the fact
that a restoration of the currency to its former value would raise the
recurrent annual burden of the fixed charges of the National Debt to
an insupportable level.

There is, nevertheless, an alternative to Devaluation in such cases,
provided the opponents of Devaluation are prepared to face it in time,
which they generally are not,--namely a Capital Levy. The purpose of
this section is to bring out clearly the _alternative_ character of
these two methods of moderating the claims of the _rentier_, when the
State’s contractual liabilities, fixed in terms of money, have reached
an excessive proportion of the national income.

The active and working elements in no community, ancient or modern,
will consent to hand over to the _rentier_ or bond-holding class
more than a certain proportion of the fruits of their work. When the
piled-up debt demands more than a tolerable proportion, relief has
usually been sought in one or other of two out of the three possible
methods. The first is Repudiation. But, except as the accompaniment of
Revolution, this method is too crude, too deliberate, and too obvious
in its incidence. The victims are immediately aware and cry out too
loud; so that, in the absence of Revolution, this solution may be ruled
out at present, as regards _internal_ debt, in Western Europe.

The second method is Currency Depreciation, which becomes Devaluation
when it is fixed and confirmed by law. In the countries of Europe
lately belligerent, this expedient has been adopted already on a
scale which reduces the real burden of the debt by from 50 to 100 per
cent. In Germany the National Debt has been by these means practically
obliterated, and the bond-holders have lost everything. In France
the real burden of the debt is less than a third of what it would be
if the franc stood at par; and in Italy only a quarter. The owners
of small savings suffer quietly, as experience shows, these enormous
depredations, when they would have thrown down a Government which had
taken from them a fraction of the amount by more deliberate but juster

This fact, however, can scarcely justify such an expedient on its
merits. Its indirect evils are many. Instead of dividing the burden
between all classes of wealth-owners according to a graduated scale,
it throws the whole burden on to the owners of fixed interest bearing
stocks, lets off the _entrepreneur_ capitalist and even enriches him,
and hits small savings equally with great fortunes. It follows the
line of least resistance, and responsibility cannot be brought home
to individuals. It is, so to speak, nature’s remedy, which comes into
silent operation when the body politic has shrunk from curing itself.

The remaining, the scientific, expedient, the Capital Levy, has never
yet been tried on a large scale; and perhaps it never will be. It is
the rational, the deliberate method. But it is difficult to explain,
and it provokes violent prejudice by coming into conflict with the
deep instincts by which the love of money protects itself. Unless the
patient understands and approves its purpose, he will not submit to so
severe a surgical operation.

Once Currency Depreciation has done its work, I should not advocate
the unwise, and probably impracticable, policy of retracing the path
with the aid of a Capital Levy. But if it has become clear that the
claims of the bond-holder are more than the taxpayer can support, and
if there is still time to choose between the policies of a Levy and
of further Depreciation, the Levy must surely be preferred on grounds
both of expediency and of justice. It is an overwhelming objection
to the method of Currency Depreciation, as compared with that of the
Levy, that it falls entirely upon persons whose wealth is in the form
of claims to legal-tender money, and that these are generally, amongst
the capitalists, the poorer capitalists. It is entirely ungraduated; it
falls on small savings just as hardly as on big ones; and incidentally
it benefits the capitalist _entrepreneur_ class for the reasons
explained in Chapter I. Unfortunately the small savers who have most to
lose by Currency Depreciation are precisely the sort of conservative
people who are most alarmed by a Capital Levy; whilst, on the other
hand, the _entrepreneur_ class must obviously prefer Depreciation which
does not hit them very much and may actually enrich them. It is the
combination of these two forces which will generally bring it about
that a country will prefer the inequitable and disastrous courses of
Currency Depreciation to the scientific deliberation of a Levy.

There is a respectable and influential body of opinion which,
repudiating with vehemence the adoption of either expedient, fulminates
alike against Devaluations and Levies, on the ground that they infringe
the untouchable sacredness of contract; or rather of vested interest,
for an alteration of the legal tender and the imposition of a tax on
property are neither of them in the least illegal or even contrary to
precedent. Yet such persons, by overlooking one of the greatest of
all social principles, namely the fundamental distinction between the
right of the individual to repudiate contract and the right of the
State to control vested interest, are the worst enemies of what they
seek to preserve. For nothing can preserve the integrity of contract
between individuals, except a discretionary authority in the State
to revise what has become intolerable. The powers of uninterrupted
usury are too great. If the accretions of vested interest were to grow
without mitigation for many generations, half the population would be
no better than slaves to the other half. Nor can the fact that in time
of war it is easier for the State to borrow than to tax, be allowed
permanently to enslave the taxpayer to the bond-holder. Those who
insist that in these matters the State is in exactly the same position
as the individual, will, if they have their way, render impossible
the continuance of an individualist society, which depends for its
existence on moderation.

These conclusions might be deemed obvious if experience did not show
that many conservative bankers regard it as more consonant with their
cloth, and also as economising thought, to shift public discussion of
financial topics off the logical on to an alleged “moral” plane, which
means a realm of thought where vested interest can be triumphant over
the common good without further debate. But it makes them untrustworthy
guides in a perilous age of transition. The State must never neglect
the importance of so acting in ordinary matters as to promote certainty
and security in business. But when great decisions are to be made,
the State is a sovereign body of which the purpose is to promote the
greatest good of the whole. When, therefore, we enter the realm of
State action, _everything_ is to be considered and weighed on its
merits. Changes in Death Duties, Income Tax, Land Tenure, Licensing,
Game Laws, Church Establishment, Feudal Rights, Slavery, and so on
through all ages, have received the same denunciations from the
absolutists of contract,--who are the real parents of Revolution.

In our own country the question of the Capital Levy depends for its
answer on whether the great increase in the claims of the bond-holder,
arising out of the fact that it was easier, and perhaps more expedient,
to raise a large part of the current costs of the war by loans rather
than by taxes, is more than the taxpayer can be required, in the
long run, to support. The high levels of the Death Duties and of the
income- and super-taxes on unearned income, by which the net return
to the bond-holder is substantially diminished,[17] modify the case.
Nevertheless, immediately after the war, when it seemed that the normal
budget could scarcely be balanced without a level of taxation of which
a tax on earned income at a standard rate between 6s. and 10s. in the
£ would be typical, a levy seemed to be necessary. At the present
time the case is rather more doubtful. It is not yet possible to know
how the normal budget will work out, and much depends on the level at
which sterling prices are stabilised. If the level of sterling prices
is materially lowered, whether in pursuance of a policy of restoring
the old gold parity or for any other reason, a levy may be required.
If, however, sterling prices are stabilised somewhere between 80 and
100 per cent above the pre-war level--a settlement probably desirable
on other grounds--and if the progressive prosperity of the country
is restored, then perhaps we may balance our future budgets without
oppressive taxation on earned income and without a levy either. A levy
is from the practical view perfectly feasible, and is not open to more
objection than any other _new_ tax of like magnitude. Nevertheless,
like all new taxes, it cannot be brought in without friction, and
is, therefore, scarcely worth advocating for its own sake merely
in substitution for an existing tax of similar incidence. It is to
be regarded as the fairest and most expedient method of adjusting
the burden of taxation between past accumulations and the fruits of
present efforts, whenever, in the general judgment of the country, the
discouragement to the latter is excessive. A levy is to be judged, not
by itself, but as against the practicable alternatives. Experience
shows with great certainty that the active part of the community will
not submit in the long run to pay too much to vested interest, and, if
the necessary adjustment is not made in one way, it will be made in
another,--probably by the depreciation of the currency.

       [17] The net return to the French _rentier_ is more than 6 per
            cent; to the British not much above 3 per cent.

In several countries the existing burden of the internal debt
renders Devaluation inevitable and certain sooner or later. It will
be sufficient to illustrate the case by reference to the situation
of France,--the home of absolutism of all kinds, and hence, sooner
or later, of _bouleversement_. The finances of Humpty Dumpty are as

At the end of 1922 the internal debt of France, excluding altogether
her external debt, exceeded 250 milliard francs. Further borrowing
budgeted for in the ensuing period, together with loans on
reconstruction account guaranteed by the Government, may bring this
total to the neighbourhood of 300 milliards by the end of 1923. The
service of this debt will absorb nearly 18 milliards per annum. The
total normal receipts under the provisional[18] Budget for 1923 are
estimated at round 23 milliards. That is to say, the service of the
debt will shortly absorb, at the value of the franc current early in
1923, almost the entire yield of taxation. Since other Government
expenditure in the ordinary budget (_i.e._, excluding war pensions and
future expenditure on reconstruction) cannot be put below 12 milliards
a year, it follows that, even on the improbable hypothesis that further
expenditure in the extraordinary budget after 1923 will be paid for by
Germany, the yield of taxation must be increased permanently by 30 per
cent to make both ends meet. If, however, the franc were to depreciate
to (say) 100 to the pound sterling, the ordinary budget could be
balanced by taking little more of the real income of the country than
in 1922.

       [18] The forecasts of the final outcome of the year are
            frequently changed and may be somewhat different from the
            above,--though not sufficiently to affect the argument.
            M. de Lasteyrie has lately pointed out with pride how
            the further depreciation of the franc, since he first
            introduced his budget, is already improving the receipts
            measured in terms of francs.

In these circumstances it will be difficult, if not impossible, to
avoid the subtle assistance of a further depreciation. What, then,
is to be said of those who still discuss seriously the project of
restoring the franc to its former parity? In such an event the already
intolerable burden of the _rentier’s_ claims would be about trebled.
It is unthinkable that the French taxpayer would submit. Even if the
franc were put back to par by a miracle, it could not stay there. Fresh
inflation due to the inadequacy of tax receipts must drive it anew on
its downward course. Yet I have assumed the cancellation of the whole
of France’s external debt, and the assumption by Germany of the burdens
of the extraordinary budget after 1923, an assumption which is not
justified by present expectations. These facts alone render it certain
that the franc cannot be restored to its former value.

France must come in due course to some compromise between increasing
taxation, and diminishing expenditure, and reducing what they owe their
_rentiers_. I have not much doubt that the French public, as they have
hitherto, will consider a further dose of depreciation--attributing it
to the “bad will” of Germany or to financial Machiavellism in London
and New York--as far more conservative, orthodox, and in the interest
of small savers, than a justly constructed Capital Levy, the odium of
which could be less easily escaped by the French Ministry of Finance.

If we look ahead, averting our eyes from the ups and downs which can
make and unmake fortunes in the meantime, the level of the franc
is going to be settled in the long run not by speculation or the
balance of trade, or even the outcome of the Ruhr adventure, but by
the proportion of his earned income which the French taxpayer will
permit to be taken from him to pay the claims of the French _rentier_.
The level of the franc exchange will continue to fall until the
commodity-value of the francs due to the _rentier_ has fallen to a
proportion of the national income, which accords with the habits and
mentality of the country.



The evil consequences of instability in the standard of value have
now been sufficiently described. In this chapter[19] we must lay
the theoretical foundations for the practical suggestions of the
concluding chapters. Most academic treatises on monetary theory have
been based, until lately, on so firm a presumption of a gold standard
régime that they need to be adapted to the existing régime of mutually
inconvertible paper standards.

       [19] Parts of this chapter raise, unavoidably, matters of much
            greater difficulty to the layman than the rest of the book.
            The reader whose interest in the theoretical foundations is
            secondary can pass on.

I. _The Quantity Theory of Money_

This Theory is fundamental. Its correspondence with fact is not open to
question.[20] Nevertheless it is often misstated and misrepresented.
Goschen’s saying of sixty years ago, that “there are many persons
who cannot hear the relation of the level of prices to the volume of
currency affirmed without a feeling akin to irritation,” still holds

       [20] “The Quantity Theory is often defended and opposed as
            though it were a definite set of propositions that must
            be either true or false. But in fact the formulæ employed
            in the exposition of that theory are merely devices for
            enabling us to bring together in an orderly way the
            principal causes by which the value of money is determined”

The Theory flows from the fact that money as such has no utility except
what is derived from its exchange-value, that is to say from the
utility of the things which it can buy. Valuable articles other than
money have a utility in themselves. Provided that they are divisible
and transferable, the total amount of this utility increases with their
quantity;--it will not increase in full proportion to the quantity,
but, up to the point of satiety, it does increase.

If an article is used for money, such as gold, which has a utility
in itself for other purposes, aside from its use as money, the
strict statement of the theory, though fundamentally unchanged, is a
little complicated. In present circumstances we can excuse ourselves
this complication. A Currency Note has no utility in itself and is
completely worthless except for the purchasing power which it has as

Consequently what the public want is not so many ounces or so many
square yards or even so many £ sterling of currency notes, but a
quantity sufficient to cover a week’s wages, or to pay their bills,
or to meet their probable outgoings on a journey or a day’s shopping.
When people find themselves with more cash than they require for
such purposes, they get rid of the surplus by buying goods or
investments, or by leaving it for a bank to employ, or, possibly, by
increasing their hoarded reserves. Thus the _number_ of notes which
the public ordinarily have on hand is determined by the amount of
_purchasing power_ which it suits them to hold or to carry about,
and by nothing else. The amount of this purchasing power depends
partly on their wealth, partly on their habits. The wealth of the
public in the aggregate will only change gradually. Their habits
in the use of money--whether their income is paid them weekly or
monthly or quarterly, whether they pay cash at shops or run accounts,
whether they deposit with banks, whether they cash small cheques at
short intervals or larger cheques at longer intervals, whether they
keep a reserve or hoard of money about the house--are more easily
altered. But if their wealth and their habits in the above respects
are unchanged, then the amount of purchasing power which they hold in
the form of money is definitely fixed. We can measure this definite
amount of purchasing power in terms of a unit made up of a collection
of specified quantities of their standard articles of consumption or
other objects of expenditure; for example, the kinds and quantities of
articles which are combined for the purpose of a cost-of-living index
number. Let us call such a unit a “consumption unit” and assume that
the public require to hold an amount of money having a purchasing power
over _k_ consumption units. Let there be _n_ currency notes or other
forms of cash in circulation with the public, and let _p_ be the price
of each consumption unit (_i.e._ _p_ is the index number of the cost
of living), then it follows from the above that _n = pk_. This is the
famous Quantity Theory of Money. So long as _k_ remains unchanged, _n_
and _p_ rise and fall together; that is to say, the greater or the
fewer the number of currency notes, the higher or the lower is the
price level in the same proportion.

So far we have assumed that the whole of the public requirement for
purchasing power is satisfied by cash, and on the other hand that this
requirement is the only source of demand for cash; neglecting the fact
that the public, including the business world, employ for the same
purpose bank deposits and overdraft facilities, whilst the banks must
for the same reason maintain a reserve of cash. The theory is easily
extended, however, to cover this case. Let us assume that the public,
including the business world, find it convenient to keep the equivalent
of _k_ consumption units in cash and of a further _k´_ available
at their banks against cheques, and that the banks keep in cash a
proportion _r_ of their potential liabilities (_k´_) to the public. Our
equation then becomes

    _n = p(k + rk´)_.

So long as _k_, _k´_, and _r_ remain unchanged, we have the same
result as before, namely, that _n_ and _p_ rise and fall together. The
proportion between _k_ and _k´_ depends on the banking arrangements of
the public; the absolute value of these on their habits generally; and
the value of _r_ on the reserve practices of the banks. Thus, so long
as these are unaltered, we still have a direct relation between the
_quantity_ of cash (_n_) and the level of prices (_p_).[21]

       [21] My exposition follows the general lines of Prof. Pigou
            (_Quarterly Journal of Economics_, Nov. 1917) and of Dr.
            Marshall (_Money, Credit, and Commerce_, I. iv.), rather
            than the perhaps more familiar analysis of Prof. Irving
            Fisher. Instead of starting with the amount of cash held by
            the public, Prof. Fisher begins with the volume of business
            transacted by means of money and the frequency with which
            each unit of money changes hands. It comes to the same
            thing in the end and it is easy to pass from the above
            formula to Prof. Fisher’s; but the above method of approach
            seems less artificial than Prof. Fisher’s and nearer to the
            observed facts.

We have seen that the amount of _k_ and _k´_ depends partly on the
wealth of the community, partly on its habits. Its habits are fixed by
its estimation of the extra convenience of having more cash in hand
as compared with the advantages to be got from spending the cash or
investing it. The point of equilibrium is reached where the estimated
advantages of keeping more cash in hand compared with those of spending
or investing it about balance. The matter cannot be summed up better
than in the words of Dr. Marshall:

    “In every state of society there is some fraction of their income
    which people find it worth while to keep in the form of currency;
    it may be a fifth, or a tenth, or a twentieth. A large command of
    resources in the form of currency renders their business easy and
    smooth, and puts them at an advantage in bargaining; but on the
    other hand it locks up in a barren form resources that might yield
    an income of gratification if invested, say, in extra furniture; or
    a money income, if invested in extra machinery or cattle.” A man
    fixes the appropriate fraction “after balancing one against another
    the advantages of a further ready command, and the disadvantages
    of putting more of his resources into a form in which they yield
    him no direct income or other benefit.” “Let us suppose that the
    inhabitants of a country, taken one with another (and including
    therefore all varieties of character and of occupation), find
    it just worth their while to keep by them on the average ready
    purchasing power to the extent of a tenth part of their annual
    income, together with a fiftieth part of their property; then the
    aggregate value of the currency of the country will tend to be
    equal to the sum of these amounts.”[22]

       [22] _Money, Credit, and Commerce_, I. iv. 3. Dr. Marshall
            shows in a footnote as follows that the above is in fact
            a development of the traditional way of considering the
            matter: “Petty thought that the money ‘sufficient for’
            the nation is ‘so much as will pay half a year’s rent
            for all the lands of England and a quarter’s rent of the
            Houseing, for a week’s expense of all the people, and about
            a quarter of the value of all the exported commodities.’
            Locke estimated that ‘one-fiftieth of wages and one-fourth
            of the landowner’s income and one-twentieth part of the
            broker’s yearly returns in ready money will be enough to
            drive the trade of any country.’ Cantillon (A.D. 1755),
            after a long and subtle study, concludes that the value
            needed is a ninth of the total produce of the country; or,
            what he takes to be the same thing, a third of the rent
            of the land. Adam Smith has more of the scepticism of the
            modern age and says: ‘it is impossible to determine the
            proportion,’ though ‘it has been computed by different
            authors at a fifth, at a tenth, at a twentieth, and at a
            thirtieth part of the whole value of the annual produce.’”
            In modern conditions the normal proportion of the
            circulation to this national income seems to be somewhere
            between a tenth and a fifteenth.

So far there should be no room for difference of opinion. The error
often made by careless adherents of the Quantity Theory, which may
partly explain why it is not universally accepted, is as follows.

Every one admits that the habits of the public in the use of money
and of banking facilities and the practices of the banks in respect
of their reserves change from time to time as the result of obvious
developments. These habits and practices are a reflection of changes
in economic and social organisation. But the Theory has often been
expounded on the further assumption that a _mere_ change in the
quantity of the currency cannot affect _k_, _r_, and _k´_,--that is to
say, in mathematical parlance, that _n_ is an _independent variable_
in relation to these quantities. It would follow from this that an
arbitrary doubling of _n_, since this in itself is assumed not to
affect _k_, _r_, and _k´_, must have the effect of raising _p_ to
double what it would have been otherwise. The Quantity Theory is often
stated in this, or a similar, form.

Now “in the long run” this is probably true. If, after the American
Civil War, the American dollar had been stabilised and defined by law
at 10 per cent below its present value, it would be safe to assume that
_n_ and _p_ would now be just 10 per cent greater than they actually
are and that the present values of _k_, _r_, and _k´_ would be entirely
unaffected. But this _long run_ is a misleading guide to current
affairs. _In the long run_ we are all dead. Economists set themselves
too easy, too useless a task if in tempestuous seasons they can only
tell us that when the storm is long past the ocean is flat again.

In actual experience, a change of n is liable to have a reaction both
on _k_ and _k´_ and on _r_. It will be enough to give a few typical
instances. Before the war (and indeed since) there was a considerable
element of what was conventional and arbitrary in the reserve policy
of the banks, but especially in the policy of the State Banks towards
their gold reserves. These reserves were kept for show rather than for
use, and their amount was not the result of close reasoning. There
was a decided tendency on the part of these banks between 1900 and
1914 to bottle up gold when it flowed towards them and to part with
it reluctantly when the tide was flowing the other way. Consequently,
when gold became relatively abundant they tended to hoard what came
their way and to raise the proportion of the reserves, with the result
that the increased output of South African gold was absorbed with less
effect on the price level than would have been the case if an increase
of _n_ had been totally without reaction on the value of _r_.

In agricultural countries where peasants readily hoard money, an
inflation, especially in its early stages, does not raise prices
proportionately, because when, as a result of a certain rise in the
price of agricultural products, more money flows into the pockets of
the peasants, it tends to stick there;--deeming themselves that much
richer, the peasants increase the proportion of their receipts that
they hoard.

Thus in these and in other ways the terms of our equation tend in
their movements to favour the stability of _p_, and there is a certain
friction which prevents a moderate change in _n_ from exercising its
full proportionate effect on _p_.

On the other hand a large change in _n_, which rubs away the initial
friction, and especially a change in _n_ due to causes which set up
a general expectation of a further change in the same direction, may
produce a _more_ than proportionate effect on _p_. After the general
analysis of Chapter I. and the narratives of catastrophic inflations
given in Chapter II., it is scarcely necessary to illustrate this
further,--it is a matter more readily understood than it was ten years
ago. A large change in _p_ greatly affects individual fortunes. Hence a
change after it has occurred, or sooner in so far as it is anticipated,
may greatly affect the monetary habits of the public in their attempt
to protect themselves from a similar loss in future, or to make gains
and avoid loss during the passage from the equilibrium corresponding to
the old value of _n_ to the equilibrium corresponding to its new value.
Thus after, during, and (so far as the change is anticipated) before a
change in the value of _n_, there will be some reaction on the values
of _k_, _k´_, and _r_, with the result that the change in the value of
_p_, at least temporarily and perhaps permanently (since habits and
practices, once changed, will not revert to exactly their old shape),
will not be precisely in proportion to the change in _n_.

The terms _inflation_ and _deflation_ are used by different writers
in varying senses. It would be convenient to speak of an increase
or decrease in _n_ as an inflation or deflation of _cash_; and of a
decrease or increase in _r_ as an inflation or deflation of _credit_.
The characteristic of the “credit-cycle” (as the alternation of boom
and depression is now described) consists in a tendency of _k_ and
_k´_ to diminish during the boom and increase during the depression,
irrespective of changes in _n_ and _r_, these movements representing
respectively a diminution and an increase of “real” balances (_i.e._
balances, in hand or at the bank, measured in terms of purchasing
power); so that we might call this phenomenon deflation and inflation
of real balances.

It will illustrate the “Quantity Theory” equation in general and the
phenomena of deflation and inflation of real balances in particular,
if we endeavour to fill in actual values for our symbolic quantities.
The following example does not claim to be exact and its object is to
illustrate the idea rather than to convey statistically precise facts.
October 1920 was about the end of the recent boom, and October 1922
was near the bottom of the depression. At these two dates the figures
of price level (taking October 1922 as 100), cash circulation (note
circulation _plus_ private deposits at the Bank of England[23]), and
bank deposits in Great Britain were roughly as follows:

       [23] It would take me too far from the immediate matter in hand
            to discuss why I take this definition of “cash” in the case
            of Great Britain. It is discussed further in Chapter V.

                Price Level.  Cash Circulation.   Bank Deposits.
  October 1920      150        £585,000,000       £2,000,000,000
  October 1922      100        £504,000,000       £1,700,000,000

The value of _r_ was not very different at the two dates--say about
12 per cent. Consequently our equation for the two dates works out as

  October 1920  _n_ = 585  _p_ = 1·5  _k_ = 230  _k´_ = 1333
  October 1922  _n_ = 504  _p_ = 1    _k_ = 300  _k´_ = 1700

       [24] For 585 = 1·5(230 + 1333 × ·12), and 504 = 1(300 + 1700 ×

Thus during the depression _k_ rose from 230 to 300 and _k´_ from 1333
to 1700, which means that the cash holdings of the public at the former
date were worth 23/30, and their bank balances 1333/1700, what they
were worth at the latter date. It thus appears that the tendency of
_k_ and _k´_ to increase had more to do, than the deflation of “cash”
had, with the fall of prices between the two periods. If _k_ and _k´_
were to fall back to their 1920 values, prices would rise 30 per cent
without any change whatever in the volume of cash or the reserve policy
of the banks. Thus even in Great Britain the fluctuations of _k_ and
_k´_ can have a decisive influence on the price level; whilst we have
already seen (pp. 51, 52) how enormously they can change in the recent
conditions of Russia and Central Europe.

The moral of this discussion, to be carried forward in the reader’s
mind until we reach Chapters IV. and V., is that the price level is not
mysterious, but is governed by a few, definite, analysable influences.
Two of these, _n_ and _r_, are under the direct control (or ought to
be) of the central banking authorities. The third, namely _k_ and _k´_,
is not directly controllable, and depends on the mood of the public and
the business world. The business of stabilising the price level, not
merely over long periods but so as also to avoid cyclical fluctuations,
consists partly in exercising a stabilising influence over _k_ and
_k´_, in so far as this fails or is impracticable, in deliberately
varying _n_ and _r_ so as to _counterbalance_ the movement of _k_ and

The usual method of exercising a stabilising influence over _k_ and
_k´_ especially over _k´_, is that of bank-rate. A tendency of _k´_
to increase may be somewhat counteracted by lowering the bank-rate,
because easy lending diminishes the advantage of keeping a margin for
contingencies in cash. Cheap money also operates to _counterbalance_
an increase of _k´_, because, by encouraging borrowing from the banks,
it prevents _r_ from increasing or causes _r_ to diminish. But it
is doubtful whether bank-rate by itself is always a powerful enough
instrument, and, if we are to achieve stability, we must be prepared to
vary _n_ and _r_ on occasion.

Our analysis suggests that the first duty of the central banking
and currency authorities is to make sure that they have _n_ and _r_
thoroughly under control. For example, so long as inflationary taxation
is in question _n_ will be influenced by other than currency objects
and cannot, therefore, be fully under control; moreover, at the other
extreme, under a gold standard _n_ is not always under control, because
it depends on the unregulated forces which determine the demand and
supply of gold throughout the world. Again, without a central banking
system _r_ will not be under proper control because it will be
determined by the unco-ordinated decisions of numerous different banks.

At the present time in Great Britain _r_ is very completely controlled,
and _n_ also, so long as we refrain from inflationary finance on the
one hand and from a return to an unregulated gold standard on the
other.[25] The second duty of the authorities is therefore worth
discussing, namely, the _use_ of their control over _n_ and _r_ to
counterbalance changes in _k_ and _k´_. Even if _k_ and _k´_ were
entirely outside the influence of deliberate policy, which is not in
fact the case, nevertheless _p_ could be kept reasonably steady by
suitable modifications of the values of _n_ and _r_.

       [25] In the case of the United States the same thing is more or
            less true, so long as the Federal Reserve Board is prepared
            to incur the expense of bottling up redundant gold.

Old-fashioned advocates of sound money have laid too much emphasis
on the need of keeping _n_ and _r_ steady, and have argued as if
this policy by itself would produce the right results. So far from
this being so, steadiness of _n_ and _r_, when _k_ and _k´_ are not
steady, is bound to lead to unsteadiness of the price level. Cyclical
fluctuations are characterised, not primarily by changes in _n_ or _r_,
but by changes in _k_ and _k´_. It follows that they can only be cured
if we are ready deliberately to increase and decrease _n_ and _r_, when
symptoms of movement are showing in the values of _k_ and _k´_. I am
being led, however, into a large subject beyond my immediate purpose,
and am anticipating also the topic of Chapter V. These hints will
serve, nevertheless, to indicate to the reader what a long way we may
be led by an understanding of the implications of the simple Quantity
equation with which we started.

II. _The Theory of Purchasing Power Parity._

The Quantity Theory deals with the purchasing power or commodity-value
of a given national currency. We come now to the _relative_ value of
_two_ distinct national currencies,--that is to say, to the theory of
the Foreign Exchanges.

When the currencies of the world were nearly all on a gold basis, their
relative value (_i.e._ the exchanges) depended on the actual amount of
gold metal in a unit of each, with minor adjustments for the cost of
transferring the metal from place to place.

When this common measure has ceased to be effective and we have instead
a number of independent systems of inconvertible paper, what basic
fact determines the rates at which units of the different currencies
exchange for one another?

The explanation is to be found in the doctrine, as old in itself as
Ricardo, with which Professor Cassel has lately familiarised the public
under the name of “Purchasing Power Parity.”[26]

       [26] This term was first introduced into economic literature in
            an article contributed by Prof. Cassel to the _Economic
            Journal_, December 1918. For Prof. Cassel’s considered
            opinions on the whole question, see his _Money and Foreign
            Exchange after 1914_ (1922). The theory, as distinct from
            the name, is essentially Ricardo’s.

This doctrine in its baldest form runs as follows: (1) The purchasing
power of an inconvertible currency within its own country, _i.e._ the
currency’s _internal_ purchasing power, depends on the currency policy
of the Government and the currency habits of the people, in accordance
with the Quantity Theory of Money just discussed. (2) The purchasing
power of an inconvertible currency in a foreign country, _i.e._ the
currency’s _external_ purchasing power, must be the rate of exchange
between the home-currency and the foreign-currency, multiplied by
the foreign-currency’s purchasing power in its own country. (3) In
conditions of equilibrium the _internal_ and _external_ purchasing
powers of a currency must be the _same_, allowance being made for
transport charges and import and export taxes; for otherwise a movement
of trade would occur in order to take advantage of the inequality.
(4) It follows, therefore, from (1), (2), and (3) that the rate of
exchange between the home-currency and the foreign-currency must
tend in equilibrium to be the ratio between the purchasing powers of
the home-currency at home and of the foreign-currency in the foreign
country. This ratio between the respective home purchasing powers of
the two currencies is designated their “purchasing power parity.”

If, therefore, we find that the internal and external purchasing
powers of the home-currency are widely different, and, which is the
same thing, that the actual exchange rates differ widely from the
purchasing power parities, then we are justified in inferring that
equilibrium is not established, and that, as time goes on, forces will
come into play to bring the actual exchange rates and the purchasing
power parities nearer together. The actual exchanges are often more
sensitive and more volatile than the purchasing power parities, being
subject to speculation, to sudden movements of funds, to seasonal
influences, and to _anticipations_ of impending changes in purchasing
power parity (due to relative inflation or deflation); though also on
other occasions they may lag behind. Nevertheless it is the purchasing
power parity, according to this doctrine, which corresponds to the old
gold par. This is the point about which the exchanges fluctuate, and at
which they must ultimately come to rest; with one material difference,
namely, that it is not itself a fixed point,--since, if internal prices
move differently in the two countries under comparison, the purchasing
power parity also moves, so that equilibrium may be restored, not only
by a movement in the market rate of exchange, but also by a movement of
the purchasing power parity itself.

At first sight this theory appears to be one of great practical
utility; and many persons have endeavoured to draw important practical
conclusions about the future course of the exchanges from charts
exhibiting the divergences between the market rate of exchange and the
purchasing power parities,--undeterred by the perplexity whether an
existing divergence from equilibrium will be remedied by a movement of
the exchanges or of the purchasing power parity or of both.

In practical applications of the doctrine there are, however, two
further difficulties, which we have allowed so far to escape our
attention,--both of them arising out of the words _allowance being
made for transport charges and import and export taxes_. The first
difficulty is how to make allowance for such charges and taxes. The
second difficulty is how to treat purchasing power over goods and
services which _do not enter into international trade at all_.

The doctrine, in the form in which it is generally applied, endeavours
to deal with the first difficulty by assuming that the percentage
difference between internal and external purchasing power at some
standard date, when approximate equilibrium may be presumed to have
existed, generally the year 1913, may be taken as an approximately
satisfactory correction for the same disturbing factors at the present
time. For example, instead of calculating directly the cost of a
standard set of goods at home and abroad respectively, the calculations
are made that $2 are required to buy in the United States a standard
set which $1 would have bought in 1913, and that £2·43 are required to
buy in England what £1 would have bought in 1913. On this basis (the
pre-war purchasing power parity being assumed to be in equilibrium
with the pre-war exchange of $4·86 = £1) the present purchasing power
parity between dollars and sterling is given by $4 = £1, since 4·86 ×
2 ÷ 2·43 = 4.

The obvious objection to this method of correction is that transport
and tariff costs, especially if this term is taken to cover all
export and import regulations, including prohibitions and official or
semi-official combines for differentiating between export and home
prices, are notoriously widely different in many cases from those which
existed in 1913. We should not get the same result if we were to take
some year other than 1913 as the basis of the calculation.

The second difficulty--the treatment of purchasing power over articles
which do not enter into international trade--is still more serious.
For, if we restrict ourselves to articles entering into international
trade and make exact allowance for transport and tariff costs, we
should find that the theory is always in accordance with the facts,
with perhaps a short time-lag, the purchasing power parity being never
very far from the market rate of exchange. Indeed, it is the whole
business of the international merchant to see that this is so; for
whenever the rates are temporarily out of parity he is in a position
to make a profit by moving goods. The prices of cotton in New York,
Liverpool, Havre, Hamburg, Genoa, and Prague, expressed in dollars,
sterling, francs, marks, lire, and krone respectively, are never for
any length of time much divergent from one another on the basis of
the exchange rates actually obtaining in the market, due allowance
being made for tariffs and the cost of moving cotton from one centre to
another; and the same is true of other articles of international trade,
though with an increasing time-lag as we pass to articles which are
not standardised or are not handled in organised markets. In fact, the
theory, stated thus, is a truism, and as nearly as possible jejune.

For this reason practical applications of the theory are not thus
restricted. The standard set of commodities selected is not confined
to goods which are exported from and imported into the countries
under comparison, but is the same set, generally speaking, as is used
for compiling index numbers of general purchasing power or of the
working-class cost of living. Yet applied in this way--namely, in a
comparison of movements of the _general_ index numbers of home prices
in two countries with movements in the rates of exchange between their
currencies--the theory requires a further assumption for its validity,
namely, that in the long run the home prices of the goods and services
which do not enter into international trade, move in more or less the
same proportions as those which do.[27]

       [27] “Our calculation of the purchasing power parity rests
            strictly on the proviso that the rise in prices in the
            countries concerned has affected all commodities in a like
            degree. If that proviso is not fulfilled, then the actual
            exchange rate may deviate from the calculated purchasing
            power parity.” Cassel, _Money and Foreign Exchange after
            1914_, p. 154.

So far from this being a truism, it is not literally or exactly true
at all; and one can only say that it is more or less true according
to circumstances. If capital and labour can freely move on a large
scale between home and export industries without loss of relative
efficiency, if there is no movement in the “equation of exchange” (see
below) with the other country, and if the fluctuations in price are
solely due to monetary influences and not to changes in other economic
relationships between the two countries, then this further assumption
may be approximately justified. But this is not always the case; and
such a cataclysm as the war, with its various consequences to victor
and vanquished, may set up a new equilibrium position. There may, for
example, be a change more or less permanent, or at least as prolonged
as the reparation payments, in the relative exchange values of
Germany’s imports and exports respectively, or of those German products
and services which can enter into international trade and those which
cannot. Or, again, the strengthening of the financial position of the
United States as against Europe, which has resulted from the war, may
have shifted the old equilibrium in a direction favourable to the
United States. In such cases it is not correct to assume that the
coefficients of purchasing power parity, calculated, as they generally
are calculated, by means of the relative variations of index numbers of
general purchasing power from their pre-war levels, must ultimately
approximate to the actual rates of exchange, or that internal and
external purchasing power must ultimately bear to one another the same
relation as in 1913.

The Index Number calculated for the United States by the Federal
Reserve Board illustrates how disturbing may be the influence of the
change since 1913 in the relative prices of imported goods, exported
goods, and commodities generally:

                 Goods         Goods           All
                Imported.    Exported.     Commodities.
  1913            100           100           100
  July 1922       128           165           165
  April 1923      156           186           169
  July 1923       141           170           159

Thus the theory does not provide a simple or ready-made measure of the
“true” value of the exchanges. When it is restricted to foreign-trade
goods, it is little better than a truism. When it is not so restricted,
the conception of purchasing power parity becomes much more
interesting, but is no longer an accurate forecaster of the course of
the foreign exchanges. If, therefore, we follow the ordinary practice
of fixing purchasing power parity by comparisons of the _general_
purchasing power of a country’s currency at home and abroad, then we
must not infer from this that the actual rate of exchange _ought_ to
stand at the purchasing power parity, or that it is only a matter of
time and adjustment before the two will return to equality. Purchasing
power parity, thus defined, tells us an important fact about the
relative changes in the purchasing power of money in (_e.g._) England
and the United States or Germany between 1913 and, say, 1923, but it
does not necessarily settle what the equilibrium exchange rate in 1923
between sterling and dollars or marks ought to be.

Thus defined “purchasing power parity” deserves attention, even though
it is not always an accurate forecaster of the foreign exchanges. The
practical importance of our qualifications must not be exaggerated.
If the fluctuations of purchasing power parity are markedly different
from the fluctuations in the exchanges, this indicates an actual or
impending change in the relative prices of the two classes of goods
which respectively do and do not enter into international trade. Now
there is certainly a tendency for movements in the prices of these
two classes of goods to influence one another in the long run. The
relative valuation placed on them is derived from deep economic and
psychological causes which are not easily disturbed. If, therefore, the
divergence from the pre-existing equilibrium is mainly due to monetary
causes (as, for example, different degrees of inflation or deflation in
the two countries), as it often is, then we may reasonably expect that
purchasing power parity and exchange value will come together again
before long.

When this is the case, it is not possible to say in general whether
exchange value will move towards purchasing power parity or the other
way round. Sometimes, as recently in Europe, it is the exchanges
which are the more sensitive to impending relative price-changes and
move first; whilst in other cases the exchanges may not move until
after the change in the relation between the internal and external
price-levels is an accomplished fact. But the essence of the purchasing
power parity theory, considered as an explanation of the exchanges,
is to be found, I think, in its regarding internal purchasing power
as being in the long run a more trustworthy indicator of a currency’s
value than the market rates of exchange, because internal purchasing
power quickly reflects the monetary policy of the country, which is
the final determinant. If the market rates of exchange fall further
than the country’s existing or impending currency policy justifies by
its effect on the internal purchasing power of the country’s money,
then sooner or later the exchange value is bound to recover. Thus,
provided no persisting change is taking place in the basic economic
relations between two countries, and provided the internal purchasing
power of the currency has in each country settled down to equilibrium
in relation to the currency policy of the authorities, then the rate
of exchange between the currencies of the two countries must also
settle down in the long run to correspond with their comparative
internal purchasing powers. Subject to these assumptions comparative
internal purchasing power does take the place of the old gold parity
as furnishing the point about which the short-period movements of the
exchanges fluctuate.

If, on the other hand, these assumptions are not fulfilled and changes
are taking place in the “equation of exchange,” as economists call it,
between the services and products of one country and those of another,
either on account of movements of capital, or reparation payments, or
changes in the relative efficiency of labour, or changes in the urgency
of the world’s demand for that country’s special products, or the like,
then the equilibrium point between purchasing power parity and the rate
of exchange may be modified permanently.

This point may be made clearer by an example. Let us consider two
countries, Westropa and the United States of the Hesperides, and let
us assume for the sake of simplicity, and also because it may often
correspond to the facts, that in both countries the price of exported
goods moves in the same way as the price of other home-produced
goods, but that the “equation of exchange” has moved in favour of the
Hesperides so that a smaller number than before of units of Hesperidean
products exchange for a given quantity of Westropean products. It
follows from this that imported products in Westropa will rise in
price more than commodities generally, whilst in the Hesperides
they will rise less. Let us suppose that between 1913 and 1923 the
Westropean index number of prices has risen from 100 to 155 and the
Hesperidean index number from 100 to 160; that these index numbers are
so constructed in each case that imported commodities constitute 20
per cent and home-produced commodities 80 per cent of the whole; and
that the “equation of exchange” has moved 10 per cent in favour of
the Hesperides, that is to say a given quantity of the goods exported
by the Hesperides will buy 10 per cent more than before of the goods
exported by Europe. The state of affairs is then as follows:[28]

  _Westropa_: Price index of imported commodities (_x_) 167.
                   „       home-produced   „      (_y_) 152.
                   „       all             „            155.
  _Hesperides_:    „       imported        „     (_x´_) 148.
                   „       home-produced   „     (_y´_) 163.
                   „       all             „            160.

[Footnote 28:

                     For 10_x_ = 11_y_
                   8_y_ + 2_x_ = 1550

                        11_x´_ = 10_y´_
                 8_y´_ + 2_x´_ = 1600.

Thus it appears that the purchasing power parity of the Westropean
currency in 1923 compared with 1913 is (160/155 = )103; whereas the
rate of exchange, compared with the 1913 parity, is (163/167 = 148/152
= )97. If the worsening of Westropa’s equation of exchange with the
Hesperides is permanent, then its purchasing power parity (on the 1913
basis) will also remain permanently above the equilibrium value of the
market rate of exchange.

A tendency of these two measures of the value of a country’s currency
to move differently is, therefore, a highly interesting symptom. If the
market rate of exchange shows a continuing tendency to stand below the
purchasing power parity, we have, failing any other explanation, some
reason to suspect a worsening of the “equation of exchange” as compared
with the base year.

In the charts and tables below, the actual results are worked out of
applying the theory to the exchange value of sterling, francs, and lire
in terms of dollars since 1919. The figures show that, quantitatively
speaking, the influences, which detract from the precision of the
purchasing power parity theory, have been in these cases small, on the
whole, as compared with those which function in accord with it. There
seems to have been some disturbance in the “equations of exchange”
since 1913,--which would probably show up more distinctly if it were
not that the index numbers employed in the following enquiry are
of the type which is largely built up from articles entering into
international trade. Nevertheless general price changes, affecting
all commodities more or less equally, due to currency inflation or
deflation, have been so dominant in their influence that the theory
has been actually applicable with remarkable accuracy. In the case,
however, of such countries as Germany, where the shocks to equilibrium
have been much more violent in many respects, the concordance between
the purchasing power parity based on 1913 and the actual rate of
exchange has suffered, whether temporarily or permanently, very great

The first of these charts, which deals with the value of sterling
in terms of dollars, shows that whilst the purchasing power parity,
calculated with 1913 as base, is often somewhat above the actual
exchange, there is a persevering tendency for the two to come together.
The two curves are within one point of each other in September-November
1919, March-April 1920, April 1921, September 1921, January-June 1922,
and February-June 1923, which is certainly a remarkable illustration
of the tendency to concordance between the purchasing power parity
and the rate of exchange. On inductive grounds it would be tempting
to conclude from this chart that the financial consequences of the
war have depressed the equilibrium of the purchasing power parity of
sterling as against the dollar from 1 to 2½ per cent since 1913, if it
were not that this figure barely exceeds the margin of error resulting
from the choice of one pair of index numbers rather than another from
amongst those available.[29] It will be interesting to see what effect
is produced by the payment, just commenced, of the interest on the
American debt.

       [29] Nevertheless, if I had used the Board of Trade or the
            _Statist_ index number in place of the _Economist_ index
            number in the table below, the presumption of a slight
            worsening of the “equation of index” against Great Britain
            would be somewhat strengthened.

This chart brings out clearly, as also do those for France and
Italy, the susceptibility of the foreign exchange rates to seasonal
influences, whereas the purchasing power parity is naturally less
affected by them.

In the case of France the curves are together at the end of 1919,
diverge in 1920, come together again in the middle of 1921, and keep
together until a divergence occurred again in the latter part of 1922.

For Italy, rather unexpectedly perhaps, the relationship is
extraordinarily steady, although here, as in the case of France and
Great Britain, there are indications that the war may have resulted
in a slight lowering of the equilibrium point, by (say) 10 per
cent;[30]--the parity, calculated with 1913 as the base year, has been
almost invariably somewhat above the actual rate of exchange. The
Italian curve illustrates in a remarkable way the manner in which the
external and internal purchasing powers of the currency fall together,
when the main influence at work is a progressive depreciation due to
currency inflation.

       [30] The use of any of the other Italian index numbers would
            have accentuated this indication. The table of American
            prices given on p. 94 above confirms the suggestion that
            the “equation of exchange” between the U.S. and the rest of
            the world as a whole has moved, say, 10 per cent in favour
            of the former.

The broad effect of these curves and tables is to give substantial
inductive support to the general theory outlined above, even under such
abnormal conditions as have existed since the Armistice. During this
period the movements of the relative price level in France and Italy
due to monetary inflation have been so much larger than any shifting
in the “equation of exchange” (a movement of more than 10 or 20 per
cent in which would be startling) that their foreign exchanges have
been much more influenced by their internal price policy in relation
to the internal price policies of other countries than by any other
factor; with the result that the Purchasing Power Parity Theory, even
in its crude form, has worked passably well.


 |              |  Price Index Number.   |             |  Actual   |
 | Per cent of  +------------+-----------+ Purchasing  | Exchange  |
 | 1913 Parity. |  Great     |  United   |   Power     | (Monthly  |
 |              |Britain[31] |States[32] | Parity.[33] | Average). |
 | 1919 Aug.    |     242    |    216    |    89.3     |   87.6    |
 |      Sept.   |     245    |    210    |    85.7     |   85.8    |
 |      Oct.    |     252    |    211    |    83.7     |   85.9    |
 |      Nov.    |     259    |    217    |    83.8     |   84.3    |
 |      Dec.    |     273    |    223    |    81.7     |   78.4    |
 | 1920 Jan.    |     289    |    233    |    81.0     |   75.6    |
 |      Feb.    |     303    |    232    |    76.6     |   69.5    |
 |      March   |     310    |    234    |    75.6     |   76.2    |
 |      April   |     306    |    245    |    80.1     |   80.6    |
 |      May     |     305    |    247    |    81.0     |   79.0    |
 |      June    |     291    |    243    |    83.5     |   81.1    |
 |      July    |     293    |    241    |    82.3     |   74.2    |
 |      Sept.   |     284    |    226    |    79.6     |   72.2    |
 |      Oct.    |     266    |    211    |    79.3     |   71.4    |
 |      Nov.    |     246    |    196    |    79.7     |   70.7    |
 |      Dec.    |     220    |    179    |    81.4     |   71.4    |
 | 1921 Jan.    |     209    |    170    |    81.4     |   76.7    |
 |      Feb.    |     192    |    160    |    83.3     |   79.6    |
 |      March   |     189    |    155    |    82.0     |   80.3    |
 |      April   |     183    |    148    |    80.9     |   80.7    |
 |      May     |     182    |    145    |    79.7     |   81.5    |
 |      June    |     179    |    142    |    79.3     |   78.0    |
 |      July    |     178    |    141    |    79.2     |   74.8    |
 |      Aug.    |     179    |    142    |    79.3     |   75.1    |
 |      Sept.   |     183    |    141    |    77.0     |   76.5    |
 |      Oct.    |     170    |    142    |    83.5     |   79.5    |
 |      Nov.    |     166    |    141    |    84.9     |   81.5    |
 |      Dec.    |     162    |    140    |    86.4     |   85.3    |
 | 1922 Jan.    |     159    |    138    |    86.8     |   86.8    |
 |      Feb.    |     158    |    141    |    89.1     |   89.6    |
 |      March   |     160    |    142    |    88.7     |   89.9    |
 |      April   |     159    |    143    |    89.9     |   90.7    |
 |      May     |     162    |    148    |    91.4     |   91.4    |
 |      June    |     163    |    150    |    92.0     |   91.5    |
 |      July    |     163    |    155    |    95.1     |   91.4    |
 |      Aug.    |     158    |    155    |    98.1     |   91.7    |
 |      Sept.   |     158    |    154    |    97.4     |   91.2    |
 |      Nov.    |     159    |    156    |    98.1     |   92.0    |
 |      Dec.    |     158    |    156    |    98.7     |   94.6    |
 | 1923 Jan.    |     160    |    156    |    97.5     |   95.7    |
 |      Feb.    |     163    |    157    |    96.3     |   96.2    |
 |      March   |     163    |    159    |    97.5     |   96.5    |
 |      April   |     165    |    159    |    96.4     |   95.7    |
 |      May     |     164    |    156    |    95.1     |   95.0    |
 |      June    |     160    |    153    |    95.6     |   94.8    |

       [31] _Economist_ Index Number.

       [32] U.S. Bureau of Labour Index Number, as revised.

       [33] The U.S. Bureau of Labour Index Number divided by the
            _Economist_ Index Number.

[Illustration: ENGLAND]


 |              | Purchasing  |           |
 | Per cent of  |   Power     |  Actual   |
 | 1913 Parity. | Parity.[34] | Exchange. |
 | 1919 Aug.    |     62      |    66     |
 |      Sept.   |     58      |    61     |
 |      Oct.    |     55      |    60     |
 |      Nov.    |     53      |    55     |
 |      Dec.    |     52      |    48     |
 | 1920 Jan.    |     48      |    44     |
 |      Feb.    |     44      |    36     |
 |      March   |     42      |    37     |
 |      April   |     41      |    32     |
 |      May     |     45      |    35     |
 |      June    |     49      |    41     |
 |      July    |     48      |    42     |
 |      Aug.    |     46      |    37     |
 |      Sept.   |     43      |    35     |
 |      Oct.    |     42      |    34     |
 |      Nov.    |     43      |    31     |
 |      Dec.    |     41      |    30     |
 | 1921 Jan.    |     42      |    33     |
 |      Feb.    |     42      |    37     |
 |      March   |     43      |    36     |
 |      April   |     43      |    37     |
 |      May     |     44      |    43     |
 |      June    |     44      |    42     |
 |      July    |     43      |    40     |
 |      Aug.    |     43      |    40     |
 |      Sept.   |     41      |    38     |
 |      Oct.    |     43      |    38     |
 |      Nov.    |     42      |    37     |
 |      Dec.    |     43      |    40     |
 | 1922 Jan.    |     44      |    42     |
 |      Feb.    |     46      |    45     |
 |      March   |     46      |    47     |
 |      April   |     46      |    48     |
 |      May     |     44      |    47     |
 |      June    |     46      |    45     |
 |      July    |     48      |    43     |
 |      Aug.    |     47      |    41     |
 |      Sept.   |     46      |    40     |
 |      Oct.    |     46      |    38     |
 |      Nov.    |     44      |    35     |
 |      Dec.    |     43      |    37     |
 | 1923 Jan.    |     40      |    34     |
 |      Feb.    |     37      |    32     |
 |      March   |     37      |    33     |
 |      April   |     38      |    35     |
 |      May     |     38      |    34     |
 |      June    |     37      |    33     |

       [34] U.S. Bureau of Labour Index divided by French official
            wholesale Index.


 |              | Purchasing  |           |
 | Per cent of  |   Power     |  Actual   |
 | 1913 Parity. | Parity.[35] | Exchange. |
 | 1919 Aug.    |     59      |    56     |
 |      Sept.   |     56      |    53     |
 |      Oct.    |     54      |    51     |
 |      Nov.    |     50      |    44     |
 |      Dec.    |     49      |    40     |
 | 1920 Jan.    |     46      |    37     |
 |      Feb.    |     42      |    29     |
 |      March.  |     38      |    28     |
 |      April   |     36      |    23     |
 |      May     |     38      |    27     |
 |      June    |     40      |    31     |
 |      July    |     39      |    30     |
 |      Aug.    |     37      |    25     |
 |      Sept.   |     34      |    23     |
 |      Oct.    |     32      |    20     |
 |      Nov.    |     30      |    19     |
 |      Dec.    |     28      |    18     |
 | 1921 Jan.    |     26      |    18     |
 |      Feb.    |     26      |    19     |
 |      March   |     26      |    20     |
 |      April   |     25      |    24     |
 |      May     |     27      |    27     |
 |      June    |     28      |    26     |
 |      July    |     27      |    24     |
 |      Aug.    |     26      |    22     |
 |      Sept.   |     24      |    22     |
 |      Oct.    |     24      |    20     |
 |      Nov.    |     24      |    21     |
 |      Dec.    |     23      |    23     |
 | 1922 Jan.    |     24      |    23     |
 |      Feb.    |     25      |    25     |
 |      March.  |     27      |    26     |
 |      April   |     27      |    28     |
 |      May     |     28      |    27     |
 |      June    |     28      |    26     |
 |      July    |     28      |    24     |
 |      Aug.    |     27      |    23     |
 |      Sept.   |     26      |    22     |
 |      Oct.    |     26      |    22     |
 |      Nov.    |     26      |    23     |
 |      Dec.    |     27      |    26     |
 | 1923 Jan.    |     27      |    26     |
 |      Feb.    |     27      |    25     |
 |      March.  |     27      |    25     |
 |      April   |     27      |    26     |
 |      May     |     27      |    25     |
 |      June    |     26      |    24     |

       [35] U.S. Bureau of Labour Index Number divided by the “Bachi”
            Index Number.

[Illustration: FRANCE]

[Illustration: ITALY]

III. _The Seasonal Fluctuation._

Thus the Theory of Purchasing Power Parity tells us that movements in
the rate of exchange between the currencies of two countries tend,
subject to adjustment in respect of movements in the “equation of
exchange,” to correspond pretty closely to movements in the internal
price levels of the two countries each expressed in their own currency.
It follows that the rate of exchange can be improved in favour of one
of the countries by a financial policy directed towards a lowering
of its internal price level relatively to the internal price level
of the other country. On the other hand a financial policy which has
the effect of raising the internal price level must result, sooner or
later, in depressing the rate of exchange.

The conclusion is generally drawn, and quite correctly, that budgetary
deficits covered by a progressive inflation of the currency render
the stabilisation of a country’s exchanges impossible; and that the
cessation of any increase in the volume of currency, due to this cause,
is a necessary pre-requisite to a successful attempt at stabilising.

The argument, however, is often carried further than this, and it is
supposed that, if a country’s budget, currency, foreign trade, and
its internal and external price levels are properly adjusted, then,
automatically, its foreign exchange will be steady.[36] So long,
therefore, as the exchanges fluctuate--thus the argument runs--this
in itself is a symptom that an attempt to stabilise would be
premature. When, on the other hand, the basic conditions necessary for
stabilisation are present, the exchange will steady itself. In short,
any deliberate or artificial scheme of stabilisation is attacking the
problem at the wrong end. It is the regulation of the currency, by
means of sound budgetary and bank-rate policies, that needs attention.
The proclamation of convertibility will be the last and crowning
stage of the proceedings, and will amount to little more than the
announcement of a _fait accompli_.

       [36] Dr. R. Estcourt, criticising one of my articles in _The
            Annalist_ for June 12, 1922, writes: “The arrangement
            would not last for any appreciable period unless, as a
            preliminary, the Governments took the necessary steps to
            balance their budgets. If that were done, the so-called
            stabilisation speedily would become unnecessary; exchange
            would stabilise itself at pre-war rates.” This passage puts
            boldly an opinion which is widely held.

There is a certain force in this mode of reasoning. But in one
important respect it is fallacious.

Even though foreign trade is properly adjusted, and the country’s
claims and liabilities on foreign account are in equilibrium over
the year as a whole, it does not follow that they are in equilibrium
every day. Indeed, it is well known that countries which import large
quantities of agricultural produce do not find it convenient, if they
are to secure just the quality and the amount which they require, to
buy at an equal rate throughout the year, but prefer to concentrate
their purchases on the autumn period.[37] Thus, quite consistently
with equilibrium over the year as a whole, industrial countries
tend to owe money to agricultural countries in the second half of
the year, and to repay in the first half. The satisfaction of these
seasonal requirements for credit with the least possible disturbance
to trade was recognised before the war as an important function of
international banking, and the seasonal transference of short-term
credits from one centre to another was carried out for a moderate

       [37] Whilst the fact of seasonal pressure is well ascertained,
            the exact analysis of it is a little complicated. Food
            arrivals into Great Britain, for example, are nearly 10
            per cent heavier in the third and fourth quarters of the
            year than in the first and second, and reach their maximum
            in the fourth quarter. (These and the following figures
            are based on averages for the pre-war period 1901–1913
            worked out by the Cambridge and London Economic Service).
            Raw material imports are more than 20 per cent heavier
            in the fourth and first quarters than in the second and
            third, and reach their maximum in the three months November
            to January. Thus the fourth quarter of the year is the
            period at which there are heavy imports of both food and
            raw materials. Manufactured exports, on the other hand,
            are distributed through the year much more evenly, and are
            about normal during the last quarter. Allowing for the fact
            that imports are paid for, generally speaking, before they
            arrive, these dates correspond pretty closely with the date
            at which seasonal pressure is actually experienced by the
            dollar-sterling exchange. In France, since the war, imports
            in the last quarter of the year seem to have been quite 50
            per cent heavier than, for example, in the first quarter.
            In Italy the third quarter seems to be the slackest, and
            the last quarter, again, a relatively heavy period. When we
            turn to the statistics for the United States we find the
            other side of the picture. August and September are the
            months of heavy wheat export; October to January those of
            heavy cotton export. The strength of the dollar exchanges
            in the early autumn is further increased by the financial
            pressure in the United States during the crop-moving
            period, which leads to a withdrawal of funds from foreign
            centres to New York.

It was possible for this service to be rendered cheaply because, with
the certainty provided by convertibility, the price paid for it did
not need to include any appreciable provision against risk. A somewhat
higher rate of discount in the temporarily debtor country, together
with a small exchange profit provided by the slight shift of the
exchanges within the gold points, was quite sufficient.

But what is the position now? As always, the balance of payments
must balance every day. As before, the balance of trade is spread
unevenly through the year. Formerly the daily balance was adjusted by
the movement of bankers’ funds, as described above. But now it is no
longer a purely bankers’ business, suitably and sufficiently rewarded
by an arbitrage profit. If a banker moves credits temporarily from
one country to another, he cannot be certain at what rate of exchange
he will be able to bring them back again later on. Even though he may
have a strong opinion as to the probable course of exchange, his profit
is no longer definitely calculable beforehand, as it used to be; he
has learnt by experience that unforeseen movements of the exchange
may involve him in heavy loss; and his prospective profit must be
commensurate with the risk he runs. Even if he thinks that the risk is
covered actuarially by the prospective profit, a banker cannot afford
to run such risks on a large scale. In fact, the seasonal adjustment of
credit requirements has ceased to be arbitrage banking business, and
demands the services of speculative finance.

Under present conditions, therefore, a large fluctuation of the
exchange may be necessary before the daily account can be balanced,
even though the annual account is level. Where in the old days a banker
would have readily remitted millions to and from New York, hundreds
of thousands are now as much as the biggest institutions will risk.
The exchange must fall (or rise, as the case may be) until either the
speculative financier feels sufficiently confident of a large profit to
step in, or the merchant, appalled by the rate of exchange quoted to
him for the transaction, decides to forgo the convenience of purchasing
at that particular season of the year, and postpones a part of his

The services of the professional exchange speculator, being discouraged
by official and banking influences, are generally in short supply, so
that a heavy price has to be paid for them, and trade is handicapped
by a corresponding expense, in so far as it continues to purchase its
materials at the most convenient season of the year.

The extent to which the exchange fluctuations which have troubled trade
during the past three years have been seasonal, and therefore due, not
to a continuing or increasing disequilibrium, but merely to the absence
of a fixed exchange, is not, I think, fully appreciated.

During 1919 there was a heavy fall of the chief European exchanges due
to the termination of the inter-Allied arrangements which had existed
during the war. During 1922 there was a rise of the sterling exchange,
which was independent of seasonal influences. During 1923 there has
been a further non-seasonal collapse of the franc exchange due to
certain persisting features of France’s internal finances and external
policy. But the following table shows how largely _recurrent_ the
fluctuations have been during the four years since the autumn of 1919:--


 |August-July.|     Sterling.    |      Francs.     |       Lire.      |
 |            | Lowest. Highest. | Lowest. Highest. | Lowest. Highest. |
 | 1919–1920  |    69      88    |   31      66     |    22     56     |
 | 1920–1921  |    69      82    |   30      45     |    18     29     |
 | 1921–1922  |    73      92    |   37      48     |    20     28     |
 | 1922–1923  |    90      97    |   29      41     |    20     27     |

On the experience of the past three years, francs and lire are at their
best in April and May and at their worst between October and December.
Sterling is not quite so punctual in its movements, the best point of
the year falling somewhere between March and June and the worst between
August and November.

The comparative stability of the highest and lowest quotations
respectively in each year, especially in the case of Italy, is very
striking, and indicates that a policy of stabilisation at some mean
figure might have been practicable; whilst, on the other hand, the wide
divergences between the highest and lowest are a measure of the expense
and interference that trade has suffered.

These results correspond so closely to the facts of seasonal trade
(see above, p. 108) that we may safely attribute most of the major
fluctuations of the exchanges from month to month to the actual
pressure of trade remittances, and not to speculation. Speculators,
indeed, by anticipating the movements tend to make them occur a little
earlier than they would occur otherwise, but by thus spreading the
pressure more evenly through the year their influence is to diminish
the absolute amount of the fluctuation. General opinion greatly
overestimates the influence of exchange-speculators acting under the
stimulus of merely political and sentimental considerations. Except
for brief periods the influence of the speculator is washed out; and
political events can only exert a lasting influence on the exchanges,
in so far as they modify the internal price level, the volume of trade,
or the ability of a country to borrow on foreign markets. A political
event, which does not materially affect any of these facts, cannot
exert a lasting effect on the exchanges merely by its influence on
sentiment. The only important exception to this statement is where
there exists on a large scale a long-period speculative investment in a
country’s currency on the part of foreigners, as in the case of German
marks. But such investments are comparable to borrowing abroad and
exercise a different kind of influence altogether from a speculative
transaction proper, which is opened with the intention of its being
closed again within a short period. And even speculative investment
in a currency, since it is bound to diminish sooner or later, cannot
permanently prevent the exchanges from reaching the equilibrium
justified by conditions of trading and relative price levels.

It follows that, whilst purely seasonal fluctuations do not interfere
with the forces which determine the ultimate equilibrium of the
exchanges, nevertheless stability of the exchange from day to day
cannot be maintained merely by the _fact_ of stability in these
underlying conditions. It is necessary also that bankers should have a
sufficiently certain _expectation_ of such stability to induce them to
look after the daily and seasonal fluctuations of the market in return
for a moderate commission.

After recent experience it is unlikely that they will actually
entertain any such expectation, even if the underlying facts were of
a kind to justify it, with sufficient conviction to act, unless it is
backed up by a guarantee on the part of the Central Authority (Bank or
Government) to employ all their resources for the maintenance of the
level of exchange at a stated figure. At present the declared official
policy is to bring the franc and the lira (for example) back to par,
so that operations favouring a fall of these currencies are not free
from danger. On the other hand no steps are taken to make this policy
effective, and the conditions of internal finance in France and Italy
indicate that their exchanges may go much worse. Thus, since no one can
have complete confidence whether they are to be a great deal better or
very much worse, there must be a wide fluctuation before financiers
will come in, purely from motives of self-interest, to balance the
day-to-day fluctuations and the month-to-month fluctuations round about
the unpredictable point of equilibrium.

If, therefore, the exchanges are not stabilised by policy, they
will never come to an equilibrium of themselves. As time goes on
and experience accumulates, the oscillations may be smaller than at
present. Speculators may come in a little sooner, and importers may
make greater efforts to spread their requirements more evenly over the
year. But even so, there must be a substantial difference of rates
between the busy season and the slack season, until the business world
knows for certain at what level the exchanges in question are going to
settle down. Thus a seasonal fluctuation of the exchanges (including
the sterling-dollar exchange) is inevitable, even in the absence of
any decided long-period tendency of an exchange to rise or to fall,
unless the Central Authority, by a guarantee of convertibility or
otherwise, takes special steps to provide against it.

IV. _The Forward Market in Exchanges._

When a merchant buys or sells goods in a foreign currency the
transaction is not always for immediate settlement by cash or
negotiable bill. During the interval before he can cover himself by
buying or selling (as the case may be) the foreign currency involved,
he runs an exchange risk, losses or gains on which may often, in these
days, swamp his trading profit. He is thus involuntarily engaged in a
heavy risk of a kind which it is hardly in his province to undertake.
The subject of what follows is a piece of financial machinery--namely,
the market in “forward” exchanges as distinguished from “spot”
exchanges--for enabling the merchant to avoid this risk, not, indeed,
during the interval when he is negotiating the contract, but as soon as
the negotiation is completed.

Transactions in “spot” exchange are for cash--that is to say, cash in
one currency is exchanged for cash in another currency. But merchants
who have bought goods in terms of foreign currency for future delivery
may not have the cash available pending delivery of the goods; whilst
merchants who have sold goods in terms of foreign currency, but are
not yet in a position to sell a draft on the buyer, cannot, even if
they have plenty of cash in their own currency, protect themselves by a
“spot” sale of the exchange involved, save in the exceptional case when
they have cash available in the foreign currency also.

A “forward” contract is for the conclusion of a “spot” transaction
in exchanges at a later date, fixed on the basis of the spot rate
prevailing at the original date. Pending the date of the maturity
of the forward contract no cash need pass (although, of course, the
contracting party may be required to give some security or other
evidence for his ability to complete the contract in due course), so
that the merchant entering into a forward contract is not required to
find cash any sooner than if he ran the risk on the exchange until the
goods were delivered; yet he is protected from the consequences of any
fluctuation in the exchanges in the meantime.

The tables given below show that in London, in the case of the
exchanges which have a big market (the dollar, the franc, and the
lira), competition between dealers has brought down the charges for
these facilities to a fairly moderate rate. During 1920 and 1921 the
cost to an English buyer of foreign currency for forward delivery
was a little more expensive than for spot delivery in the case of
francs, lire, and marks, and a little cheaper in the case of dollars.
Correspondingly, French, Italian, and German merchants were generally
in a position to buy both sterling and dollars for forward delivery
at a slightly cheaper rate than for spot delivery--that is to say, if
they dealt in London. As regards the rates charged in foreign centres
my information is not extensive, but it indicates that in Milan,
for example, very much less favourable terms for these transactions
are frequently charged to the seller of forward sterling than those
ruling in London. During 1922, however, the effect of the progressive
cheapening of money in London was, for reasons to be explained in a
moment, to cheapen the cost to English buyers of foreign currency for
forward delivery, forward francs falling to an appreciable discount
on spot francs, and forward dollars becoming at the end of the year
decidedly cheaper than spot dollars. Later on, the raising of the
bank-rate in June 1923 acted again, as could have been predicted, in
the opposite direction.

Proceeding to details, we see below (pp. 118, 119) the quotations for
forward exchange ruling in the London market since the beginning of
1920. During 1920–21 forward dollars were generally cheaper than spot
dollars to a London buyer to the extent of from 1 to 1½ per cent per
annum. Occasionally, however, when big movements of the exchange were
taking place, the discount on forward dollars was temporarily much
higher, having risen, for example, in November 1920, when sterling
was at its lowest point, to nearly 6 per cent--for reasons which I
will endeavour to elucidate later. During the first half of 1922 the
discount on forward dollars dwindled, but rose again during the latter
half of the year, reacting again in the middle of 1923 after money
rates in London had been slightly raised. Thus a London merchant, who
has had dollar commitments for the purchase of goods, has not only been
able to cover his exchange risk by means of a forward transaction, but
on the average he has got his exchange a little cheaper by providing
for it in advance.


 |                     NEW YORK.                    |
 |          |            | One Month   | Difference |
 |   Date.  |    Spot.   |  Forward.   |  per cent  |
 |          |            |             | per annum. |
 |   1920   |            |             |            |
 |January   | 3·79       | + ⅜ cent    |   +1·2     |
 |February  | 3·48⅞      | + ¼   „     |   + ·9     |
 |March     | 3·41⅜      | + ¼   „     |   + ·9     |
 |April     | 3·90¾      | + ⅜   „     |   +1·2     |
 |May       | 3·82⅞      | + ½   „     |   +1·6     |
 |June      | 3·89-15/16 | + ⅜   „     |   +1·2     |
 |July      | 3·96⅛      | + ⅝   „     |   +1·9     |
 |August    | 3·67       | + ½   „     |   +1·6     |
 |September | 3·56⅞      | + ½   „     |   +1·7     |
 |October   | 3·48-5/16  | + ½   „     |   +1·7     |
 |November  | 3·44⅜      | +1⅝   „     |   +5·7     |
 |December  | 3·49       | + ½   „     |   +1·7     |
 |   1921   |            |             |            |
 |January   | 3·58⅜      | + ⅜   „     |   +1·3     |
 |February  | 3·84¾      | +1    „     |   +3·1     |
 |March     | 3·88⅜      | + ⅞   „     |   +2·7     |
 |April     | 3·92       | + ⅜   „     |   +1·1     |
 |May       | 3·98       | + ½   „     |   +1·5     |
 |June      | 3·90⅝      | + ¾   „     |   +2·3     |
 |July      | 3·71-15/16 | + ⅝   „     |   +2·0     |
 |August    | 3·56⅜      | + ½   „     |   +1·7     |
 |September | 3·71⅝      | + ⅜   „     |   +1·2     |
 |October   | 3·76⅛      | + ½   „     |   +1·6     |
 |November  | 3·92-1/16  | + ⅞   „     |   +2·7     |
 |December  | 4·08-5/16  | + ⅜   „     |   +1·1     |
 |   1922   |            |             |            |
 |January   | 4·20½      | + ⅛   „     |   + ·4     |
 |February  | 4·30½      |   par       |    ...     |
 |March     | 4·42       |    „        |    ...     |
 |April     | 4·39       |    „        |    ...     |
 |May       | 4·44½      |    „        |    ...     |
 |June      | 4·46¾      | + 3/16 cent |   + ·5     |
 |July      | 4·44¾      | + 1/16  „   |   + .17    |
 |August    | 4·45¼      | + 3/16  „   |   + .5     |
 |September | 4·46       | + ⅜     „   |   +1       |
 |October   | 4·42       | + ¼     „   |   + .68    |
 |November  | 4·46½      | + ⅝     „   |   +1·68    |
 |December  | 4·51¾      | +1      „   |   +2·65    |
 |   1923   |            |             |            |
 |January   | 4·64¾      | +1¼     „   |   +3·23    |
 |February  | 4·67       | + ⅞     „   |   +2·25    |
 |March     | 4·70⅝      | +1      „   |   +2·55    |
 |April     | 4·66⅞      | + ¾     „   |   +1·93    |
 |May       | 4·62½      | + 15/16 „   |   +2·43    |
 |June      | 4·62¾      | + ⅞     „   |   +2·27    |
 |July      | 4·56½      | + ½     „   |   +1·31    |
 |August    | 4·57       | + ¼     „   |   +0·66    |

 |                      PARIS.                      |
 |          |            |  One Month  | Difference |
 |   Date.  |    Spot.   |   Forward.  |  per cent  |
 |          |            |             | per annum. |
 |   1920   |            |             |            |
 |January   | 40·90      | + 6 centime |   +1·7     |
 |February  | 46·90      | + 4    „    |   +1·0     |
 |March     | 48·55      | + 3    „    |   + ·7     |
 |April     | 57·80      | + 3    „    |   + ·6     |
 |May       | 64·04      | + 1    „    |   + ·18    |
 |June      | 50·45      | - 5    „    |   -1·2     |
 |July      | 47·05      | -10    „    |   -2·8     |
 |August    | 49·00      | -10    „    |   -2·4     |
 |September | 51·22½     | - 5    „    |   -1·2     |
 |October   | 52·10      | -10    „    |   -2·3     |
 |November  | 54·45      | -15    „    |   -3·3     |
 |December  | 57·45      | -15    „    |   -3·2     |
 |   1921   |            |             |            |
 |January   | 61·07½     | -30    „    |   -5·9     |
 |February  | 54·50      | -20    „    |   -4·4     |
 |March     | 54·40      | -27    „    |   -5·9     |
 |April     | 55-37½     | -15    „    |   -3·3     |
 |May       | 50·22½     | -12    „    |   -2·9     |
 |June      | 46·35      | -10    „    |   -2·6     |
 |July      | 46·72½     | -10    „    |   -2·6     |
 |August    | 46·77½     | + 2    „    |   + ·5     |
 |September | 48·68½     | + 3    „    |   + ·7     |
 |October   | 52·27½     | + 1    „    |   + ·2     |
 |November  | 53·44      | + 4    „    |   + ·9     |
 |December  | 54·24      | + 2    „    |   + ·4     |
 |   1922   |            |             |            |
 |January   | 52·32½     |   par       |    ...     |
 |February  | 51·62½     |    „        |    ...     |
 |March     | 48·45      |    „        |    ...     |
 |April     | 48·15      | - 1 centime |   - .25    |
 |May       | 48·47      | + 1    „    |   + .25    |
 |June      | 49·00      | + 2    „    |   + ·49    |
 |July      | 56·20      | + 8    „    |   +1·8     |
 |August    | 54·10      | +10    „    |   +2·21    |
 |September | 57·40      | + 3    „    |   + ·63    |
 |October   | 58·25      | + 3    „    |   + ·62    |
 |November  | 64·65      | +14    „    |   +2·59    |
 |December  | 64·30      | + 8    „    |   +1·49    |
 |   1923   |            |             |            |
 |January   | 66·40      | + 5    „    |   + ·9     |
 |February  | 75·50      | +16    „    |   +2·54    |
 |March     | 77·50      | +11    „    |   +1·70    |
 |April     | 70·40      | + 5    „    |   + .85    |
 |May       | 69·35      | + 5    „    |   + ·86    |
 |June      | 71·60      | + 5    „    |   + ·84    |
 |July      | 78·35      | + 4    „    |   + ·61    |
 |August    | 79·20      | + 9    „    |   + ·60    |

First day of month in 1920, first Wednesday in 1921, and first Friday


 |                      ITALY.                      |
 |          |            |  One Month  | Difference |
 |   Date.  |    Spot.   |   Forward.  |  per cent  |
 |          |            |             | per annum. |
 |1920[38]  |            |             |            |
 |January   |  50        | - ⅛ lire    |   - 3·0    |
 |February  |  55        | - ⅛    „    |   - 2·7    |
 |March     |  62¾       | - ¼    „    |   - 4·7    |
 |April     |  80½       | - ¼    „    |   - 3·7    |
 |May       |  83        | - ½    „    |   - 7·1    |
 |June      |  66⅜       | - ½    „    |   - 9·1    |
 |July      |  65⅜       | - ½    „    |   - 9·2    |
 |August    |  70        | - ½    „    |   - 8·5    |
 |September |  76¼       | - ½    „    |   - 7·9    |
 |October   |  83-9/16   | - ½    „    |   - 7·2    |
 |November  |  93-11/16  | - ½    „    |   - 6·4    |
 |December  |  94-11/16  | - ½    „    |   - 6·3    |
 |   1921   |            |             |            |
 |January   | 104⅜       |  par        |     ...    |
 |February  | 105½       | - ¾ lire    |   - 8·5    |
 |March     | 106½       | - ⅝    „    |   - 7·0    |
 |April     |  92¼       | - ½    „    |   - 6·5    |
 |May       |  81⅜       | - ⅝    „    |   - 9·1    |
 |June      |  73-11/16  | - ½    „    |   - 8·1    |
 |July      |  77        | - ½    „    |   - 7·8    |
 |August    |  85-1/16   | - ¼    „    |   - 3·5    |
 |September |  85-9/16   | - ⅜    „    |   - 5·2    |
 |October   |  94⅛       | - ⅜    „    |   - 4·8    |
 |November  |  96⅝       | - ¼    „    |   - 3·1    |
 |December  |  93-15/16  | - ½    „    |   - 6·4    |
 |   1922   |            |             |            |
 |January   |  97⅛       | - ¼    „    |   - 3·0    |
 |February  |  92½       | - 7/16 „    |   - 5·7    |
 |March     |  83-3/16   | - ¼    „    |   - 3·6    |
 |April     |  83-5/16   | -15 pts.    |   - 2·16   |
 |May       |  83        | -10  „      |   - 1·45   |
 |June      |  85⅞       | - 3  „      |   -  ·41   |
 |July      | 100        |  par        |     ...    |
 |August    |  96        |  par        |     ...    |
 |September | 101        | -11  „      |   - 1·31   |
 |October   | 103        | -10  „      |   - 1·16   |
 |November  | 106        | - 8  „      |   -  ·91   |
 |December  |  93¾       | -20  „      |   - 2·56   |
 |   1923   |            |             |            |
 |January   |  92        | -11  „      |   - 1·43   |
 |February  |  97½       | -23  „      |   - 2·83   |
 |March     |  97⅜       | -23  „      |   - 2·82   |
 |April     |  93¾       | -18  „      |   - 2·30   |
 |June      |  99        | -15  „      |   - 1·82   |
 |July      | 106⅞       | -22  „      |   - 2·47   |
 |August    | 105½       | -28  „      |   - 3·18   |

 |                       GERMANY.                        |
 |          |            |    One Month     | Difference |
 |   Date.  |    Spot.   |     Forward.     |  per cent  |
 |          |            |                  | per annum. |
 |1920[38]  |            |                  |            |
 |January   |       187  |       marks      |            |
 |February  |       305  |                  |            |
 |March     |       337  |                  |            |
 |April     |       275  |                  |            |
 |May       |       218½ | - 1     „        |    - 5·5   |
 |June      |       150½ | - 1     „        |    - 8·0   |
 |July      |       150  | -  ½    „        |    - 4·0   |
 |August    |       160½ | - 1     „        |    - 7·5   |
 |September |       176  | -  ½    „        |    - 3·4   |
 |October   |       215  | - 1     „        |    - 5·6   |
 |November  |       266½ | -  ½    „        |    - 2·2   |
 |December  |       241½ | - 1     „        |    - 4·9   |
 |   1921   |            |                  |            |
 |January   |       269½ | - 2     „        |    - 8·9   |
 |February  |       243½ | - 1     „        |    - 4·9   |
 |March     |        24½ | - 1     „        |    - 4·9   |
 |April     |       239½ | - 2     „        |    -10·0   |
 |May       |       262½ | - 1¾    „        |    - 8·0   |
 |June      |       245¼ | - 1½    „        |    - 7·3   |
 |July      |       279½ | - 1½    „        |    - 6·45  |
 |August    |       286  | - 1     „        |    - 4·2   |
 |September |       347½ | - 1½    „        |    - 5·1   |
 |October   |       471  | - 5     „        |    -12·7   |
 |November  |       764½ | - 2¼    „        |    - 3·5   |
 |December  |       855  | - 1½    „        |    - 2·1   |
 |   1922   |            |                  |            |
 |January   |       777½ | - 3½    „        |    - 5·4   |
 |February  |       872  | - 2½    „        |    - 3·4   |
 |March     |      1117  | - 1½    „        |    - 1·6   |
 |April     |      1440  | - 8     „        |    - 6·6   |
 |May       |      1270  | -  ½    „        |    -  ·47  |
 |June      |      1222  |    par           |     ...    |
 |July      |      2320  | + 5   marks      |   +  2·59  |
 |August    |      3175  | +20     „        |   +  7·56  |
 |September |      5700  |   nominal        |     ...    |
 |October   |      9900  | +      450   mks |   + 54·54  |
 |November  |    26,250  | +    6,000     „ |   +274·3   |
 |December  |    35,000  | +    5,500     „ |   +188·58  |
 |   1923   |            |                  |            |
 |January   |    39,500  | +    1,750     „ |   + 53·16  |
 |February  |   190,000  | +   27,000     „ |   +170·53  |
 |March     |   105,000  | +   10,000     „ |   +114·28  |
 |April     |    97,500  | +   20,000     „ |   +141·18  |
 |June      |   350,000  | +   40,000     „ |   +137·14  |
 |July      |   900,000  | +   30,000[38] „ |   + 40·00  |
 |August    | 5,500,000  | +1,500,000[38] „ |   +327·27  |

       [38] Nominal.

Forward purchases of francs, after being dearer than spot transactions
by 2½ per cent per annum or more from the middle of 1920 to the middle
of 1921, were nearly level in price from the middle of 1921 to the
middle of 1922, whilst since that time they have been ½ to 2½ per cent
per annum cheaper. In the case of lire there have been much wider gaps,
forward purchases being frequently 3 per cent or more dearer than
spot. In the case of German marks, the forward rate, after ranging
round about 5 per cent per annum dearer than spot, has reached, since
the autumn of 1922 and the complete collapse of the mark, a figure
fantastically cheaper, thus reflecting the sensational rate of interest
for short loans current inside Germany.

But in all these cases (except in Germany since the complete collapse
of the mark), whether forward exchange is at a discount or at a
premium on spot, the expense, if any, of dealing forward has been small
in relation to the risks that are avoided.

Nevertheless, in practice merchants do not avail themselves of these
facilities to the extent that might have been expected. The nature of
forward dealings in exchange is not generally understood. The rates
are seldom quoted in the newspapers. There are few financial topics of
equal importance which have received so little discussion or publicity.
The present situation did not exist before the war (although even at
that time forward rates for the dollar were regularly quoted), and did
not begin until after the “unpegging” of the leading exchanges in 1919,
so that the business world has only begun to adapt itself. Moreover,
for the ordinary man, dealing in forward exchange has, it seems, a
smack of speculation about it. Unlike Manchester cotton spinners, who
have learnt by long experience that it is not the hedging of open
cotton commitments on the Liverpool futures market, but the failure to
do so, which is speculative, merchants, who buy or sell goods of which
the price is expressed in a foreign currency, do not yet regard it as
part of the normal routine of prudent business to hedge these indirect
exchange commitments by a transaction in forward exchange.

It is important, on the other hand, not to exaggerate the extent to
which, at the present time, merchants can by this means protect
themselves from risk. In the first place, for reasons, some of which
will be considered below, it is only in certain of the leading
exchanges that these transactions can be carried out at a reasonable
charge. It is not clear that even the banks themselves have yet learnt
to look on the provision for their clients of such facilities at fair
and reasonable rates as one of the most useful services they can offer.
They have been too much influenced, perhaps, by the fear that these
facilities might tend at the same time to increase speculation.

But there is a further qualification, not to be overlooked, to the
value of forward transactions as a protection against risk. The price
of a particular commodity, in terms of a particular currency, does
not exactly respond to changes in the value of that currency on the
exchange markets of the world, with the result that a movement in a
country’s exchanges may, in the case of a commodity of which that
country is a large seller or a large purchaser, change the commodity’s
world-value expressed in terms of gold. In that case a merchant, even
though he is hedged in respect of the exchange itself, may lose,
in respect of his unsold trading stocks, through a movement in the
world-value of the commodity he is dealing in, directly occasioned by
the exchange fluctuation.

       *       *       *       *       *

If we turn to the theoretical analysis of the forward market, what is
it that determines the amount and the sign (whether plus or minus) of
the divergence between the spot and forward rates as recorded above?

If dollars one month forward are quoted cheaper than spot dollars
to a London buyer in terms of sterling, this indicates a preference
by the market, on balance, in favour of holding funds in New York
during the month in question rather than in London,--a preference the
degree of which is measured by the discount on forward dollars. For
if spot dollars are worth $4.40 to the pound and dollars one month
forward $4.40½ to the pound, then the owner of $4.40 can, by selling
the dollars spot and buying them back one month forward, find himself
at the end of the month with $4.40½, merely by being during the
month the owner of £1 in London instead of $4.40 in New York. That
he should require and can obtain half a cent, which, earned in one
month, is equal to about 1½ per cent per annum, to induce him to do the
transaction, shows, and is, under conditions of competition, a measure
of, the market’s preference for holding funds during the month in
question in New York rather than in London.

Conversely, if francs, lire, and marks one month forward are quoted
dearer than the spot rates to a London buyer, this indicates a
preference for holding funds in London rather than in Paris, Rome, or

The difference between the spot and forward rates is, therefore,
precisely and exactly the measure of the preference of the money and
exchange market for holding funds in one international centre rather
than in another, _the exchange risk apart_, that is to say under
conditions in which the exchange risk is covered. What is it that
determines these preferences?

1. The most fundamental cause is to be found in the interest rates
obtainable on “short” money--that is to say, on money lent or deposited
for short periods of time in the money markets of the two centres under
comparison. If by lending dollars in New York for one month the lender
could earn interest at the rate of 5½ per cent per annum, whereas by
lending sterling in London for one month he could only earn interest
at the rate of 4 per cent, then the preference observed above for
holding funds in New York rather than in London is wholly explained.
That is to say, forward quotations for the purchase of the currency of
the dearer money market tend to be cheaper than spot quotations by a
percentage per month equal to the excess of the interest which can be
earned in a month in the dearer market over what can be earned in the
cheaper. It must be noticed that the governing factor is the rate of
interest obtainable for short periods, so that a country where, owing
to the absence or ill-development of an organised money market, it
is difficult to lend money satisfactorily at call or for very short
periods, may, for the purposes of this calculation, reckon as a low
interest-earning market, even though the prevailing rate of interest
for longer periods is not low at all. This consideration generally
tends to make London and New York more attractive markets for short
money than any Continental centres.

The effect of the cheap money rates ruling in London from the middle of
1922 to the middle of 1923 in diminishing the attractiveness of London
as a depository of funds is strikingly shown, in the above tables,
by the cheapening of the forward quotations of foreign currencies
relatively to the spot quotations. In the case of the dollar the
forward quotation had risen by the beginning of 1923 to a rate 3 per
cent per annum above the spot quotation (_i.e._ forward dollars were 3
per cent per annum _cheaper_ than spot dollars in terms of sterling),
which meant (subject to modification by the other influences to be
mentioned below) that the effective rate for short loans approached 3
per cent higher in New York than in London.

In the case of francs forward quotations which had been below spot,
so long as money was dear in London, rose above the spot quotations,
thus indicating that the relative dearness of money in London as
compared with Paris had disappeared; whilst in the case of lire forward
quotations, although still below spot quotations, rose, under the same
influence, nearer to the spot level. Nevertheless, in the case of both
these currencies, a preponderance of bearish anticipations about their
future prospects probably also played a part, for the reasons given in
detail below, in producing the observed result.

The most interesting figures, however, are those relating to marks,
which illustrate vividly what I have mentioned on page 23 above
concerning the enormous money rates of interest current in Germany
subsequent to the collapse of October 1922, as a result of the effort
of the real rate of interest to remain positive in face of a general
anticipation of a catastrophic collapse of the monetary unit. It will
be noticed that the effective short money rate of interest in terms
of marks ranged from 50 per cent per annum upwards, until finally the
quotations were merely nominal.

2. If questions of credit did not enter in, the factor of the rate of
interest on short loans would be the dominating one. Indeed, as between
London and New York, it probably is so under existing conditions.
Between London and Paris it is still important. But elsewhere the
various uncertainties of financial and political risk, which the
war has left behind, introduce a further element which sometimes
quite transcends the factor of relative interest. The possibility of
financial trouble or political disturbance, and the quite appreciable
probability of a moratorium in the event of any difficulties arising,
or of the sudden introduction of exchange regulations which would
interfere with the movement of balances out of the country, and
even sometimes the contingency of a drastic demonetisation,--all
these factors deter bankers, even when the exchange risk proper is
eliminated, from maintaining large floating balances at certain foreign
centres. Such risks prevent the business from being based, as it should
be, on a mathematical calculation of interest rates; they obliterate by
their possible magnitude the small “turns” which can be earned out of
differences between interest rates plus a normal banker’s commission;
and, being incalculable, they may even deter conservative bankers from
doing the business on a substantial scale at any reasonable rate at
all. In the case of Roumania or Poland, for example, this factor is, at
times, the dominating one.

3. There is a third factor of some significance. We have assumed so
far that the forward rate is fixed at such a level that the dealer or
banker can cover himself by a simultaneous spot transaction and be left
with a reasonable profit for his trouble. But it is not necessary to
cover every forward transaction by a corresponding spot transaction; it
may be possible to “marry” a forward sale with a forward purchase of
the same currency. For example, whilst some of the market’s clients may
wish to sell forward dollars, other clients will wish to buy forward
dollars. In this case the market can set off these, one against the
other, in its books, and there will be no need of any movement of
cash funds in either direction. The third factor depends, therefore,
on whether it is the sellers or the buyers of forward dollars who
predominate. To fix our minds, let us suppose that money-market
conditions exist in which a sale of forward dollars against the
purchase of spot dollars, at a discount of 1½ per cent per annum for
the former, yields neither profit nor loss. Now if in these conditions
the purchasers of forward dollars, other than arbitragers, exceed
sellers of forward dollars, then this excess of demand for forward
dollars can be met by arbitragers, who have cash resources in London,
at a discount which falls short of 1½ per cent per annum by such amount
(say ½ per cent) as will yield the arbitragers sufficient profit for
their trouble. If, however, sellers of forward dollars exceed the
purchasers, then a sufficient discount has to be accepted by the former
to induce arbitrage the other way round--that is to say, by arbitragers
who have cash resources in New York--namely, a discount which exceeds
1½ per cent per annum by, say, ½ per cent. Thus the discount on forward
dollars will fluctuate between 1 and 2 per cent per annum according as
buyers or sellers predominate.

4. Lastly, we have to provide for the case, quite frequent in practice,
where our assumption of a large and free market breaks down. A business
in forward exchange can only be transacted by banks or similar
institutions. If the bulk of the business in a particular exchange is
in a few hands, or if there is a tacit agreement between the principal
institutions concerned to maintain differences which will allow more
than a competitive profit, then the surcharge representing the profit
of a bank for arbitraging between spot and forward transactions may
much exceed the moderate figure indicated above. The quotations of the
rates charged in Milan for forward dealings in lire, when compared
with the rates current in London at the same date, indicate that a
bank which is free to operate in both markets can frequently make an
abnormal profit.

But there is a further contingency of considerable importance which
occurs when speculation is exceptionally active and is all one way. It
must be remembered that the floating capital normally available, and
ready to move from centre to centre for the purpose of taking advantage
of moderate arbitrage profits between spot and forward exchange,
is by no means unlimited in amount, and is not always adequate to
the market’s requirements. When, for example, the market is feeling
unusually bullish of the European exchanges as against sterling, or
of sterling as against dollars, the pressure to sell forward sterling
or dollars, as the case may be, may drive the forward price of these
currencies to a discount on their spot price which represents an
altogether abnormal profit to any one who is in a position to buy
these currencies forward and sell them spot. This abnormal discount
can only disappear when the high profit of arbitrage between spot and
forward has drawn fresh capital into the arbitrage business. So few
persons understand even the elements of the theory of the forward
exchanges that there was an occasion in 1920, even between London and
New York, when a seller of spot dollars could earn at the rate of 6
per cent per annum above the London rate for short money by converting
his dollars into sterling and providing at the same time by a forward
sale of the sterling for reconversion into dollars in a month’s time;
whilst, according to figures supplied me, it was possible, at the end
of February 1921, by selling spot sterling in Milan and buying it back
a month forward, to earn at the rate of more than 25 per cent per annum
over and above any interest obtainable on a month’s deposit of cash
lire in Milan.

It is interesting to notice that when the differences between forward
and spot rates have become temporarily abnormal, thus indicating an
exceptional pressure of speculative activity, the speculators have
often turned out to be right. For example, the abnormal discount on
forward dollars, which persisted more or less from November 1920 to
February 1921, thus indicating that the market was a bull of sterling,
coincided with the sensational rise of sterling from 3.45 to 3.90.
This discount was at its maximum when sterling touched its lowest
point and at its minimum (in the middle of May 1921) when sterling
reached its highest point on that swing, which showed a remarkably
accurate anticipation of events by the balance of professional opinion.
The comparatively high discount on forward dollars current at the
end of 1922 may, in the same way, have been partly due to an excess
of bull speculation in favour of sterling based on an expectation of
its recovery towards par, and not merely to the cheapness of money in
London as compared with New York.

The same thing seems to have been true for the franc. In January and
February 1921, the abnormal premium on the forward franc indicated
that, in the view of the market, the franc had fallen too low, which
turned out to be the case. They turned round at the precise moment
when the franc reached its highest value (end of July 1921), and were
right again. During the first five months of 1922, when the franc was
almost stable, spot and forward quotations were practically at par with
one another, whilst the progressive fall of the franc since June 1922
has been accompanied by a steady and sometimes substantial discount on
forward francs; indicating, on this test, that the professional market
was bearish of francs and therefore right once more. The lira tells
somewhat the same tale. Thus, whilst the reader can see for himself by
a study of the tables that no precise generalisation would be accurate,
nevertheless the market has been broadly right when it has taken a
very decided view, as measured by forward rates.

This result may seem surprising in view of the huge amounts which
exchange speculators in European currencies, more particularly on
the bull side, are reputed to have lost. But the mass of amateur
speculators throughout the world operate by cash purchases of the
currency of which they are bulls, forward transactions being neither
known nor available to them. Such speculation may afford temporary
support to the spot exchange, but it has no influence on the difference
between spot and forward, the subject now under discussion. The above
conclusion is limited to the fact that when the type of professional
speculation which makes use of the forward market is exceptionally
active and united in its opinion, it has proved roughly correct,
and has, therefore, been a useful factor in moderating the extreme
fluctuations which would have occurred otherwise.

       *       *       *       *       *

Out of the various practical conclusions which might be drawn from this
discussion and the figures which accompany it, I will pick out three.

1. Those exchanges in which the fluctuations are wildest and the
merchant is most in need of facilities for hedging his risk are
precisely those in which facilities for forward dealing at moderate
rates are least developed. But this is to be explained, not
necessarily by the instability of the exchange in itself, but by
certain accompanying circumstances, such as distrust of the country’s
internal arrangements or its banking credit, a fear of the sudden
imposition of exchange regulations or of a moratorium, and the
other analogous influences mentioned above (pp. 126–7). There is no
theoretical reason why there should not be an excellent forward market
in a highly unstable exchange. In those countries, therefore, where
regulation is still premature, it may nevertheless be possible to
mitigate the evil consequences of fluctuation by organising facilities
for forward dealings.

This is a function which the State banks of such countries could
usefully perform. For this they must either themselves command a
certain amount of foreign currency or they must provide facilities for
accepting short-period deposits in their own currency from foreign
bankers, on conditions which inspire these bankers with complete
confidence in the freedom and liquidity of such deposits. Various
technical devices could be suggested. But the simplest method might be
for the State banks themselves to enter the forward market and offer
to buy or sell forward exchange at a reasonable discount or premium on
the spot quotation. I suggest that they should deal not direct with the
public but only with approved banks and financial houses, from whom
they should require adequate security; that they should quote every day
their rates for buying and selling exchange either one or three months
forward; but that such quotation should take the form, not of a price
for the exchange itself, but of a percentage difference between spot
and forward, and should be a quotation for the double transaction of
a spot deal one way and a simultaneous forward deal the other--_e.g._
the Bank of Italy might offer to sell spot sterling and buy forward
sterling at a premium of ⅛ per cent per month for the former over the
latter, and to buy spot sterling and sell forward sterling at par.
For the transaction of such business the State banks would require
to command a certain amount of resources abroad, either in cash or
in borrowing facilities. But this fund would be a revolving one,
automatically replenished at the maturity of the forward contracts, so
that it need not be on anything like the scale necessary for a fund
for the purpose of supporting the exchange. Nor is it a business which
involves any more risk than is inherent in all banking business as
such; from exchange risk proper is free.

With free forward markets thus established no merchant need run an
exchange risk unless he wishes to, and business might find a stable
foothold even in a fluctuating world. A recommendation in favour of
action along these lines was included amongst the Financial Resolutions
of the Genoa Conference of 1922.

I shall develop below (Chap. V.) a proposal that the Bank of England
should strengthen its control by fixing spot and forward prices for
gold every Thursday just as it now fixes its discount rate. But other
Central Banks also would increase their control over fluctuations in
exchange if they were to adopt the above plan of quoting rates for
forward exchange in terms of spot exchange. By varying these rates they
would be able, in effect, to vary the interest offered for _foreign_
balances, as a policy distinct from whatever might be their bank-rate
policy for the purpose of governing the interest obtainable on _home_

2. It is not unusual at present for banks to endeavour to distinguish
between speculative dealings in forward exchange and dealings which are
intended to hedge a commercial transaction, with a view to discouraging
the former; whilst official exchange regulations in many countries have
been aimed at such discrimination. I think that this is a mistake.
Banks should take stringent precautions to make sure that their clients
are in a position to meet any losses which may accrue without serious
embarrassment. But, having fully assured themselves on this point,
it is not useful that they should inquire further--for the following

In the first place, it is almost impossible to prevent the evasion
of such regulations; whilst, if the business is driven to methods
of evasion, it tends to be pressed underground, to yield excessive
profits to middlemen, and to fall into undesirable hands.

But, what is more important and is less appreciated, the speculator
with resources can provide a useful, indeed almost an essential,
service. Since the volume of actual trade is spread unevenly through
the year, the seasonal fluctuation, as explained above, is bound to
occur with undue force unless some financial, non-commercial factor
steps in to balance matters. A free forward market, from which
speculative transactions are not excluded, will give by far the best
facilities for the trader, who does not wish to speculate, to avoid
doing so. The same sort of advantages will be secured for merchants
generally as are afforded, for example, to the cotton trade by the
dealings in “futures” in the New York and Liverpool markets. Where risk
is unavoidably present, it is much better that it should be carried by
those who are qualified or are desirous to bear it, than by traders,
who have neither the qualification nor the desire to do so, and whose
minds it distracts from their own business. The wide fluctuations in
the leading exchanges over the past three years, as distinct from
their persisting depreciation, have been due, not to the presence of
speculation, but to the absence of a sufficient volume of it relatively
to the volume of trade.

3. A failure to analyse the relation between spot and forward exchange
may be, sometimes, partly responsible for a mistaken bank-rate policy.
Dear money--that is to say, high interest rates for short-period
loans--has two effects. The one is indirect and gradual--namely, in
diminishing the volume of credit quoted by the banks. This effect is
much the same now as it always was. It is desirable to produce it when
prices are rising and business is trying to expand faster than the
supply of real capital and effective demand can permit in the long run.
It is undesirable when prices are falling and trade is depressed.

The other effect of dear money, or rather of dearer money in one centre
than in another, used to be to draw gold from the cheaper centre for
temporary employment in the dearer. But nowadays the only immediate
effect is to cause a new adjustment of the difference between the
spot and forward rates of exchange between the two centres. If money
becomes dearer in London, the discount on forward dollars diminishes or
gives way to a premium. The effect has been pointed out above of the
relative cheapening of money in London in the latter half of 1922 in
increasing the discount on forward dollars, and of the relative raising
of money-rates in the middle of 1923 in diminishing the discount. Such
are, in present circumstances, the principal direct consequences of a
moderate difference between interest rates in the two centres, apart,
of course, from the indirect, long-period influence. Since no one is
likely to remit money temporarily from one money market to another
on any important scale, with an uncovered exchange risk, merely to
take advantage of ½ or 1 per cent per annum difference in the interest
rate, the direct effect of dearer money on the _absolute_ level of
the exchanges, as distinguished from the difference between spot and
forward, is very small, being limited to the comparatively slight
influence which the relation between spot and forward rates exerts on
exchange speculators.[39] The pressure of arbitragers between spot
and forward exchange, seeking to take advantage of the new situation,
leads to a rapid adjustment of the difference between these rates,
until the business of temporary remittance, as distinct from exchange
speculation, is no more profitable than it was before, and consequently
does not occur on any increased scale; with the result that there is no
marked effect on the absolute level of the spot rate.

       [39] If interest rates are raised in London, the discount on
            forward dollars will decrease or a premium will appear.
            This is likely to have some influence in encouraging
            speculative sales of forward dollars (how much influence
            depends on the proportion borne by the difference
            between the spot and forward rates to the probable range
            of fluctuation of the spot rate which the speculator
            anticipates); and in so far as this is the case, the
            covering sales of spot dollars by banks will move the rate
            of exchange in favour of London.

The reasons given for the maintenance of a close relationship between
the Bank of England’s rate and that of the American Federal Reserve
Board sometimes show confusion. The eventual influence of an effective
high bank-rate on the general situation is undisputed; but the belief
that a moderate difference between bank-rates in London and New York
reacts directly on the sterling-dollar exchange, as it used to do under
a régime of convertibility, is a misapprehension. The direct reaction
of this difference is on the discount for forward dollars as against
spot dollars; and it cannot much affect the absolute level of the
spot rate unless the change in relative money-rates is comparable in
magnitude (as it used to be but no longer is) with the possible range
of exchange fluctuations.



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

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

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

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

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

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

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

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

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

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

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.



A sound constructive scheme must provide--if it is to satisfy the
arguments and the analysis of this book:

I. A method for regulating the supply of currency and credit with a
view to maintaining, so far as possible, the stability of the internal
price level; and

II. A method for regulating the supply of foreign exchange so as to
avoid purely temporary fluctuations, caused by seasonal or other
influences and not due to a lasting disturbance in the relation between
the internal and the external price level.

I believe that in Great Britain the ideal system can be most nearly
and most easily reached by an adaptation of the actual system which
has grown up, half haphazard, since the war. After the general idea
has been exhibited by an application in detail to the case of Great
Britain, it will be sufficient to deal somewhat briefly with the
modifications required in the case of other countries.

I. _Great Britain._

The system actually in operation to-day is broadly as follows:

(1) The internal price level is mainly determined by the amount
of credit created by the banks, chiefly the Big Five; though in a
depression, when the public are increasing their real balances, a
greater amount of credit has to be created to support a given price
level (in accordance with the theory explained above in Chapter III.,
p. 84) than is required in a boom, when real balances are being

The amount of credit, so created, is in its turn roughly measured by
the volume of the banks’ deposits--since variations in this total
must correspond to variations in the total of their investments,
bill-holdings, and advances. Now there is no necessary reason _a
priori_ why the proportion between the banks’ deposits and their
“cash in hand and at the Bank of England” should not fluctuate within
fairly wide limits in accordance with circumstances. But in practice
the banks usually work by rule of thumb and do not depart widely from
their preconceived “proportions.”[51] In recent times their aggregate
deposits have always been about nine times their “cash.” Since this
is what is generally considered a “safe” proportion, it is bad for a
bank’s reputation to fall below it, whilst on the other hand it is bad
for its earning power to rise above it. Thus in one way or another
the banks generally adjust their total creation of credit in one form
or another (investments, bills, and advances) up to their capacity as
measured by the above criterion; from which it follows that the volume
of their “cash” in the shape of Bank and Currency Notes and Deposits at
the Bank of England closely determines the volume of credit which they

       [51] The Joint Stock banks have published monthly returns
            since January 1921. Excluding the half-yearly statement
            when a little “window-dressing” is temporarily arranged,
            the extreme range of fluctuation has been between 11·0
            per cent and 11·9 per cent in the proportion of “cash”
            to deposits, and between 41·1 per cent and 50·1 per cent
            in the proportion of advances to deposits. These figures
            cover two and a half years of widely varying conditions.
            The “proportions” of individual banks differ amongst
            themselves, and the above is an average result, the
            steadiness of which is strengthened by the fact that each
            big bank is pretty steadfast in its own policy.

In order to follow, therefore, the train of causation a stage further,
we must consider what determines the volume of their “cash.” Its amount
can only be altered in one or other of three ways: (_a_) by the public
requiring more or fewer notes in circulation, (_b_) by the Treasury
borrowing more or less from the Currency Note Reserve, and (_c_) by the
Bank of England increasing or diminishing its assets.[52]

       [52] For the aggregate of its liabilities in the shape of
            deposits and of notes in circulation automatically depends
            on the volume of its assets.

To complete the argument, one further factor, not yet mentioned, must
be introduced, namely (_d_) the proportion of the banks’ second-line
reserve in the shape of their holdings of Treasury Bills, which
can be regarded as cash at one remove. In determining what is a
safe proportion of “cash,” they pay some regard to the amount of
Treasury Bills which they hold, since by reducing this holding they
can immediately increase their “cash” and compel the Treasury to
borrow more either from the Currency Note Reserve or from the Bank of
England. The ninefold proportion referred to above presumes a certain
minimum holding of Treasury Bills, and might have to be modified if a
sufficient volume of such Bills was not available. This factor (_d_)
is, however, also important because the banks in their turn are open to
pressure by the Treasury, whenever it draws to itself the resources of
their depositors--whether by taxation or by offering them attractive
longer-dated loans--and uses them to pay off, if not Ways and Means
advances from the Bank of England (which reduces the banks’ first-line
reserve of cash), then alternatively Treasury Bills held by the banks
themselves (which reduces their second-line reserve of bills).

Items (_a_), (_b_), (_c_), and (_d_) together, therefore, more or less
settle the matter. For the purpose of the present argument, however, we
need not pay much separate attention to (_a_) and (_b_), since their
effect is, for the most part, reflected over again in (_c_) and (_d_).
(_a_) depends partly on the volume of trade but mainly on the price
level itself; and in practice fluctuations in (_a_) do not _directly_
affect the banks’ “cash,”--for if more notes are required under
(_a_), more notes are issued, the Treasury borrowing a corresponding
additional amount from the Currency Note Reserve, in which case the
Treasury either repays the Bank of England, which diminishes the Bank’s
assets and consequently the other banks’ “cash,” or withdraws an
equivalent amount of Treasury Bills, which diminishes the other banks’
second-line reserve; _i.e._ a change in (_a_) operates on the banks’
resources through (_c_) and (_d_).[53] Whilst as for (_b_), a change in
the amount of what the Treasury borrows from the Currency Note Reserve
is reflected by a corresponding change in the opposite sense in what it
borrows in Ways and Means Advances or in Treasury Bills.

       [53] If the additional issue of notes is covered by transferring
            gold from the Bank of England, this is merely an
            alternative way of diminishing the Bank of England’s assets.

Thus we can concentrate our attention on (_c_) and (_d_) as the main
determining factors of the price level.

Now (_c_), namely the assets of the Bank of England, consist (so far as
their variable part is concerned) of

(i.) Ways and Means advances to the Treasury.

(ii.) Gilt-edged and other investments.

(iii.) Advances to its customers and bills of exchange.

(iv.) Gold.

An increase in any of these items tends, therefore, to increase the
other banks’ “cash,” thereby to stimulate the creation of credit, and
hence to raise the price level; and contrariwise.

And (_d_), namely the banks’ holdings of Treasury Bills, depend on
the excess of the expenditure of the Treasury over and above what it
secures (i.) from the public by taxation and loans, (ii.) from the Bank
of England in Ways and Means advances, and (iii.) by borrowing from the
Currency Note Reserve.

It follows that the capacity of the Joint Stock banks to create credit
is mainly governed by the policies and actions of the Bank of England
and of the Treasury. When these are settled, (_a_), (_b_), (_c_), and
(_d_) are settled.

How far can these two authorities control their own actions and how
far must they remain passive agents? In my opinion the control, if
they choose to exercise it, is mainly in their own hands. As regards
the Treasury, the extent to which they draw money from the public to
discharge floating debt clearly depends on the rate of interest and
the type of loan which they are prepared to offer. A point might be
reached when they could not fund further on any reasonable terms; but
within fairly wide limits the policy of the Treasury can be whatever
the Chancellor of the Exchequer and the House of Commons may decide.
The Bank of England also is, within sufficiently wide limits, mistress
of the situation if she acts in conjunction with the Treasury. She can
increase or decrease at will her investments and her gold by buying or
selling the one or the other. In the case of advances and of bills,
whilst their volume is not so immediately or directly controllable,
here also adequate control can be obtained by varying the price
charged, that is to say the bank rate.[54]

       [54] It is often assumed that the bank rate is the _sole_
            governing factor. But the bank rate can only operate by its
            reaction on (_c_), namely, the Bank of England’s assets.
            Formerly it acted pretty directly on two of the components
            of (_c_), namely, (_c_) (iii.) advances to customers and
            bills of exchange and (_c_) (iv.) gold. Now it acts only
            on one of them, namely, (_c_) (iii.). But changes in (_c_)
            (i.) the Bank’s advances to the Treasury and (_c_) (ii.)
            the Bank’s investments can often be nearly as potent in
            their effect on the creation of credit. Thus a low bank
            rate can be largely neutralised by a simultaneous reduction
            of (_c_) (i.) or (_c_) (ii.) and a high bank rate by an
            increase of these. Indeed the Bank of England can probably
            bring the money-market to heel more decisively by buying or
            selling securities than in any other way; and the utility
            of bank rate, operated by itself and without assistance
            from deliberate variations in the volume of (_c_) (ii.), is
            lessened by the various limitations which exist in practice
            to its freedom of movement, and to the limits within which
            it can move, upwards and downwards.

Therefore it is broadly true to say that the level of prices, and
hence the level of the exchanges, depends in the last resort on the
policy of the Bank of England and of the Treasury in respect of the
above particulars;--though the other banks, if they strongly opposed
the official policy, could thwart, or at least delay it to a certain
extent--provided they were prepared to depart from their usual

(2) Cash, in the form of Bank or Currency Notes, is supplied _ad
libitum_, _i.e._ in such quantities as are called for by the amount of
credit created and the internal price level established under (1). That
is to say, in practice;--in theory, a limit to the issue of Currency
Notes has been laid down, namely the maximum fiduciary issue actually
attained in the preceding calendar year. Since this theoretical
maximum was prescribed, it has never yet been actually operative;
and, as the rule springs from a doctrine now out of date and out of
accordance with most responsible opinion, it is probable that, if it
were becoming operative, it would be relaxed. This is a matter where
the recommendations of the Cunliffe Committee call for urgent change,
unless we desire deliberately to pursue still further a process of
Deflation. A point must come when, a year of brisk trade and employment
following one of depression, there will be an increased demand for
currency, which must be met unless the revival is to be deliberately
damped down.

Thus the tendency of to-day--rightly I think--is to watch and to
control the creation of credit and to let the creation of currency
follow suit, rather than, as formerly, to watch and to control the
creation of currency and to let the creation of credit follow suit.

(3) The Bank of England’s gold is immobilised. It neither buys nor
sells. The gold plays no part in our system. Occasionally, however, the
Bank may ship a consignment to the United States, to help the Treasury
in meeting its dollar liabilities. The South African and other gold
which finds its way here comes purely as a commodity to a convenient
_entrepôt_ centre, and is mostly re-exported.

(4) The foreign exchanges are unregulated and left to look after
themselves. From day to day they fluctuate in accordance with the
seasons and other irregular influences. Over longer periods they
depend, as we have seen, on the relative price levels established here
and abroad by the respective credit policies adopted here and abroad.
But whilst this is, for the most part, the actual state of affairs,
it is not, as yet, the avowed or consistent policy of the responsible
authorities. Fixity of the dollar exchange at the pre-war parity
remains their aspiration; and it still may happen that the bank rate
is raised for the purpose of influencing the exchange at a time when
considerations of internal price level and credit policy point the
other way.

       *       *       *       *       *

This, in brief--I apologise to the reader if I have compressed the
argument unduly--is the present state of affairs, one essentially
different from our pre-war system. It will be observed that in practice
we have already gone a long way towards the ideal of directing bank
rate and credit policy by reference to the internal price level and
other symptoms of under- or over-expansion of internal credit, rather
than by reference to the pre-war criteria of the amount of cash in
circulation (or of gold reserves in the banks) or the level of the
dollar exchange.

I. Accordingly my first requirement in a good constructive scheme can
be supplied merely by a development of our existing arrangements on
more deliberate and self-conscious lines. Hitherto the Treasury and
the Bank of England have looked forward to the stability of the dollar
exchange (preferably at the pre-war parity) as their objective. It
is not clear whether they intend to stick to this irrespective of
fluctuations in the value of the dollar (or of gold); whether, that
is to say, they would sacrifice the stability of sterling prices to
the stability of the dollar exchange in the event of the two proving
to be incompatible. At any rate, my scheme would require that they
should adopt the stability of sterling prices as their _primary_
objective--though this would not prevent their aiming at exchange
stability also as a secondary objective by co-operating with the
Federal Reserve Board in a common policy. So long as the Federal
Reserve Board was successful in keeping dollar prices steady the
objective of keeping sterling prices steady would be identical with
the objective of keeping the dollar sterling exchange steady. My
recommendation does not involve more than a determination that, in
the event of the Federal Reserve Board failing to keep dollar prices
steady, sterling prices should not, if it could be helped, plunge with
them merely for the sake of maintaining a fixed parity of exchange.

If the Bank of England, the Treasury, and the Big Five were to
adopt this policy, to what criteria should they look respectively
in regulating bank-rate, Government borrowing, and trade-advances?
The first question is whether the criterion should be a precise,
arithmetical formula or whether it should be sought in a general
judgement of the situation based on all the available data. The
pioneer of price-stability as against exchange-stability, Professor
Irving Fisher, advocated the former in the shape of his “compensated
dollar,” which was to be automatically adjusted by reference to an
index number of prices without any play of judgement or discretion.
He may have been influenced, however, by the advantage of propounding
a method which could be grafted as easily as possible on to the
pre-war system of gold-reserves and gold-ratios. In any case, I doubt
the wisdom and the practicability of a system so cut and dried. If
we wait until a price movement is actually afoot before applying
remedial measures, we may be too late. “It is not the _past_ rise in
prices but the _future_ rise that has to be counteracted.”[55] It
is characteristic of the impetuosity of the credit cycle that price
movements tend to be cumulative, each movement promoting, up to a
certain point, a further movement in the same direction. Professor
Fisher’s method may be adapted to deal with long-period trends in the
value of gold but not with the, often more injurious, short-period
oscillations of the credit cycle. Nevertheless, whilst it would
not be advisable to postpone action until it was called for by an
actual movement of prices, it would promote confidence and furnish an
objective standard of value, if, an official index number having been
compiled of such a character as to register the price of a standard
composite commodity, the authorities were to adopt this composite
commodity as their standard of value in the sense that they would
employ all their resources to prevent a movement of its price by more
than a certain percentage in either direction away from the normal,
just as before the war they employed all their resources to prevent
a movement in the price of gold by more than a certain percentage.
The precise composition of the standard composite commodity could be
modified from time to time in accordance with changes in the relative
economic importance of its various components.

       [55] Hawtrey, _Monetary Reconstruction_, p. 105.

As regards the criteria, other than the actual trend of prices, which
should determine the action of the controlling authority, it is beyond
the scope of this volume to deal adequately with the diagnosis and
analysis of the credit cycle. The more deeply that our researches
penetrate into this subject, the more accurately shall we understand
the right time and method for controlling credit-expansion by bank-rate
or otherwise. But in the meantime we have a considerable and growing
body of general experience upon which those in authority can base their
judgements. Actual price-movements must of course provide the most
important datum; but the state of employment, the volume of production,
the effective demand for credit as felt by the banks, the rate of
interest on investments of various types, the volume of new issues,
the flow of cash into circulation, the statistics of foreign trade and
the level of the exchanges must all be taken into account. The main
point is that the _objective_ of the authorities, pursued with such
means as are at their command, should be the stability of prices.

It would at least be possible to avoid, for example, such action
as has been taken lately (in Great Britain) whereby the supply of
“cash” has been deflated at a time when real balances were becoming
inflated,--action which has materially aggravated the severity of
the late depression. We might be able to moderate very greatly the
amplitude of the fluctuations if it was understood that the time to
deflate the supply of cash is when real balances are falling, _i.e._
when prices are rising out of proportion to the increase, if any, in
the volume of cash, and that the time to inflate the supply of cash
is when real balances are rising, and not, as seems to be our present
practice, the other way round.

II. How can we best combine this primary object with a maximum
stability of the exchanges? Can we get the best of both
worlds--stability of prices over long periods and stability of
exchanges over short periods? It is the great advantage of the gold
standard that it overcomes the excessive sensitiveness of the exchanges
to temporary influences, which we analysed in Chapter III. Our object
must be to secure this advantage, if we can, without committing
ourselves to follow big movements in the value of gold itself.

I believe that we can go a long way in this direction if the Bank
of England will take over the duty of regulating the price of gold,
just as it already regulates the rate of discount. “Regulate,” but
not “peg.” The Bank of England should have a buying and a selling
price for gold, just as it did before the war, and this price might
remain unchanged for considerable periods, just as bank-rate does.
But it would not be fixed or “pegged” once and for all, any more than
bank-rate is fixed. The Bank’s rate for gold would be announced every
Thursday morning at the same time as its rate for discounting bills,
with a difference between its buying and selling rates corresponding to
the pre-war margin between £3 : 17 : 10½ per oz. and £3 : 17 : 9 per
oz.; except that, in order to obviate too frequent changes in the rate,
the difference might be wider than 1½d. per oz.--say, ½ to 1 per cent.
A willingness on the part of the Bank both to buy and to sell gold at
rates fixed for the time being would keep the dollar-sterling exchange
steady within corresponding limits, so that the exchange rate would
not move with every breath of wind but only when the Bank had come to
a considered judgement that a change was required for the sake of the
stability of sterling prices.

If the bank rate and the gold rate in conjunction were leading to an
excessive influx or an excessive efflux of gold, the Bank of England
would have to decide whether the flow was due to an internal or to an
external movement away from stability. To fix our ideas, let us suppose
that gold is flowing outwards. If this seemed to be due to a tendency
of sterling to depreciate in terms of commodities, the correct remedy
would be to raise the bank rate. If, on the other hand, it was due to
a tendency of gold to appreciate in terms of commodities, the correct
remedy would be to raise the gold rate (_i.e._ the buying price for
gold). If, however, the flow could be explained by seasonal, or other
passing influences, then it should be allowed to continue (assuming,
of course, that the Bank’s gold reserves were equal to any probable
calls on them) unchecked, to be redressed later on by the corresponding

Two subsidiary suggestions may be made for strengthening the Bank’s

(1) The service of the American debt will make it necessary for the
British Treasury to buy nearly $500,000 every working day. It is clear
that the particular method adopted for purchasing these huge sums will
greatly affect the short-period fluctuations of the exchange. I suggest
that this duty should be entrusted to the Bank of England to be carried
out by them with the express object of minimising those fluctuations
in the exchange which are due to the daily and seasonal ebb and flow
of the ordinary trade demand. In particular the proper distribution
of these purchases through the year might be so arranged as greatly to
mitigate the normal seasonal fluctuation discussed in Chapter III. If
the trade demand is concentrated in one half of the year the Treasury
demand should be concentrated in the other half.

(2) It would effect an improvement in the technique of the system here
proposed, without altering its fundamental characteristics, if the
Bank of England were to quote a daily price, not only for the purchase
and sale of gold for immediate delivery, but also for delivery three
months forward. The difference, if any, between the cash and forward
quotations might represent either a discount or a premium of the latter
on the former, according as the bank desired money rates in London to
stand below or above those in New York. The existence of the forward
quotation of the Bank of England would afford a firm foundation for
a free market in forward exchange, and would facilitate the movement
of funds between London and New York for short periods, in much the
same way as before the war, whilst at the same time keeping down to a
minimum the actual movement of gold bullion backwards and forwards. I
need not develop this point further, because it is only an application
of the argument of Section III. of Chapter III. which will be most
readily intelligible to the reader, if he will refer back to the
previous argument.

There remains the question of the regulation of the Note Issue. My
proposal here may appear shocking until the reader realises that,
apart from its disregarding the conventions, it does not differ in
substance from the existing state of affairs. The object of fixing
the amount of gold to be held against a note issue is to set up a
danger signal which cannot be easily disregarded, when a curtailment
of credit and purchasing power is urgently required to maintain the
legal tender money at its lawful parity. But this system, whilst far
better than no system at all, is primitive in its ideas and is, in
fact, a survival of an earlier evolutionary stage in the development
of credit and currency. For it has two great disadvantages. In so far
as we fix a minimum gold reserve against the note issue, the effect
is to immobilise this quantity of gold and thus to reduce the amount
actually available for use as a store of value to meet temporary or
sudden deficits in the country’s international balance of payments.
And in so far as we regard an approach towards the prescribed minimum
or a departure upwards from it as a barometer warning us to curtail
credit or encouraging us to expand it, we are using a criterion which
most people would now agree in considering second-rate for the purpose,
because it cannot give the necessary warning _soon enough_. If gold
movements are actually taking place, this means that the disequilibrium
has proceeded a very long way; and whilst this criterion may pull us
up in time to preserve convertibility on the one hand or to prevent
an excessive flood of gold on the other, it will not do so in time to
avoid an injurious oscillation of prices. This method belongs indeed to
a period when the preservation of convertibility was all that any one
thought about (all indeed that there was to think about so long as we
were confined to an unregulated gold standard), and before the idea of
utilising bank-rate as a means of keeping prices and employment steady
had become practical politics.

We have scarcely realised how far our thoughts have travelled during
the past five years. But to re-read the famous Cunliffe Report on
Currency and Foreign Exchange after the War, published in 1918, brings
vividly before one’s mind what a great distance we have covered since
then. This document was published three months before the Armistice.
It was compiled long before the unpegging of sterling and the great
break in the European exchanges in 1919, before the tremendous boom
and crash of 1920–21, before the vast piling up of the world’s gold
in America, and without experience of the Federal Reserve policy
in 1922–23 of burying this gold at Washington, withdrawing it from
the exercise of its full effect on prices, and thereby, in effect,
demonetising the metal. The Cunliffe Report is an unadulterated pre-war
prescription--inevitably so considering that it was written after four
years’ interregnum of war, before Peace was in sight, and without
knowledge of the revolutionary and unforeseeable experiences of the
past five years.

Of all the omissions from the Cunliffe Report the most noteworthy is
the complete absence of any mention of the problem of the stability of
the price-level; and it cheerfully explains how the pre-war system,
which it aims at restoring, operated to bring back equilibrium by
deliberately causing a “consequent slackening of employment.” The
Cunliffe Report belongs to an extinct and an almost forgotten order
of ideas. Few think on these lines now; yet the Report remains the
authorised declaration of our policy, and the Bank of England and the
Treasury are said still to regard it as their marching orders.

Let us return to the regulation of note issue. If we agree that gold
is not to be employed in the circulation, and that it is better to
employ some other criterion than the ratio of gold reserves to note
issue in deciding to raise or to lower the bank rate, it follows that
the only employment for gold (nevertheless important) is as a store
of value to be held as a war-chest against emergencies and as a means
of rapidly correcting the influence of a temporarily adverse balance
of international payments and thus maintaining a day-to-day stability
of the sterling-dollar exchange. It is desirable, therefore, that the
whole of the reserves should be under the control of the authority
responsible for this, which, under the above proposals, is the Bank
of England. The volume of the paper money, on the other hand, would
be consequential, as it is at present, on the state of trade and
employment, bank-rate policy and Treasury Bill policy. The governors
of the system would be bank-rate and Treasury Bill policy, the objects
of government would be stability of trade, prices, and employment,
and the volume of paper money would be a consequence of the first
(just--I repeat--as it is at present) and an instrument of the second,
the precise arithmetical level of which could not and need not be
predicted. Nor would the amount of gold, which it would be prudent
to hold as a reserve against international emergencies and temporary
indebtedness, bear any logical or calculable relation to the volume of
paper money;--for the two have no close or necessary connection with
one another. Therefore I make the proposal--which may seem, but should
not be, shocking--of separating entirely the gold reserve from the note
issue. Once this principle is adopted, the regulations are matters of
detail. The gold reserves of the country should be concentrated in the
hands of the Bank of England, to be used for the purpose of avoiding
short-period fluctuations in the exchange. The Currency Notes may,
just as well as not--since the Treasury is to draw the profit from
them--be issued by the Treasury, without the latter being subjected to
any formal regulations (which are likely to be either inoperative or
injurious) as to their volume. Except in form, this régime would not
differ materially from the existing state of affairs.

The reader will observe that I retain for gold an important rôle in
our system. As an ultimate safeguard and as a reserve for sudden
requirements, no superior medium is yet available. But I urge that
it is possible to get the benefit of the advantages of gold, without
irrevocably binding our legal-tender money to follow blindly all the
vagaries of gold and future unforeseeable fluctuations in its real
purchasing power.

II. _The United States._

The above proposals are recommended to Great Britain and their details
have been adapted to her case. But the principles underlying them
remain just as true across the Atlantic. In the United States, as in
Great Britain, the methods which are being actually pursued at the
present time, half consciously and half unconsciously, are mainly on
the lines I advocate. In practice the Federal Reserve Board often
ignores the proportion of its gold reserve to its liabilities and
is influenced, in determining its discount policy, by the object
of maintaining stability in prices, trade, and employment. Out of
convention and conservatism it accepts gold. Out of prudence and
understanding it buries it. Indeed the theory and investigation of
the credit cycle have been taken up so much more enthusiastically and
pushed so much further by the economists of the United States than by
those of Great Britain, that it would be even more difficult for the
Federal Reserve Board than for the Bank of England to ignore such ideas
or to avoid being, half-consciously at least, influenced by them.

The theory on which the Federal Reserve Board is supposed to govern its
discount policy, by reference to the influx and efflux of gold and the
proportion of gold to liabilities, is as dead as mutton. It perished,
and perished justly, as soon as the Federal Reserve Board began to
ignore its ratio and to accept gold without allowing it to exercise its
full influence,[56] merely because an expansion of credit and prices
seemed at that moment undesirable. From that day gold was demonetised
by almost the last country which still continued to do it lip-service,
and a dollar standard was set up on the pedestal of the Golden Calf.
For the past two years the United States has _pretended_ to maintain
a gold standard. _In fact_ it has established a dollar standard; and,
instead of ensuring that the value of the dollar shall conform to that
of gold, it makes provision, at great expense, that the value of gold
shall conform to that of the dollar. This is the way by which a rich
country is able to combine new wisdom with old prejudice. It can enjoy
the latest scientific improvements, devised in the economic laboratory
of Harvard, whilst leaving Congress to believe that no rash departure
will be permitted from the hard money consecrated by the wisdom and
experience of Dungi, Darius, Constantine, Lord Liverpool, and Senator

       [56] The influx of gold could not be prevented from having
            _some_ inflationary effect because its receipt
            automatically increased the balances of the member banks.
            This uncontrollable element cannot be avoided so long as
            the United States Mints are compelled to accept gold.
            But the gold was not allowed to exercise the multiplied
            influence which the pre-war system presumed.

No doubt it is worth the expense--for those that can afford it. The
cost of the fiction to the United States is not more than £100,000,000
per annum and should not average in the long run above £50,000,000 per
annum. But there is in all such fictions a certain instability. When
the accumulations of gold heap up beyond a certain point the suspicions
of Congressmen may be aroused. One cannot be quite certain that some
Senator might not read and understand this book. Sooner or later the
fiction will lose its value.

Indeed it is desirable that this should be so. The new methods will
work more efficiently and more economically when they can be pursued
consciously, deliberately, and openly. The economists of Harvard know
more than those of Washington, and it will be well that in due course
their surreptitious victory should swell into public triumph. At any
rate those who are responsible for establishing the principles of
British currency should not overlook the possibility that some day soon
the Mints of the United States may be closed to the acceptance of gold
at a fixed dollar price.

Closing the Mints to the compulsory acceptance of gold need not affect
the existing obligation of convertibility;--the liability to encash
notes in gold might still remain. Theoretically this might be regarded
as a blemish on the perfection of the scheme. But, for the present at
least, it is unlikely that such a provision would compel the United
States to deflate,--which possibility is the only theoretical objection
to it. On the other hand, the retention of convertibility would remain
a safeguard satisfactory to old-fashioned people; and would reduce to
a minimum the new and controversial legislation required to effect the
change. Many people might agree to relieve the Mint of the liability to
accept gold which no one wants, who would be dismayed at any tampering
with convertibility. Moreover, in certain quite possible circumstances,
the obligation of convertibility might really prove to be a safeguard
against inflation brought about by political pressure contrary to the
judgement of the Federal Reserve Board;--for we have not, as yet,
sufficient experience as to the independence of the Federal Reserve
system against the farmers, for example, or other compact interests
possessing political influence.

Meanwhile Mr. Hoover and many banking authorities in England and
America, who look to the dispersion through the world of a reasonable
proportion of Washington’s gold, by the natural operation of trade and
investment, as a desirable and probable development, much misunderstand
the situation. At present the United States is open to accept gold at
a price in terms of goods above its natural value (above the value it
would have, that is to say, if it were allowed to affect credit and,
through credit, prices in orthodox pre-war fashion); and so long as
this is the case, gold must continue to flow there. The stream can
be stopped (so long as a change in the gold-value of the dollar is
ruled out of the question) only in one of two ways;--either by a fall
in the value of the dollar or by an increase in the value of gold
in the outside world. The former of these alternatives, namely the
depreciation of the dollar through inflation in the United States,
is that on which many English authorities have based their hopes.
But it could only come about by a reversal or defeat of the present
policy of the Federal Reserve Board. Moreover, the volume of redundant
gold is now so great, and the capacity of the rest of the world for
its absorption so much reduced, that the inflation would need to be
prolonged and determined to produce the required result. Dollar prices
would have to rise very high before America’s impoverished customers,
starving for real goods and having no use for barren metal, would
relieve her of £200,000,000 worth of gold in preference to taking
commodities. The banking authorities of the United States would be
likely to notice in good time that, if the gold is not wanted and must
be got rid of, it would be much simpler just to reduce the dollar price
of gold. The only way of selling redundant stocks of anything, whether
gold or copper or wheat, is to abate the price.

The alternative method, namely the increase in the value of gold in
the outside world, could scarcely be brought about unless some other
country or countries stepped in to relieve the United States of the
duty of burying unwanted gold. Great Britain, France, Italy, Holland,
Sweden, Argentine, Japan, and many other countries have fully as much
unoccupied gold as they require for an emergency store. Nor is there
anything to prevent them from buying gold now if they prefer gold to
other things.

The notion, that America can get rid of her gold by showing a greater
readiness to make loans to foreign countries, is incomplete. This
result will only follow if the loans are inflationary loans, not
provided for by the reduction of expenditure and investment in other
directions. Foreign investments formed out of real savings will no more
denude the United States of her gold than they denude Great Britain
of hers. But if the United States places a large amount of dollar
purchasing power in the hands of foreigners, as a pure addition to
the purchasing power previously in the hands of her own nationals,
then no doubt prices will rise and we shall be back on the method
of depreciating the dollar, just discussed, by a normal inflationary
process. Thus the invitation to the United States to deal with the
problem of her gold by increasing her foreign investments will not be
effective unless it is intended as an invitation to inflate.

       *       *       *       *       *

I argue, therefore, that the same policy which is wise for Great
Britain is wise for the United States, namely to aim at the stability
of the commodity-value of the dollar rather than at stability of the
gold-value of the dollar, and to effect the former if necessary by
varying the gold-value of the dollar.

If Great Britain and the United States were both embarked on this
policy and if both were successful, our secondary desideratum, namely
the stability of the dollar-exchange standard, would follow as a
consequence. I agree with Mr. Hawtrey that the ideal state of affairs
is an intimate co-operation between the Federal Reserve Board and
the Bank of England, as a result of which stability of prices and of
exchange would be achieved at the same time. But I suggest that it is
wiser and more practical that this should be allowed to develop out of
experience and mutual advantage, without either side binding itself to
the other. If the Bank of England aims primarily at the stability of
sterling, and the Federal Reserve Board at the stability of dollars,
each authority letting the other into its confidence so far as may be,
better results will be obtained than if sterling is unalterably fixed
by law in terms of dollars and the Bank of England is limited to using
its influence on the Federal Reserve Board to keep dollars steady. A
collaboration which is not free on both sides is likely to lead to
dissensions, especially if the business of keeping dollars steady
involves a heavy expenditure in burying unwanted gold.

We have reached a stage in the evolution of money when a “managed”
currency is inevitable, but we have not yet reached the point when the
management can be entrusted to a single authority. The best we can do,
therefore, is to have _two_ managed currencies, sterling and dollars,
with as close a collaboration as possible between the aims and methods
of the managements.

III. _Other Countries._

What course, in such an event, should other countries pursue? It is
necessary to presume to begin with that we are dealing with countries
which have not lost control of their currencies. But a stage can and
should be reached before long at which nearly all countries have
regained the control. In Russia, Poland, and Germany it is only
necessary that the Governments should develop some other source of
revenue than the inflationary or turn-over tax on the use of money
discussed in Chapter II. In France and Italy it is only necessary that
the franc and the lira should be devaluated at a level at which the
service of the internal debt is within the capacity of the taxpayer.

Control having been regained, there are probably no countries, other
than Great Britain and the United States, which would be justified in
attempting to set up an independent standard. Their wisest course would
be to base their currencies either on sterling or on dollars by means
of an exchange standard, fixing their exchanges in terms of one or the
other (though preserving, perhaps, a discretion to vary in the event
of a serious divergence between sterling and dollars), and maintaining
stability by holding reserves of gold at home and balances in London
and New York to meet short-period fluctuations, and by using bank-rate
and other methods to regulate the volume of purchasing power, and thus
to maintain stability of relative price level, over longer periods.

Perhaps the British Empire (apart from Canada) and the countries of
Europe would adopt the sterling standard; whilst Canada and the other
countries of North and South America would adopt the dollar standard.
But each could choose freely, until, with the progress of knowledge and
understanding, so perfect a harmony had been established between the
two that the choice was a matter of indifference.


  American debt, 191

  Aurelian, 152

  Austria, elasticity of demand for money, 48
    value of note issue, 52
    currency of, 55

  Bank of England, and forward exchange, 135
    and gold, 171, 184, 190, 192
    and existing system, 178

  Bank rate, and prices, 21
    and forward exchange, 136
    pre-war effect of, 159

  “Big Five,” 178

  British Empire, currency of, 205

  Business class, 18, 29

  Cannan, Professor, 47

  Capital, diminution of, 29

  Capital levy, _versus_ currency depreciation, 63, 65
    in Great Britain, 68

  Cassel, Professor, 87, 92

  Chervonetz, 51, 57

  Consols, 12, 15

  Credit-cycle, 83, 86, 187, 188

  Cunliffe Committee, 140, 184, 194, 195

  Cuno, Dr., 60

  Currency depreciation, in history, 9, 11
    advantage to debtor class, 10
    incidence of, 42
    _versus_ capital levy, 63
    social evils of, 65

  Czecho-Slovakia, 143, 146

  Debtor class, political influence of, 9

  Deflation, 143
    and distribution of wealth, 4
    and production of wealth, 4, 32
    meaning of, 82
    arguments for, 147
    and Aurelian, 152

  Devaluation, 64, 67
    and deflation, 141, 142
    and currency reform, 145

  Dollar, forward exchange in, 118, 123, 125

  Edward III., 163

  Equation of exchange, 93, 97, 99

  Estcourt, Dr., 107

  Exchange speculation, effect of, 112
    and forward market, 130, 138
    services of, 136

  External purchasing power, 88

  Federal Reserve Board, and gold, 86, 167, 175, 197
    index number, 94
    co-operation with, 186

  Fisher, Prof. Irving, 78, 148, 155, 163, 187

  Foreign exchange, and purchasing power parity, 87
    forward market in, 115
    stability of, 141, 154, 189

  Forward market in exchanges, 115
    as an insurance, 121
    and interest rates, 124
    and State banks, 133
    and bank rate, 136

  Franc, exchange, 73
    purchasing power parity, 101, 104
    seasonal movement, 111
    forward exchange in, 116, 118, 120, 125
    devaluation of, 143, 145

  France, losses of investors, 13, 65
    burden of internal debts, 70

  Genoa Conference, 134, 142, 143, 173

  Germany, interest rates in, 22
    and currency inflation, 41
    elasticity of demand for money in, 48
    value of note issue, 51
    currency of, 54
    sums raised by inflation, 58
    recent financial history, 61
    equation of exchange, 99

  Gibbon, 152

  Gold and State banks, 81
    price of, 190
    cost of burying, 199

  Gold discoveries, 164

  Gold mining, 165

  Gold standard, 9, 12
    restoration of, 149, 163

  Great Britain, capital levy in, 68
    currency statistics of, 83
    seasonal trade, 108
    ideal currency, 177, 203
    banking system of, 178, 185
    note issue, 193

  Harvard, economists of, 199

  Hawtrey, R. G., 163, 173, 174, 176, 187, 203

  Hoover, Mr., 200

  Huskisson, 153

  Index numbers, for regulating money, 187

  India, 141
    prices in, 156

  Individualism, and monetary stability, 40

  Inflation, and distribution of wealth, 4, 5
    and production of wealth, 4, 32
    and redistribution of wealth, 30
    as a method of taxation, 41
    importance of rate of, 49
    sums raised by in Russia, 57
    sums raised by in Germany, 58
    meaning of, 82

  Interest, “money” and “real” rates of, 20

  Interest rates and forward exchange, 129

  Internal purchasing power, 88

  Investment system, 5

  Investors, losses of, 13, 16

  Italy, losses of investors, 14, 65
    Bank of, and forward exchange, 134

  Labour, effect of rising prices on, 27

  Lasteyeri, M. de, 71

  Lehfeldt, Professor, 48

  Lira, purchasing power parity, 101
    seasonal movement, 111
    forward exchange in, 116, 119, 129
    devaluation of, 143, 145

  “Managed” currency, 166

  Marks, speculation in, 113
    forward exchange in, 119

  Marshall, Dr., 78, 79

  Middle Ages, and currency debasement, 162

  Middle class, losses of, 30

  Money, elasticity of demand for, 47
    stability of, 40
    future regulation of, 177

  Moscow, and use of money, 46

  Mussolini, 145, 153

  Note issue, existing system in G.B., 183
    suggested system, 193

  Pigou, Professor, 74, 78

  Poland, elasticity of demand for money, 48

  Population, 31

  Prices, index numbers for various countries, 1913–1923, 3
    fluctuations in nineteenth century, 2
    steadiness in nineteenth century, 11
    raw materials, 1919–1922, 19
    effect of expectation of rise or fall, 22, 33, 37
    effect of falling, 24
    stability of, 154

  Profiteers, 25, 26, 28

  Purchasing power parity, 87

  Quantity theory, 42, 74

  Rasin, Dr., 146, 147

  Real balances, 78, 83

  Reichsbank discount rate, 23, 60

  Ricardo, 87, 152, 153, 154

  Risk, and production, 35

  Rupee exchange, 157

  Russia, and currency inflation, 41, 63
    value of note issue, 52
    currency of, 55

  Saving, 7

  Seasonal movement of exchanges, 106, 108, 111, 177, 191

  Sterling, purchasing power parity, 100, 102
    seasonal movement, 111
    forward exchange in, 116, 117, 125

  Taxation, by means of inflation, 41

  Treasury Bills, relation of, to currency, 179, 196

  Trustee investments, 8

  United States, proposals for, 197
    closing mints of, 200
    and redundant gold, 201

  Vienna, and use of money, 46

  Wages, and prices, 27, 29

  “Ways and Means” advances, 180


_Printed in Great Britain by_ R. & R. CLARK, LIMITED, _Edinburgh_.


8_vo._ ~8s. 6d.~ _net_.


_THE TIMES._--“Mr. Keynes writes with knowledge; he was himself one
of the chief actors in the Conference, and his book is an important
political event.... He brings great literary ability, a broad view, a
clear grasp of general principles, to bear upon the very complicated
matters with which he is occupied, and in his hands these questions
of coal, exchange, and reparation can be read with pleasure by the
non-technical student.”

_THE WESTMINSTER GAZETTE._--“Mr. Keynes has produced a smashing and
unanswerable indictment of the economic settlement.”

_THE ATHENÆUM._--“This book is a perfectly well-equipped arsenal of
facts and arguments, to which every one will resort for years to
come who wishes to strike a blow against the forces of prejudice,
delusion, and stupidity. It is not easy to make large numbers of
men reasonable by a book, yet there are no limits to which, without
undue extravagance, we may not hope that the influence of this book
may extend.... Never was the case for reasonableness more powerfully
put. It is enforced with extraordinary art. What might easily have
been a difficult treatise, semi-official or academic, proves to be as
fascinating as a good novel.”

8_vo._ ~7s. 6d.~ _net_.


Being a Sequel to “The Economic Consequences of the Peace.”

_THE SPECTATOR._--“The sequel, like the earlier book, is a brilliant
performance regarded as economic argument and compact analysis, and it
also has the advantage of dealing in sardonic and sometimes pitiless

_THE NATION._--“We found Mr. Keynes’s second book to be of the same
delightful texture as his first; showing a playfully impressive irony,
alternating with warning seriousness, and the extraordinary power of
economic analysis which has made him the greatest intellectual force in
the work of European restoration.”

_THE TIMES._--“Mr. Keynes has the gift of interesting his readers in
problems that are at once vital and obscure.”

_THE NEW STATESMAN._--“It is, like its predecessor, a pleasure to read,
lucid and concise in its economic arguments, dashing in its political
satires and its judgment of persons.”

8_vo._ ~18s.~ _net_.


_THE TIMES._--“Mr. Keynes’s book will certainly add to his reputation,
and is, indeed, in our opinion, the best book he has yet written.”

_THE NEW STATESMAN._--“The book will be at once ranked among the most
important contributions to the subject.”

_Prof. PIGOU in the ECONOMIC JOURNAL._--“The problems which Mr. Keynes
has touched, he has not only illuminated with a marvellous lucidity of
style, but has also substantially advanced.”

_THE MANCHESTER GUARDIAN._--“Mr. Keynes’s book is undoubtedly one of
first-rate importance, and it is especially valuable on account of
the extension of its subject beyond the bounds of purely mathematical

_THE SPECTATOR._--“The book contains a great deal that the general
reader will find both interesting and exhilarating.”

8_vo._ ~7s. 6d.~ _net_.


_THE ECONOMIC JOURNAL._--“The book is, and is likely long to remain,
the standard work on its subject.... While academic students will
be grateful for this acute and informing work, it will be read with
as much interest, and perhaps even greater appreciation, by men of
business and affairs.”

_THE SPECTATOR._--“Mr. Keynes’s careful and disinterested study of the
monetary facts of twenty years, and his methodical marshalling of facts
and figures, will be useful even to those--and they will probably be
few--who are not convinced by his reasoning.”

_THE CLARE MARKET REVIEW._--“By his really masterly treatment of the
Indian currency system, the author has made a very valuable addition to
our economic literature.”


Transcriber’s Notes

Punctuation, hyphenation, and spelling were made consistent when a
predominant preference was found in the original book; otherwise they
were not changed.

Simple typographical errors were corrected; unbalanced quotation
marks were remedied when the change was obvious, and otherwise left

Illustrations in this eBook have been positioned between paragraphs
and outside quotations.

Some tables have been rearranged to make them narrower, and some have
been repositioned to fall between nearby paragraphs.

The index was not checked for proper alphabetization or correct page

Page 98: “goods exported by Europe” probably was intended to be “goods
exported by Westropa”.

*** End of this Doctrine Publishing Corporation Digital Book "A Tract on Monetary Reform" ***

Doctrine Publishing Corporation provides digitized public domain materials.
Public domain books belong to the public and we are merely their custodians.
This effort is time consuming and expensive, so in order to keep providing
this resource, we have taken steps to prevent abuse by commercial parties,
including placing technical restrictions on automated querying.

We also ask that you:

+ Make non-commercial use of the files. We designed Doctrine Publishing
Corporation's search system for use by individuals, and we request that you
use these files for personal, non-commercial purposes.

+ Refrain from automated querying Do not send automated queries of any sort
to Doctrine Publishing's system: If you are conducting research on machine
translation, optical character recognition or other areas where access to a
large amount of text is helpful, please contact us. We encourage the use of
public domain materials for these purposes and may be able to help.

+ Keep it legal -  Whatever your use, remember that you are responsible for
ensuring that what you are doing is legal. Do not assume that just because
we believe a book is in the public domain for users in the United States,
that the work is also in the public domain for users in other countries.
Whether a book is still in copyright varies from country to country, and we
can't offer guidance on whether any specific use of any specific book is
allowed. Please do not assume that a book's appearance in Doctrine Publishing
means it can be used in any manner anywhere in the world.
Copyright infringement liability can be quite severe.