A Fraudulent StandardCHAPTER X
MONEY SUPPLY AND INFLATION
WHENEVER a proposal is made to increase the supply of legal tender apart from the ordinary gold supplies for the purpose of meeting the growing demands of trade, the suggestion is invariably met with the cry of inflation.
From the moneylenders standpoint, whilst the issue of Treasury notes to assist the banks in redeeming their obligations and regaining public confidence is a perfectly safe and legitimate measure, a similar issue for the assistance of commerce and industry would be nothing else but rank and dangerous inflation. If any Government had attempted in times of peace to enact such a currency measure on behalf of our industries as that with which Mr. Lloyd George rescued the banks in August, 1914, we should have witnessed one of the greatest political controversies of the century. The financial classes would have compelled the Press to start a political campaign which would have ended in the Governments overthrow. The cries of Debasement of the currency ! Our honest money endangered ! Dishonest inflation ! would have been heard, and the public would have been told that the enactment of such a measure would mean the downfall of the nation !
It is, however, a notorious fact that whenever the shoe pinches in the other direction, when the public is cheated by a contraction of the currency, the financial classes are discreetly silent ! A general fall in prices is hailed by the moneylenders as a special dispensation of Providence since it means an increase in the power of money over production and their enrichment at the expense of all other classes !
But such is the political power of the financial classes, which power, legislation has placed in their hands, that although they are insignificant in numbers, no British statesman since the days of Pitt has dared to run counter to their wishes ! From such a source the cry of inflation is somewhat suspicious, and should be received with caution. Money-lending and credit-mongering are enormously profitable businesses owing to the legal-tender laws which have made money relatively a very scarce article. And it is somewhat amusing to find certain people declaiming against the sin of usury and at the same time defending the very laws under which usury flourishes. Since our legal-tender laws have raised this simple instrument of exchange to the rank and station of a commodity, it is to the interest of those who deal in money and credit to advocate a limited supply of national currency in order to ensure a constant market for the sale of their credit.
An insufficiency of legal tender constitutes the usurers opportunity. And it is such a condition which the legal-tender laws of all nations have created and fostered, the plea being that such insufficiency is essential in order to preserve the value of the monetary standard. Now variability in the standard is the result of variations in the ratio of the supply of money to the demand. It is therefore self-evident that the sine qu‚ non for the establishment of an invariable unit or standard, is an ample provision for an adequate supply of such units in the shape of credit and legal tender to meet all the public needs. Would such a provision be liable to end in inflation ? This depends on what one means by the term. Notwithstanding the suspicious character of many of these cries of inflation, it must not be supposed that inflation is neither a possibility nor a danger. On the contrary, it is both. Indeed, in one sense it is a constant menace. What is inflation ? As popularly understood it signifies an over-supply of general purchasing power resulting in a general advance in prices. It means an increase in the money demand for commodities generally, without a corresponding increase in their supply.
To the usurers, inflation means any increase in currency facilities which tends to lower the rate of interest. Under the gold standard, inflation occurs whenever credit increases beyond its normal proportion to the gold reserves. Strictly speaking, inflation necessarily exists in every industrial nation using the gold standard, i.e., there is necessarily far more credit circulating than could possibly be redeemed in gold on demand and consequently the so-called gold price scale is a composite of gold and credit. Whenever the circulation of general purchasing powerwhether legal tender or bank creditis appreciably increased without affecting a corresponding increase in wealth, there must necessarily be inflation. It frequently happens, however, that an increase of currency, by stimulating demand, also stimulates production, so that supply soon overtakes the increase in demand, and hence the price level is restored to what it was prior to the increase of the currency.
Now, in speaking of the money supply, one necessarily refers not merely to the quantity of money, but also to the speed of circulation.
If the total amount of purchasing power (i.e., legal tender and credit) expended in purchasing goods and services within a given community during a given year, be divided by the average amount of such purchasing power circulating at successive instants of time, separated by equal and very small intervals throughout the year, the resultant will be the average rate of turnover, and is called the rate of velocity of currency circulation.1
The equation is usually expressed as follows :E/C = V where E represents annual expenditure, C the average amount of currency and V = velocity of circulation. Since E = CV it follows that the average volume of currency multiplied by the velocity of circulation equals the annual expenditure.
The amount of currency necessary for effecting the exchange of commodities and carrying on the business of any community, depends upon the rapidity with which money passes from hand to hand and from one persons account to anothers. The quicker the circulation, the less the amount required to effect a given turnover. The rapidity and ease with which our cheque-currency circulates, is the reason why the annual turnover in Great Britain is greater per unit of legal tender than that of any other country in the world. A community with only £50,000,000 of legal currency, can make twice the annual turnover that another can with £100,000,000, provided the velocity of circulation of the former is four times that of the latter. It will be understood therefore, that whenever we speak of the money supply, we mean not merely so much legal tender but legal tender plus credit multiplied by their velocity of circulation. Although the term inflation is usually confined to paper money issues, a currency may become inflated by the presence of too much gold.
A recent pamphlet written by Professor Irving Fisher, of Yale University, speaks of the present flood of gold in America as Our yellow peril.
If money were reduced to its natural position, viz., the representative of existing wealth merely, and its issue confined entirely to such representation, general inflation would be impossible.
Supposing the Bank Charter Act to be repealed and the banks authorized to issue as much credit as the publics commercial and industrial needs demand, not exceeding, say, 50 per cent. of the appraised value of such productive wealth as might be offered in security. Such credit being merely the representative of wealth, would certainly not be a commodity any more than a mortgage-deed or a pawn-ticket is, although backed by commodities of every description.
Would not the use of such credit for purchasing goods constitute merely a form of barter ? If I exchange the title deed of my house for so many railway shares, am I not for the time being bartering my house for an interest in the railway ? And under a general barter system, where commodity money does not exist, inflation is meaningless.
Let us take the illustration of the balance where wealth in process of exchange is balanced by the money given in purchase. If the money is made a legal commodity, and an increase in its volume alters the general level of prices, we call this inflation. But where the currency consists merely of credit issued against wealth, purchases really involve an exchange of wealth for wealth. Hence we are merely balancing goods against goods, and since a general rise in values is impossible, the employment of credit issued as suggested, could not constitute inflation.
Supposing the public were to obtain bank credit against such productive wealth as railways, ships, farms, factories, etc., and commence buying commodities like clothing, furniture, motor-cars, etc., on a very large scale. Whilst such a demand might raise the values of these particular goods, such a rise would mean a corresponding fall in the values of railway and ship shares, factories, etc. It certainly could not raise values generally. It will be seen that there is a vast difference between employing credit as the representative of any and all kinds of wealth and employing it solely as the representative of the money metal or legal tender made specifically redeemable in gold. Credit so issued affects prices the same as legal tender.
Applying the illustration of our balance once more, the use of gold-redemption credit, means the balancing of all commodities so exchanged against gold or promises to pay gold. Hence we get a level of prices entirely different from the general level of values, as demonstrated in Chapter VIII. On the other hand, the employment (as suggested) of credit tokens against wealth in a certain fixed proportion redeemable in services and commodities generally, means balancing wealth with wealth, and hence prices and values become synonymous.
Although gold is a commodity, too much gold, as we have seen, means inflation, for the reason that unlike all other commodities it holds a supreme and unique position as the sole legal debt paying instrument. And this function, artificially established by law, is its chief attraction to which it owes its great demand. If it were demonetized, its over or under-supply could not then affect prices or values generally to the slightest extent. Now credit money issued against all kinds of wealth, prevents inflation because it cannot cause a general rise in values : which would be like a man raising himself from the ground by his own bootstraps. Inflation in this case would mean that whilst wealth was rising uniformly and generally in value, the legal rights and titles to such wealth which this credit currency would really give, were falling in value, which is absurd. Such a phenomenon would be similar to gold rising in value whilst bank-notes issued against the same gold were falling in value ! One could understand bank-notes falling whilst gold was rising in value if such notes were inconvertible, or where the existence or availability of the gold they represented was problematical.
The illustration of the balance clearly shows the enormous influence of credit on prices where such credit is legally redeemable in gold or legal tender.
Consider what it is that really balances commodities and services under the gold standard. It consists of what we term currency, which consists of a very small fraction of gold from 1 per cent. to 5 per cent., and an enormous proportion of paper from 95 per cent. to 99 per cent. Much of this paper functions as gold in influencing prices because it constitutes effective demand for goods and brings no corresponding supply of goods to market. Such of it as does represent various forms of wealth which is brought into the field of exchange, does not affect prices generally, since the demand which it creates is neutralized by the supply of goods it represents.
The difference between commodity money and representative money is this : Whilst under the first all goods purchased are balanced by the actual commodity money paid for such goods, with representative money the goods purchased are balanced not with money but with the wealth which this money is issued against. In short, the creation and circulation of commodity money like gold, means an increase in the demand for goods without necessarily a corresponding increased supply of wealth. Consequently, without the latter, prices must advance. Similarly, if commodity money be taken out of circulation, it reduces the quantity of money without reducing the supply of goods or reducing the number of exchanges to be effected. Hence we have a fall in the level of prices. On the other hand, with representative money, demand and supply are united, and hence any variation in its volume does not affect the price level.
Let us consider this branch of our subject in yet another light.
The basis of a fair exchange is reciprocal satisfaction. When a farmer exchanges half-a-dozen sheep which he doesnt need for a horse which the horse-breeder can easily spare, both traders get the satisfaction they require. But when the same farmer sells the same sheep for, say, £50, and the horse-breeder sells his horse also for £50, neither has received economic satisfaction until they have exchanged the money for what they need.
Now the theory of commodity money denies this. Since such money possesses what is called a store of value, an exchange of goods for money is a legal and final settlement. But it is evident that this is not the store of value the trading public want. They want the particular stores of value contained in commodities such as food, clothing, services, etc., which the money buys. Economic satisfaction is expressed by some such equation as the following :
1 horse = 6 sheep
100 lb. pig-iron = 25 lb. sugar
500 eggs = 6 gallons of wine, etc.
But the commodity-money advocates insist that a similar equation exists between money and goods thus :
1 horse = £50.
But what possible economic satisfaction is there in fifty golden sovereigns, except perhaps to a miser ?
The only utility of a golden sovereign is to function as currency, which a cheap valueless bank≠note performs just as well or even better. And so long as it remain a sovereign, the gold it contains is as useless as if it remained in the earth, since it cannot be employed for commodity purposes without destroying the sovereign, as we have already seen.
When we come to consider the balancing of goods generally with money, we are also met with the preposterous claim that the economic satisfaction of all these goods that are essential to nourish and support life and make it enjoyable, is equalled by the satisfaction we obtain from money Per se, which, as Euclid would have said, is absurd !
Money per se cannot afford any economic satisfaction. It is the goods it represents and can purchase which afford the satisfaction. We must remember that money is, after all, only the medium between commodities, the bridge over which commodities are exchanged. It unites the supply of commodities with the demand for them. It cannot, therefore, function as a commodity itself without ceasing to be the exchange medium. An equation of goods with money is therefore meaningless unless it is understood that money is the representative of goods and not a commodity per se.
The equation 1 horse = £50, does not actually express a fair or honest exchange. It should be 1 horse = £50 worth of commodities.
The following illustration of the triangle (Fig. 2) (see page 153) shows that at present all our huge volumes of credit are piled upon an insignificant amount of gold, so that every golden sovereign represents from twenty to one hundred sovereigns worth of credit. If, therefore, a million pounds of bullion are exported, the banks are compelled to call in all the credit resting on that sum, in order to maintain their so-called margin of safety. Hence the movement of a comparatively small amount of gold or legal tender means the addition to or cancellation of a large volume of currency. Some years ago the Bankers Magazine gave a most startling instance of the effects of gold exports upon the prices of our gilt-edged securities. During a period of ten weeks a certain group of American financiers drew from the Bank of England sums equal in all to eleven million pounds in gold and shipped it to New York. Prior to this operation these gamblers sold British securities heavily and bought United States bonds and shares. The transfer of this gold caused a fall in the prices of 325 of our representative securities equivalent to £115,500,000, whilst the absorption of this gold in New York caused a corresponding rise in Americans. This illustration (Fig. 2) explains why a relatively small addition of legal tender can sometimes seriously affect the price level. It is not due so much to this increase in legal tender but to the disproportionate amount of bank credit which is based upon it. This fact also explains the reason why the values of commodities have become so easily the sport of speculators. The sudden creation or withdrawal of credit, the export of gold from one country to another is sufficient to ensure certain profits to the cosmopolitan gamblers in finance.
As a well-known financier said when commenting on the above American gold transaction, These speculators played upon two tables at the same timeone in London and the other in New Yorkand won on both ! Having sold short in London and then created a heavy fall in prices by exporting our gold, they bought in New York for a rise which they were able also to influence by the mere act of putting the same gold in circulation there. They were gambling on a certainty on both sides of the ocean !
The currency question, like many others, has its psychological aspect. The amount of legal tender required by a nation varies from time to time and is often a question of nerves. Panics are the result of fearfear lest the margin of safety is inadequate. When knowledge is added to fear, panics are likely to become chronic. The amount of legal tender necessary varies inversely with the degree of public confidence. The public to-day know that the gold basis provides a margin, not of safety, but of bankruptcy whenever a national crisis approaches. If provision were made for issuing legal tender as required and as suggested, we should not only abolish all danger of future panics, but we should reduce the amount of legal tender needed to a minimum. The public seldom call for legal tender except in comparatively small amounts for small purchases, unless they scent danger. Remove all danger of an insufficient supply, and you get rid of what is now the chief necessity for legal tender.
One of the most complicated problems in finance is that of the foreign exchanges, in which the relations of the monetary units of various countries to each other have to be determined. These relations are constantly changing with the movements of gold from one country to another as well as with the changes in the volumes of the credit and legal tender supplies in each. The price scales of all the great industrial nations are built upon similarly unstable conditions and are all equally irrational, variable and fraudulent. But these conditions create bountiful harvests for speculators and gamblers, especially those belonging to the financial classes, and constitute the very atmosphere in which the worlds stock exchanges live and move and have their being.
Although gold is probably the most unsuitable commodity which could possibly be selected for the worlds price scale, owing to its relative scarcity, necessitating a vast array of paper to make good the deficiency, any other commodity would also be subjected to great fluctuations from time to time. Wheat, corn, silver and other commodities have all been suggested as suitable standards. Silver is the oldest and has proved the steadiest over a longer period than any other, and is still the money of the Far East. In the West it was dethroned because financiers feared its supply would be more difficult to control than its scarcer, more expensive and aristocratic rival, gold. And the economic and political supremacy of this class depends upon maintaining a world≠wide scarcity of legal tender in order that there shall exist a perpetual market for their credit, the interest upon which, amounting to an annual return of hundreds of millions, is the chief source of their income. This was the real gist of the great struggle against bi-metallism which was waged so fiercely some twenty years ago. The bankers and moneylenders won, and the public paid the price for their ignorance and folly.
The historical examples of inflation usually cited by the orthodox champions of our credit monopoly as warnings against what they call tampering with the currency have little or nothing to do with the suggestions and proposals contained in this book. The French assignats and the American greenbacks are the two favourite illustrations of the terrible effects of cheap money. Now, both of these currencies were created in emergencies. Both were issued for the purpose of carrying on destructive wars, not for the development of industry and the growth of wealth. They were to assist these nations in destroying wealth. It is one thing for a banker to give a client an overdraft to enable him to develop his business and build up a successful and profitable industry. It is quite another thing to grant him the same facilities in order that he may get drunk, burn his factory, destroy all his furniture, and indulge in a prolonged debauch ! And yet these currency writers want their readers to believe the results are the same in both cases ! Supposing the Government should find it necessary after the war to issue £100,000,000 in notes to enable numbers of returned soldiers to settle on and cultivate the land. Assuming that the money was employed wisely in procuring fertilizers, farm buildings and implements, cattle, horses, and in enabling men to live until their farms were self-supporting, is it not evident that the money so advanced would ultimately be represented by an addition of £100,000,000 and more to the real national wealth in buildings, cattle, crops, produce, etc ? On the other hand, the Government is now issuing credit at the rate of £8,000,000 per day for munitions of destruction, so that we have nothing but debt as the economic result. And yet whilst our statesmen and legislators have always shown alacrity in proposing and voting for millions of the national wealth to an unlimited extent for the work of destruction, seldom or never have they been willing to do so for creating wealth or for making the nation economically strong and prosperous ! The German Government is the only one that has shown any wisdom or intelligence in this respect. Whilst our legislators have always been willing to add to the National Debt and to the means for perpetuating it, few are they who have suggested the use of the National Credit for productive purposes.
Those, however, who regard the two historical examples cited as an evil should offer some other scheme by which nations are able to finance great wars without inflation.
Just now we are reading a good deal about the dangers of present inflation. Now a moments thought should convince these writers that where a nation is employed in making munitions as Europe is now doing, inflation is unavoidable since the bulk of our labour products are being destroyed. To first create munitions and supply them, we must have some kind of currency. But although these products are soon destroyed, the currency employed in making them remains in circulation. The only way to avoid inflation under present conditions, is to destroy a corresponding amount of currency, which would soon stop further production !
There is this to be said for cheap paper money. It is the only currency by which great crises can be met and which enables nations to survive. No great modern wars have ever been fought through on the gold currency basis. Francis Walker, the well-known American economist, says :
Governments have frequently issued paper money without adequate provision for its redemption in gold and silver, without such redemption, in fact, taking place, and sometimes without redemption being promised, and yet that paper money has circulated as rapidly as gold or silver would have done, has been taken as freely in exchange for commodities and services, and even in some instances has maintained an actual value equal to that of the amount of the precious metals to which it was nominally equivalent. The paper money of Massachusetts for the greater part of the period 1690 to 1710, the paper money of Russia for the twenty years following 1768, the so-called continental currency of the American revolution for a year and more after the first emission, the paper money of Prussia for no inconsiderable period of time, all circulated freely, even without discount in specie.
And again he says :
The so-called greenbacks of the American Civil War never, from 1862 to the close of 1878, lost their currency in the smallest degree. At their price they were always taken readily, eagerly. Men never sought to avoid their use by taking gold at a premium, or by resorting to barter or credit.
This last statement is remarkable, owing to the fact that the United States Government dishonoured its currency by the famousor rather infamousexception clause, refusing to accept it in payment for duties or issue it for interest on bonds. The real trouble the Americans suffered from, was not due to the use of their cheap currency, which pulled them safely through their great Civil War. The industrial evils and suffering which followed the Civil War were the result of the stupid attempt to bring all this currency to a gold and silver basis, i.e., by providing for redemption or conversion in specie. This piece of idiocy caused years of serious business depression, the bankruptcy of thousands, and curtailed the production of wealth enormously. But the bankers and financiers grew rich. Every dollar they had invested in the American War loans, grew to be two, three, four, five and even six dollars eventually ! And by destroying a vast mass of the national paper currency the bankers compelled the public to borrow their paper credit at rates varying from 7 per cent. to 10 per cent. ! Is it any wonder these men have endowed universities and established schools of political economy and finance, and hired professors to write books denouncing cheap money and warning the public of the dangers of national paper currencies, when they know what an inexhaustible mine of wealth the gold standard opens to the members of their profession ?
1 See Irving Fishers Purchasing Power of Money.