PART THREE: MONEY AND BANKING
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CHAPTER 20
Problems of Credit Policy
I. Prefatory Remark
1 The Conflict of Credit Policies
Since the time
of the Currency School, the policy adopted by the governments of Europe and
America with regard to the issue of fiduciary media has been guided, on the
whole, by the idea that it is necessary to impose some sort of restriction upon
the banks in order to prevent them from extending the issue of fiduciary media
in such a way as to cause a rise of prices that eventually culminates in an
economic crisis. But the course of this policy has been continually broken by
contrary aims. Endeavors have been made by means of credit policy to keep the
rate of interest low; "cheap money" (that is, low interest) and "reasonable"
(that is, high) prices have been aimed at. Since the beginning of the twentieth
century these endeavors have noticeably gained in strength; during the war and
for some time after it they were the prevailing aims.
The strange
vicissitudes of credit policy cannot be described except by passing in review
the actual tasks that it has had to solve and will have to solve in the future.
Although the problems themselves may always be the same, the form they assume
changes. And, for the very reason that our task is to strip them of their
disguises, we must first study them in their contemporary garb. In what follows,
separate consideration will be given to such problems, first, as they exhibited
themselves before the war, and then, as they have exhibited themselves in the
period immediately after the war. [1]
II. Problems of Credit Policy Before the War[2]
2 Peel's Act
Peel's Bank Act, and the ideas on which it
was based, still sets the standard by which credit policy is ultimately governed
nowadays; even those countries that do not follow the example of the English
bank legislation, or do not follow it so faithfully as others, have yet not been
able to withstand its influence altogether. Here we are confronted with a
strange phenomenon. While the economic literature of all countries was directing
the most violent and passionate attacks against the system of having a fixed
quota of the note issue not backed by metal; while people were untiring in
calling Peel's Act the unfortunate legislative product of a mistaken theory;
while the currency principle continued to be represented as a system of
erroneous hypotheses that had long been confuted; yet one legislature after
another took steps to limit the issue of uncovered banknotes. And, remarkably
enough, this procedure on the part of governments evoked but little censure, if
any at all, from those whose views on banking theory should logically have led
them most severely to condemn it. To start from the banking principle, which
denies the possibility of an overissue of banknotes and regards "elasticity" as
their essential characteristic, is necessarily to arrive at the conclusion that
any limitation of the circulation of notes, whether they are backed by money or
not, must prove injurious, since it prevents the exercise of the chief function
of the note issue, the contrivance of an adjustment between the stock of money
and the demand for money without changing the objective exchange value of money.
It might easily have appeared desirable to Tooke's followers that provision
should be made for backing that part of the note circulation that was not backed
by metal; but logically they should have condemned the prescription that a
certain proportion was to be maintained between the stock of metal and the note
circulation. There is an irreconcilable contradiction, however, between the
theoretical arguments of these writers and the practical conclusions that they
draw from them. Scarcely any writer that need be taken seriously ventures to put
forward proposals that might fundamentally disturb the various systems for
restricting the unbacked note issue; not a single one definitely demands their
complete abolition. Nothing could show the inherent uncertainty and lack of
independence of modern banking theory better than this inconsistency. That the
note issue must somehow be restricted in order to guard against serious evils is
still accepted today as the essence of government wisdom in matters of banking
policy, and the science which claims to have produced proof to the contrary
always ends up by deferring to this dogma, which nobody is nowadays able to
prove and everybody thinks himself able to refute. The conversatism of the
English hinders them from meddling with a law which stands as a monument to an
intellectual contest which went on for many years and in which the best men of
the time participated; and the example of the world's chief bank influences all
the other banks. The conclusions of two generations of economists have not been
able to shake the opinions which are supposed to be the result of practical
banking experience.
Many serious errors are involved in the currency
principle. The most serious lies in its failure to recognize the essential
similarity of banknotes and bank deposits. [3] Its opponents have skillfully
discovered these weak spots in the system and directed their sharpest attacks
accordingly. [4] But the doctrine of the Currency School does not stand or fall
by its views on the nature of checks and deposits. It is enough to correct it on
this one point—to take its propositions concerning the issue of notes and apply
them also to the opening of deposit accounts—to silence the censures of those
who adhere to the banking principle. That its mistake on this point is of small
significance in comparison with that made by the banking principle can hardly
need further discussion. And in any case, it does not seem an inexcusable
mistake to have made if we take into account the relatively backward development
of even the English deposit system at the time when the foundations of the
classical theory of banking were being laid, and if we further consider the ease
with which the legal differences between payment by note and payment by check
might give rise to error.
As far as Peel's Act was concerned, however,
this very shortcoming of the theory that had created it turned out to be an
advantage; it caused the incorporation in it of the safety valve without which
it would not have been able to cope with the subsequent increase in the
requirements of business. The fundamental mistake of Peel's system, which it
shares with all other systems which proceed by restricting the note circulation,
lies in its failure to foresee the extension of the quota of notes not backed by
metal that went with the increase in the demand for money in the broader sense.
As far as the past was concerned, the act sanctioned the creation of a certain
amount of fiduciary media and the influence that this had on the determination
of the objective exchange value of money; it did not do anything to counteract
the effects of this issue of fiduciary media. But at the same time, in order to
guard the capital market from shocks, it removed all future possibility of
partly or wholly satisfying the increasing demand for money by the issuing of
fiduciary media and so of mitigating or entirely preventing a rise in the
objective exchange value of money. This amounts to the same thing as suppressing
the creation of fiduciary media altogether and so renouncing all the attendant
advantages for the stabilization of the objective exchange value of money. It is
an heroic remedy with a vengeance, in essence hardly differing at all from the
proposals of the downright opponents of all fiduciary media.
Nevertheless,
something was overlooked in the calculations of the currency theorists. They did
not realize that unbacked deposits were substantially the same as unbacked
notes, and so they omitted to legislate for them in the same way as for the
notes. So far as the development of fiduciary media depended on the issue of
notes, Peel's Act completely restricted it; so far as it depended on the open
ing of deposit accounts, it was not interfered with at all. This forced the
technique of the English banking system in a direction in which it had already
been urged in some degree by the circumstance that the right of note issue in
London and its environs was an exclusive privilege of the Bank of England. The
deposit system developed at the expense of the note system. From the point of
view of the community this was a matter of indifference because notes and
deposits both fulfill the same functions. Thus Peel's Act did not achieve its
aim, or at least not in the degree and manner that its authors had intended;
fiduciary media, suppressed as banknotes, developed in the form of
deposits.
It is true that German writers on banking held that it was
possible to discover a fundamental difference between notes and deposits. But
they did not succeed in demonstrating their contention; in fact they did not
really attempt to do so. Nowhere is the inherent weakness of German banking
theory more obvious than in connection with this particular question of the note
versus the check, which for years has been the central issue of all discussion.
Anybody who, like them, had learned from the English Banking School that there
is no fundamental difference between notes and checks, and was in the constant
habit of stressing this,[5] should at least be prepared to supply a detailed
proof in support of an assertion that the banknote system represents "an earlier
and lower stage of development of the credit economy" than the deposit bank and
the check, with the connected system of the account current, book credit, and
clearinghouse. [6] Certainly reference to England and the United States cannot be
accepted as proof of the correctness of this assertion, least of all in the
mouth of a decided opponent of Peel's Act and of the restriction of the note
issue in general; for it is undeniable that the great importance of the deposit
system and the decreasing relative importance of the banknote in Anglo-Saxon
countries are the result of that act. The consequence is that the German
literature on banking theory is full of almost unbelievable
contradictions. [7]
The repression of the banknote, as it has occurred in
England and in the United States—in different ways and for different reasons,
but as a result of the same fundamental ideas—and the corresponding growth in
importance of the deposit, and the additional circumstance that the organization
of the deposit banks has not attained that soundness that would have enabled it
to retain the public confidence during dangerous crises, have led to serious
disturbances. In England, as also in the United States, it has repeatedly
happened in times of crisis that confidence has been destroyed in those banks
that circulate fiduciary media in the form of deposits, while confidence in
banknotes has been maintained. The measures by which the consequences which such
a collapse of a part of the national business organization would infallibly have
involved were avoided are well known. In England an attempt was made to fill the
gap in the circulation which was due to the lack of large quantities of
fiduciary media by the Bank of England being ready to increase the issue of its
own notes. In the United States, where the law made this solution impossible,
the clearinghouse certificates served the same purpose. [8] In both countries,
attempts to give this device a legislative basis were made. But Lowe's bill was
not passed, and even the Aldrich-Vreeland Act in the United States had only a
partial success. [9]
None of the many systems of limiting the note
circulation has proved ultimately capable of interposing an insurmountable
obstacle in the way of further creation of fiduciary media. This is equally true
of Peel's Act, which completely forbids the new issue of fiduciary media in the
shape of notes, and of such bank-of-issue legislation in other states as does
leave a certain scope for the augmentation of notes not backed by money. Between
the English act of 1844 and, say, the German act of 1875, there seems to be a
fundamental difference: while the one rigidly fixes, for all time, the quota of
the note circulation not backed by metal, the other, inasmuch as it only
requires that a certain proportion of the note circulation shall be backed by
metal and puts a tax upon the rest, does make provision within certain limits
for its future extension. But everything depends upon the scope that is thus
provided for extending the issue of fiduciary media. If it had been wide enough
to give free play to the development of the unbacked note circulation, then the
German law —and the same is true, not only of other laws based on the same
principle (for example, the Austrian), but also of those that attempt to limit
the circulation of notes in other ways, as for example, the French—would have
had fundamentally different results from the English. Since in fact it proved to
be too narrow for this, the difference between the two laws is merely one of
degree, not one of kind. All these laws have limited the issue of fiduciary
media in the form of notes, but have set no limits to their issue in the form of
deposits. Making the issue of notes more difficult was bound to promote an
increased employment of deposits; in place of the note, the deposit account came
into prominence. For the development of the credit system, this change was not
altogether a matter of indifference. The note is technically superior to the
deposit in medium and small transactions; in many cases for which it might have
been used as a money substitute, checks or clearing transfers could not be used,
and in such cases restriction of the issue of fiduciary media in the form of
notes was bound to have the effect of restriction of the issue of fiduciary
media in general. Under the law of the United States of America, the issue of
fiduciary media in the shape of deposits is also restricted; but since this only
applies to some of the banks, namely, the national banks, it is not enough to
make a big difference between the deposit business of the United States and that
of the other countries in which no similar regulations have been
established.
The real obstacle in the way of an unlimited extension of the
issue of fiduciary media is not constituted by legislative restriction of the
note issue, which, after all, only affects a certain kind of fiduciary medium,
but the lack of a centralized world bank or of uniform procedure on the part of
all credit-issuing banks. So long as the banks do not come to an agreement among
themselves concerning the extension of credit, the circulation of fiduciary
media can indeed be increased slowly, but it cannot be increased in a sweeping
fashion. Each individual bank can only make a small step forward and must then
wait until the others have followed its example. Every bank is obliged to
regulate its interest policy in accordance with that of the others.
3 The Nature of Discount Policy
The most obscure and incorrect concepts are
current concerning the nature of the discount policy of the central
banks-of-issue. Often the principal task of the banks is said to be the
protection of their cash reserves, as if it would pay them to make sacrifices
for such an aim as that. No less widespread, however, is the view that the
banks' obligation to follow a discount policy that takes account of the
circumstances of other banks is imposed upon them merely by a perverse
legislation and that the ideal of cheap money—in a double sense, namely, a low
purchasing power of money and a low rate of interest—could be realized by the
abandonment of certain out-of-date legal provisions.
It is unnecessary to
devote very much time to the refutation of such views as these. After all that
has been said on the nature of money and fiduciary media, there can hardly be
very much doubt as to the aim of the discount policy of the banks. Every
credit-issuing bank is obliged to fix the rate of interest it charges for loans
in a certain conformity with that of the other credit-issuing banks. The rate
cannot be allowed to sink below this level, for if it did, the sums of money
needed by the bank's rapidly extending clientele for making payments to
customers of other banks would increase in such a fashion that the bank's
solvency would be imperiled. It is by raising the rate of discount that the bank
safeguards its own capacity to pay. This end is certainly not attained by
protecting the redemption fund, the small insignificance of which for
maintaining the value of the fiduciary media has already been demonstrated, but
by avoiding the artificial extension of the circulation of fiduciary media that
would result from asking less interest than the other banks, and so also
avoiding an increase in the demands for the redemption of the fiduciary media.
The banks would still have to have a discount policy even if there were no
legislative regulation of the note cover.
In Germany there has been a
controversy as to whether certain measures of the Reichsbank are dictated by
regard to the circumstances of the domestic money market or to those of the
international. In the form in which it is usually put, the question is
meaningless. The mobility of capital goods, which nowadays is but little
restricted by legislative provisions such as customs duties, or by other
obstacles, has led to the formation of a homogeneous world capital market. In
the loan markets of the countries that take part in international trade, the net
rate of interest is no longer determined according to national, but according to
international, considerations. Its level is settled, not by the natural rate of
interest in the country, but by the natural rate of interest anywhere. Just as
the exchange ratio between money and other economic goods is the same in all
places, so also the ratio between the prices of goods of the first order and
those of goods of higher orders is the same everywhere. The whole system of
modern international trade would be completely changed if the mobility of
capital goods were to be restricted. In Germany there are many who demand such a
prohibition or at least a considerable restriction of the investment of capital
abroad. It is not our task to demonstrate what a small prospect of success a
policy like this would have, or to show that the time is now past for a nation
to decide whether or not it will take part in international trade. So long and
insofar, however, as a nation participates in international trade, its market is
only a part of the world market; prices are determined not nationally but
internationally. The fact that the rate of interest in Germany may rise, not
because any change has occurred in its determinants within the Reich but because
there have been changes, say, in the United States, should not seem any more
remarkable than, say, a rise in the price of corn that is due to the state of
foreign harvests.
It has not been easy to reconcile policy with the
extension and combination of national markets into a world market. Stronger than
the resistance encountered centuries ago by the development of the town economy
into the national economy is that which the nineteenth and twentieth centuries
have opposed to the further stage of development into a world economy. Nowadays
there is nothing like the feeling of homogeneity which previously overcame
regional interests; the pronounced emphasis upon national antagonisms which sets
the keynote of modern policy would perhaps stand in the way of attempts at
economic unification even if there were no interests to which these attempts
might prove injurious. From the point of view of the producer, low prices seem
to be the greatest of all evils, and in every state those producers who are
unable to meet competition strive with all the means at their disposal to keep
the cheap commodities of the world market out of the national market. But
whether they succeed in this in each individual case or not depends to a large
extent on the strength of the political influence of the opposing interests. For
in the case of every individual commodity, the producers' interest in high
prices is opposed by the interest of consumers in the opening of the market to
the cheapening effect of foreign competition. The matter is only decided by the
conflict of the two groups. The distribution of forces is otherwise when the
problem of freedom of capital transactions is under discussion. We have already
seen that creditor interests always get the worst of it when they clash with
debtor interests. The interests of the capitalists are scarcely ever represented
in monetary policy. Nobody ever objects to the importation of capital from
abroad on the ground that it leads to a depression of the rate of interest in
the home market and a reduction of the income of the capitalists; quite the
reverse. The universally prevailing view is that it is in the interest of the
community that the rate of interest should be as low as possible. In those
European states with large capital resources, which so far as international
dealings in capital are concerned need be considered only as creditors and not
as debtors, this policy is expressed in the endeavor to put obstacles in the way
of foreign investment. Undoubtedly, this is not the only point of view from
which modern states judge the export of capital. Other considerations enter into
the matter as well, some in favor of exportation, some against it. There is, for
instance, the fact that it is frequently impossible to export commodities except
by allowing the payment for them to be postponed, so that future goods are
acquired in exchange for the present goods surrendered; and that for this reason
alone it is consequently necessary to promote the export of capital or at least
not to hinder it. [10] Nevertheless, it must be insisted that the policy adopted
by these states with regard to the export of capital is guided by the endeavor,
among others, to keep the domestic rate of interest low. On the other hand, the
same motive leads these states which because they are poor in capital have to
play the part of international borrowers to encourage its importation.
The attempt to depress the domestic rate of interest by influencing the
international movement of capital is particularly pronounced in the so-called
money market, that is, in the market for short-term capital investments. In the
so-called capital market, that is, the market for long-term capital investments,
there is less possibility of effecting anything by intervention; in any case,
any steps that may be taken become effective much more quickly in the former
than in the latter. Consequently there is a greater propensity toward exerting
an influence on the rate of interest on loans in the money market than in the
long-term capital market. But the most important cause of the persistence of
demands for the exertion of influence upon the money market lies in the
universally prevalent errors concerning the nature of fiduciary media and of
bank credit. When a relatively small efflux of gold induces the powerful central
bank-of-issue of a rich country to raise the discount rate there is a tendency
to think that there must be some other way than this, by which the efflux of
gold could be prevented without involving the community in what is regarded as
the injurious effect of a rise in the rate of interest. It is not seen that what
is happening is the automatic adjustment of the national to the world rate of
interest owing to the way in which the country is involved in international
trade. That the country cannot be cut off from participation in international
capital dealings simply and solely by measures of banking and currency policy,
is completely overlooked. This alone can explain how it can come about in large
exporting countries that the very persons who demand measures for "cheapening"
credit are those who benefit most from the export trade. If those manufacturers,
for whom every increase in the rate of discount that can be traced to events
abroad is an inducement to plead for a modification of the banking system in the
direction of releasing the central bank-of-issue from its obligation to provide
gold for export on demand, would realize that the increase in the rate of
interest could be effectively stopped only by a suppression of the export of
capital and complete exclusion of the country from international trade, then
they would soon change their minds. And it seems that these implications have
already won some degree of general recognition, even if the literary treatment
of the problem may still leave something to be desired. In Germany and Austria
it was only the groups that demanded the seclusion of the national market that
also demanded the "isolation" of the currency.
Further explanation is
unnecessary. Nevertheless, it may not be supererogatory to examine one by one
the measures that are recommended by those who favor a low rate of interest and
to show how incapable they would prove of leading to the expected
result.
4 The Gold-Premium Policy[11]
Let us first review the systems
which are supposed to be able to maintain the level of the rate of discount in
the national money market by making it more difficult or more expensive to
procure gold at a rate below that determined by the circumstances of the
international market. The most important and most well known of these is the
gold-premium policy, as it was carried out by the Bank of France.
In view
of the circumstances that nowadays the silver five-franc piece is still legally
current coin, the Bank of France is authorized to redeem its notes at its own
choice either in gold or in these pieces. It sometimes used to make use of this
authority for the purpose of increasing the difficulty of procuring gold for
export purposes. As a rule it made no difficulty about surrendering gold in
exchange for notes. And it exchanged five-franc pieces in the same way for gold
coins, although it was not obliged to do so, and by so doing it endowed the
latter with the property of being money substitutes. Naturally, these facilities
were not requisitioned to a great extent for purposes of domestic business.
Notes and five-franc pieces enjoyed unlimited public confidence so that their
employability as money substitutes was not in the least in question. But if the
bank was asked to surrender gold for export, it did not necessarily do so. It is
true that it used to hand over gold unhesitatingly for the requirements of what
was called "legitimate" trade, that is, when it was needed to pay for imported
commodities, especially corn and cotton. But if gold was demanded for the
purpose of speculating on the difference between home and foreign interest
rates, it was not handed over as a matter of course. For this purpose, the bank
did not issue Napoleons, the French gold coins, at all; and it issued ingots and
foreign gold coins only at an additional charge, varying from four to eight
percent of the 3,437 francs at which it was legally bound to purchase a kilogram
of fine gold. It is impossible to state the exact amount of this "gold premium,"
because the rate has never been published officially. [12]
The purpose of
the gold-premium policy was to postpone as long as ever possible the moment when
the condition of the international money market would force the bank to raise
the discount rate in order to prevent an efflux of gold. The lowness of the rate
of discount is of extraordinary importance in French financial policy. In the
interest of those classes of the community by which it is supported, the
government of the Third Republic is obliged to avoid anything that might injure
the high standing of the rentes which constitute the chief investment of those
classes. Even a merely temporary high rate of discount is always dangerous to
the rentes market, for it might induce some holders of rentes to dispose of
their bonds in order to reinvest their capital more fruitfully, and the
disturbance of the market that might result from this would have a
disproportionately adverse effect on the quotation of the rentes. It is
undeniable that the result aimed at was to a certain extent attained, even
though the premium policy by no means possessed the significance that was
erroneously ascribed to it.
It is above all mistaken to ascribe the
lowness of the rate of discount in France to the procedure that has been
described. If the rate of discount has been lower in France than in other
countries, this is due to altogether different causes. France is of all the
countries in the whole world that which is richest in capital; but its people
are not greatly endowed with the spirit of initiative and enterprise. [13]
Consequently its capital has to emigrate. Now in a country which exports
capital, even disregarding the premium for risk-bearing that is contained in the
gross rate of interest, the rate of interest on loans must be lower than in a
country which imports capital. Capitalists, when comparing the yields of home
and foreign investment, are led by a series of psychological factors to prefer
the former to the latter when other circumstances are equal. This is enough to
explain why long-term and short-term investments bear lower interest in France
than in other countries, such as Germany. The cause is a general economic cause;
it is a matter in which measures of banking or currency policy can have no
influence. The ratio between the rate of interest in France and that abroad
could not for long be forced away by the premium policy of the Bank of France
from that determined by the general economic situation. The Bank of France was
not above the laws that govern the course of economic affairs. In fixing the
level of its discount rate, it was not exempt from the necessity for paying due
attention to the level of the natural rate of interest. Like every other
credit-issuing bank that has an influence on the domestic market, it had to
endeavor to keep the rate of interest on domestic short-term investments at such
a level that foreign investment did not appear so attractive to home capitalists
as to endanger the bank's own solvency. Like the others, the Bank of France
could effectively prevent an outflow of gold in one way only—by raising its
discount rate. [14] Employing the premium policy could do no more than postpone
for a short time a rise in the rate of discount that the state of the
international money market had made necessary. The premium made it more
expensive to export gold and so reduced the profitability of interest arbitrage
transactions. When it was widely believed that the difference between the French
and the foreign rates of interest was about to be altered in France's favor
through a fall in the foreign rate, then arbitrage dealers would not export gold
at all, since the small profit of the transaction would be too greatly reduced
by the premium. In this way the Bank of France may sometimes have avoided
raising the discount rate when it would otherwise have been necessary to do so
for a short time. But whenever the difference between the rates of interest was
significant enough to make short-term foreign investment still promise to be
profitable in spite of the increased cost of procuring gold due to the premium,
and whenever the result of arbitrage dealings was not jeopardized by the
prospect of an imminent reduction of the foreign rate, then even the Bank of
France could not avoid raising the rate of interest.
It has been asserted
that it is possible for a central bank to use successive increases of the
premium so as entirely to prevent the export of gold if it continually forces
back the gold point or export limit as the fall in the rate of exchange
requires. [15] This is undoubtedly correct. The procedure, as is well known, has
been employed repeatedly; it is known as cessation of cash payments. The bank
that adopts it deprives its fiduciary media of their character of money
substitutes. If they continue to function as general media of exchange, it is in
the role of credit money. Their value will have become subject to independent
variation. In such a case, it is admittedly possible for the bank to follow a
completely independent discount policy; it may now reduce to any desired extent
the rate of interest it charges without running the risk of insolvency. But this
brings to light the consequences that must follow a banking policy that
endeavors by extending the issue of fiduciary media to depress the rate of
interest on loans below the natural rate of interest. This point has already
been discussed in detail; in the present connection there is a second point that
is of importance. If the intervention of the bank leads to the artificial
retention of the rate of interest on loans at a level below that of the rate
given by international conditions, then the capitalists will be all the more
anxious to invest their capital abroad as the gap between the domestic and
foreign rates of interest increases. The demand for foreign common media of
exchange will increase, because foreign capital goods will be desired more and
home capital goods less. And there is no way in which the fall in the rate of
exchange could automatically set forces in motion to reestablish between the
bank money and gold, the world money, that exchange ratio which had previously
existed when the notes and deposits of the bank were not credit money but still
money substitutes. The mechanism of the monetary system tends to bring the
exchange value of the two kinds of money to that "natural" level determined by
the exchange ratio between each of them and the remaining goods. But in the
present case it is the natural exchange ratio itself which has moved against the
country that refuses to pay out gold. An "autonomous" interest policy must
necessarily lead to progressive depredation.
There are many advocates of
the gold-premium policy who make no attempt to deny that its employment in the
way in which they intend must infallibly lead to a credit-money or fiat-money
standard with a rapidly falling objective exchange value of the unit. In fact,
they are inclined to regard this very fact as a special advantage; for they are,
more or less, inflationists. [16]
Nevertheless, this was by no means the way
in which the Bank of France carried out its premium policy. It observed a fixed
limit, above which it never allowed the premium to rise in any circumstances
whatever. Eight per mill is probably the highest premium that it has ever
demanded. And this was certainly not an error on the part of the bank; it was
founded on the nature of the case. In the eyes of the French government and of
the administration of the bank controlled by it, the amount of depreciation
consequent upon a gold premium of eight percent was not intolerable; but, in
view of the unpredictable reactions throughout the whole community it was
thought better to avoid further depreciation. Thus the French gold-premium
policy was not able to prevent the export of gold altogether, but could only
postpone it for a short time. Now this fact alone, and not only when the
difference between the rates of interest was so inconsiderable and transient
that the rate of discount did not need to be raised at all, meant a cheapening
of the rate of interest on loans. But this was offset by the increase in the
rate of interest during those periods when the rate of interest abroad was
relatively low. Whenever the loan rate abroad sank so low that it might have
seemed advantageous to capitalists to transfer capital to France for investment,
they nevertheless refrained from doing so if a long continuance of the situation
could not be reckoned with or if the difference between the rates was not very
great, because they had reason to fear that a subsequent repatriation of the
capital when the situation was reversed would be possible only at an increased
cost. Thus the gold-premium policy did not merely constitute a hindrance to the
efflux of gold from France; it also hindered an influx. It reduced the rate of
interest on loans at certain times, but raised it at other times. It is true
that it did not altogether exclude the country from international dealings in
capital; it only made participation in them harder; but it did this in both
directions. Its effect, the intensity of which should not be overestimated, was
principally expressed in the fact that the rate of interest for short-term
investments has been more stable in France than in other countries. It has never
sunk so low as in England, for example; but neither has it ever risen so high.
This is shown quite dearly by a comparison of movements in the London and Paris
loan rates.
It has become more and more clearly recognized that the
gold-premium policy could not have these effects ascribed to it. Those who once
regarded it as the remedy for all ills are gradually becoming silent.
5 Systems Similar to the Gold-Premium Policy
The legal provisions which have
permitted the Bank of France to follow the gold-premium policy were absent in
those countries which until recently were on a pure gold standard. Where the
gold coins have not been supplemented by any money substitutes, fiat money, or
credit money, with unlimited legal tender by any payer including the central
credit-issuing bank, the fiduciary media have had to be redeemed at their full
face value in money without a premium being charged in addition. [17] But in
actual fact these banks also were tending to adopt a policy different in degree
but certainly not in kind from the described procedure of the Bank of
France.
In most countries, the central bank-of-issue was only obliged to
redeem its notes in legal tender gold coins of its own country, after the
pattern of English banking law. It is in accordance with the spirit of the
modern monetary system and with the ultimate aims of monetary policy that this
obligation has been understood also to refer to the surrender of gold ingots to
exporters at the legal ratio or at least at a price that made it more profitable
to procure bullion than coins. Thus until 1889 the Bank of England voluntarily
extended its obligation to redeem its notes by paying out on demand in ingots
the value of the notes in full-weight gold coins. It did this by fixing its
selling price for gold bullion once for all at 77s. 10½d. per ounce of standard
gold. [18] For a time the Continental banks-of-issue followed this example. But
they soon determined upon a different procedure, and eventually the Bank of
England too relinquished its old policy and adopted the practice of the
Continental banks.
The Bank of England and the German Reichsbank, apart
from the Bank of France the two most important credit-issuing banks in the
world, were in the habit of issuing for export purposes worn gold coins only of
inferior value. Sovereigns, as issued by the Bank of England for export, were
usually from two to three percent worse than newly minted sovereigns. The weight
of the twenty-mark pieces received by a person who withdrew gold coins from the
German Reichsbank for purposes of exportation was, according to the calculations
of experts, 7.943 grams on an average as against a standard average of 7.965
grams; that is, something over a quarter of one percent less than their mint
value. [19] The Bank of England sometimes refused altogether to issue gold ingots,
and sometimes would only issue them at a price in excess of the 77s. 10½d. which
alone was usual until 1889. It sometimes raised the selling price of ingots to
as much as 77s. 11d. [20]
As regards the range and the effect of these
measures, nothing need be added to what has already been said about the French
gold-premium policy. The difference—as has been said—is only quantitative, not
qualitative. [21]
The other "little devices" which have also been employed
for making the export of gold more difficult have their effect in precisely the
same fashion. As, for example, when the German Reichsbank sometimes prohibited
the issue of gold for export purposes except in Berlin by invoking the letter of
section 18 of the Bank Act, which had the effect of making the export of gold
more costly by burdening the gold exporters with the risk and cost of
transporting the gold from Berlin to the place of export.
6 The Nonsatisfaction of the So-called Illegitimate Demand for Money
In the returns of the Bank of France it has been repeatedly asserted that the
gold-premium policy was directed only against those who wished to withdraw gold
from the bank for speculative purposes. The bank, it was said, never put
difficulties in the way of procuring gold for satisfying the legitimate demands
of French trade. [22] No explanation was given of the idea of "legitimate" demand
and its contrary "illegitimate" demand.
The idea on which this distinction
is obviously based is that trade in commodities and dealings in capital are two
perfectly distinct and independent branches of economic activity and that it
would be possible to restrict the one without affecting the other; that refusal
to surrender gold for arbitrage dealing could not increase the expense of
procuring commodities from abroad so long as no difficulty was made about
placing at the disposal of the importer the sums needed by him to pay for his
purchases.
On closer examination this argument can hardly be accepted as
valid. Even if we completely ignore the fact that dealings in capital only
constitute one form of the general process of exchange of goods and consider
nothing beyond the technical problem of the withdrawal of gold, it is clear that
the bank cannot achieve its aim by discriminatory treatment of different
requests for gold. If exportation of gold did not seem profitable because of the
difference between the rates of interest, imported raw materials would actually
be paid for, partly or wholly, by the commodities exported. The importer would
not try to obtain gold from the bank; he would go into the market and buy bills
originating in the French export business. If gold were delivered to him by the
bank without a premium while the rate of exchange rose roughly by the amount of
and on account of the premium that was charged to arbitrage dealers, this might
well mean a favoring of the import business, and might possibly in some
circumstances benefit the consumer as well, although that depends entirely upon
the state of competition among importers. But all the same, the rate of exchange
would experience the variation that the bank wished to avoid. The upper gold
point would be fixed too high by an amount equal to the amount of the
premium.
Finally, it must be pointed out that the distinction between a
legitimate and an illegitimate demand for gold for export cannot be applied in
practice. The demand for gold with which to pay for imported goods may be called
legitimate, the demand for gold with which to buy foreign bills as a temporary
investment with a view to exploiting a difference in interest rates may be
called illegitimate. But there are many remaining intermediate cases, which
cannot be placed in either one or the other category. Would it have been
possible, say, for the Bank of France to put obstacles in the way of the
withdrawal of deposits held by foreign states, municipalities, and companies,
perhaps as the balances of loans? Or for the Austro-Hungarian Bank, which has
repeatedly been accused of refusing to issue bills to persons who intend to
carry out arbitrage dealings, to increase the difficulty of speculative
repurchase of home securities from abroad? [23]
7 Other Measures for Strengthening the Stock of Metal Held by the
Central Banks-of-Issue
The endeavors of the central banks-of-issue to build up as large gold reserves as
possible have led to the employment of devices which have just the opposite
appearance to that of the premium policy and the systems similar to it. By
raising the price they paid for gold imports the banks used to try to diminish
the cost to the importer of importing gold and so to reduce the lower gold
point.
Among these devices was the practice of granting interest-free or
low-interest-bearing advances to importers of gold, a practice which was not
unknown in England, France, and Germany. [24] There was also the practice of
buying gold not only at the chief office, but also at branches situated near the
national boundary. [25] Perhaps the most interesting of these devices was that of
buying certain kinds of gold coin at a price in excess of their bullion value.
If the bank issued to a gold exporter, instead of ingots or coins of the
country, coins of the country to which he intended to send the gold, it could
get a higher price for them than that corresponding to their gold content. For
the exporter would save the expense of melting and recoinage and avoid the loss
in which he would be involved by the fact that the domestic coins would be worn
down to some extent. So the bank would be able to agree to pay a higher price
than that corresponding to their metal content for the current gold coins of the
states into which a future export of gold was probable. [26]
All of these
measures can best be described as weapons against the premium policies and
related devices employed by foreign banks. If the central bank in a country A
endeavored to raise the upper gold point for export from A to country B, then
the bank in B took steps to lower it. If only used coins were issued for export
purposes in A, this procedure was rendered nugatory when a price in excess of
the gold content was paid in B for coins of country A. It is very probable that
the devices and counterdevices were largely compensatory, so that the extension
of the gap between the gold points, which otherwise would necessarily have
resulted from the intervention of the banks, did not in fact occur.
8 The Promotion of Check and Clearing Transactions as a Means of Reducing the
Rate of Discount
In Germany, where before the war relatively very much gold was in
circulation, there was a constantly growing endeavor to withdraw it from
circulation by an extension of check and clearing transactions and to divert it
into the vaults of the Reichsbank. The aim of this propaganda is set forth in a
circular of the elders of the Kaufmannschaft of Berlin, s.d. May 2, 1907, to the
following effect: "The causes to which the high rate of interest in Germany are
to be traced are rooted to a large extent in the circumstance that the German
people make greater use than those in other countries of cash media of
circulation (gold and silver) for payments arising in and out of the course of
business, but have not yet sufficiently accustomed themselves to the procedure
which might replace the use of gold and silver, and also of banknotes and
Treasury notes, as media of circulation, namely, the use of checks and the
clearing system. If a considerable proportion of payments could be settled by
means of transfers from one account to another or by checks, then this would
save large sums of currency, in gold and silver as well as in banknotes and this
saved currency would then accumulate in the reserves of the banks-of-issue,
especially of the central bank-of-issue, the Reichsbank. The more this happened,
the smaller would be the demand for currency that had to be satisfied by the
Reichsbank, and the stronger would be the cash reserve of the Reichsbank, which
circumstances would contribute considerably toward a reduction of the rate of
interest at the Reichsbank and in the whole country." [27]
In this is a
very clear demonstration of the weakness of the theoretical views that underlie
modern banking policy. The level of the rate of interest is said to depend on
the demand for currency. A strengthening of the cash reserve of the central
bank-of-issue is credited with the effect of reducing the rate of interest in
the whole country, and of reducing it appreciably. And this is not just the
opinion of some private person or other, but that of the highly respected
corporation of the Berlin Kaufmannschaft, and also, as everybody knows, that of
the leaders of German economic policy in general. On this one point, all parties
seem to be agreed, however much their views on the nature of economic phenomena
may otherwise diverge. But even if this fundamental error is for a moment
disregarded it is impossible to overlook the weakness of the doctrines
expounded, and, above all, their contradictoriness. The proportion of cover for
the Reichsbank notes provided for in the banking legislation of the seventies is
treated as sacrosanct. The possibility of changing these provisions by
substituting, say, a cover of one-quarter or one-fifth for that of one-third is
never contemplated. The letter of the law has to be preserved while the
assumptions on which it was based are being altered. When money substitutes in
the form of deposits are augmented without provision being made for a monetary
cover, the quantity of fiduciary media is increased. This is further
demonstrative of the fact that even that part of the argument of the banking
principle which was theoretically correct was unable to exert any influence on
practical politics. Tooke and Fullarton repeatedly point out that there is no
fundamental difference between notes and deposits (which they speak of as
checks). Their modern successors do not dare to draw the logical conclusion from
this incontrovertible fact; they stand for the differential treatment of
fiduciary media according to whether they are notes or deposits. [28]
If part of the gold in circulation in Germany and part of the banknotes had been
replaced by fiduciary media in the shape of deposits, this might have led to a
diminution of the rate of interest only insofar as the gold that had become
superfluous was employed for obtaining capital goods from abroad. The
replacement of notes without a metal backing by deposits without a metal backing
is of no consequence in this connection. Only so far as notes covered by metal
were replaced by deposits not covered by metal would there be any increase of
the circulation of fiduciary media at the expense of that of money certificates,
by which gold would be released for export to other countries. But the same
result could have been attained by a diminution of the ratio between cover and
banknotes; nevertheless this simpler device was generally held to be
impracticable, in spite of the fact that it was precisely as safe or precisely
as dangerous as the other. If the gold dispensed with in this way had been
exported, then the stock of other economic goods at the disposal of the German
nation would have increased correspondingly. This might have led to a fall, if
only a trifling one, in the rate of interest, assuming that the quantity of gold
expelled from Germany was absorbed abroad with a general fall in the objective
exchange value of money. But the German champions of an extension of the checks
and clearing system did not think of that when making proposals of this sort.
They recommended the extension of the circulation of fiduciary media in the form
of deposits because they believed that this would reduce the number and extent
of those applications that made demands upon the credit that the Reichsbank
granted in the form of notes; and they hoped that this would lead to a reduction
in the rate of interest on loans. There is a serious error in all this. The
level of the rate of interest on loans depends not on the amount of the national
stock of money in the wider sense, nor, of course, on the amount of fiduciary
media in circulation. It was not the legal regulations concerning cover that
forced the Reichsbank to aim at a discount policy that would prevent any tension
from arising between the natural rate of interest and the discount rate, but its
inevitable concern for its own solvency.
In all those countries whose
credit system is organized on the so-called single-reserve basis so that the
stock of money needed for the redemption on demand of money substitutes is
administered by a central bank on which in times of emergency all the
credit-issuing banks must ultimately fall back, it is the directors of this bank
who are the first to notice the outward flow of gold; and it is they who must be
the first to take steps to stop it, since its first effects are directed against
the institution for which they are responsible. Therefore, the raising of the
discount rate by the central bank usually precedes the increased severity of
lending terms in the open market and in the dealings between the private banks
and their clients. And so superficial critics jump to the conclusion post hoc
ergo propter hoc. Nothing could be more mistaken. Even quite apart from the
proceedings of the central bank-of-issue, the private banks and others who issue
money have to adjust their interest policy to the rate of interest ruling in the
world market. Sums could be withdrawn from them for the purposes of interest
arbitrage, just as from the central bank. In fact, so long as the mobility of
capital is not restricted it remains impossible for the credit-issuing banks of
any single country to follow an independent credit
policy.
[1] [Some of the problems that have
arisen since are referred to on pp. 14-22. H.E.B.]
[2] [See editor's Introduction, p. 13, above. H.E.B.]
[3] See Torrens, The Principles and
Practical Operation of Sir Robert Peel's Act of 1844 Explained and Defended,
2d ed. (London, 1857), pp. 8 ff.
[4] See Tooke, An Inquiry into the
Currency Principle (London, 1844), pp. 23 ff.
[5] See Wagner, "Banknote," in Rentzsch,
Handwörterbuch der Volkswirtschaftslehre (Leipzig, 1866), p. 91.
[6] See Wagner, "Kredit," ibid.,
p. 201.
[7] See Schumacher's criticism of this
contradiction, Weltwirtschaftliche Studien (Leipzig, 1911), pp. 62 ff.
[8] See Cannon, Clearinghouses: Their
History, Methods and Administration (New York, 1900), pp. 79 ff.
[9] The Federal Reserve Act has since
provided the United States with a basis for issuing notes in order to allay
a panic.
[10] See Sartorious von Waltershausen,
Das volkswirtschaftliche System der Kapitalanlage im Auslande
(Berlin, 1907), pp. 126 ff.
[11] [See p. 13 above. H.E.B.]
[12] See Rosendorff, "Die
Goldprämienpolitik der Banque de France und ihre deutschen Lobredner,"
Jahrbücher für Nationalökonomie und Statistik 21 (1901): 632 ff.;
Dunbar, Chapters on the Theory and History of Banking, 2d ed.
(New York, 1907), pp. 147 ff.
[13] See Kaufmann, Das französische
Bankwesen (Tübingen, 1911), pp. 35 ff.
[14] On this, see Rosendorff, op. cit.,
pp. 640 ff., and passages cited in the essay "Die neue Richtung in der
Goldpolitik der Bank von Frankreich," Bank-Archiv. 7 (1907): (72) ff.,
taken from the statements of account of the Bank of France, in which the
raising of the discount rate is spoken of as the "seul moyen connu de défendre
l'encaisse."
[15] See Landesberger, Währungssystem
und Relation (Vienna, 1891), p. 104.
[16] Ibid., p. 105, and Über
die Goldprämienpolitik der Zettelbanken (Vienna, 1892), p. 28.
[17] Even at the time when the thaler
was still unlimited legal tender and so occupied position analogous to that
of the French five-franc piece, the German Reichsbank never followed a
gold-premium policy on the French pattern, although it was often advised to
do so. This is probably to be ascribed not so much to the circumstance that
the number of thalers was relatively small as to the influence of Bamberger's
ideas throughout the Reich. An open break with the principles of the banking
and currency reform of the period after 1870-71 was, in view of the prevailing
opinion, out of the question.
[18] See Koch, Der Londoner Goldverkehr
(Stuttgart, 1905), p. 708.
[19] Ibid., pp. 81 f.
[20] See Clare, A Money Market
Primer and Key to the Exchanges, 2d ed. (London, 1893), p. 22.
[21] Rosendorff ("Die Goldprämienpolitik
der Banque de France," p. 636) would appear to be mistaken in thinking it
possible to detect a difference of principle between the procedure of the Bank
of England and the Reichsbank in paying out gold and the gold-premium policy
of the Bank of France. He bases his view on the argument that, whereas the
latter refuses altogether to pay out French gold coins and is thus theoretically
able to raise the amount of the premium indefinitely, the Bank of England and
the Reichsbank, which in contrast to the Bank of France always redeem their
notes at their full value in current gold coin and have never attempted to
refuse to pay out gold, are able to raise the selling price of bullion only by
the amount of the cost of minting and an allowance for wear and tear.
Rosendorff, in arguing from the statement that the Bank of France is
"theoretically" able to raise the amount of the gold-premium indefinitely,
flatly contradicts what he says in the rest of his book. In fact it does not
do it, quite apart from the consideration that the law forbids it also. But if
it did it, then it would completely alter the character of the French monetary
system. It could not be expected that the French government and the Chambers
would sanction the transaction to a credit-money standard which would be
involved in such a procedure.
[22] Thus, in the Compte rendu
for 1898 (pp. 12 f.): "Si nous nous efforçons de conserver de grandes
disponibilités métalliques et de les ménager le mieux possible, nous ne devons
pas non plus perdre de vue les intérêts du commerce et lui refuser les moyens
de payement qu'il réclame pour les besoins les plus légitimes, c'est-à-dire
pour l'approvisionnement du marché français."
[23] See my article Das Problem
gesetzlicher Aufnahme der Barzahlungen in Osterreich-Ungarn, p. 1017. If
the Austro-Hungarian Bank were to follow the example of the Bank of France in
this or some other way it would achieve an exactly opposite result to that
achieved by the French institution. Like that of the Bank of France, its
action would restrict not merely the efflux but also the influx of gold. In
France, the creditor nation, this means something very different from what it
means in Austria, the debtor nation. In France, restriction of the importation
of capital (which would only exceptionally occur) is unobjectionable; in
Austria, the country that is dependent on constant importation of capital from
abroad, it would have quite a different effect. The fact that there was a
possibility of difficulties in subsequently repatriating the capital would mean
that a greater gap than otherwise would have to occur between the Viennese and
the foreign rates of interest before capital would be sent to Austria, and this
would mean that the rate of interest in Austria would always be higher. The
fact, on the other hand, that the export of Austrian short-term capital would
also not be profitable except when there was a greater gap than otherwise
between the home and foreign rates would not counteract the above disadvantage,
because the question of capital exportation from Austria-Hungary to western
countries very seldom arises.
[24] See Koch, op. cit., p.
79; Die Reichsbank 1876-1900 (Berlin, 190l), p. 146.
[25] See Obst, Banken und
Bankpolitik (Leipzig, 1909), pp. 90 f.; Hertz, "Die Diskont und
Devisenpolitik der österreichisch-ungarischen Bank," Zeitschrift für
Volkswirtschaft, Sozialpolitik und Verwaltung 12 (1903): 496.
[26] See Koch, op. cit., pp.
79 ff.; Hertz, op. cit., p. 521; Spitzmüller, "Valutareform und
Währungsgesetzgebung," in Oesterreichischen Staatswörterbuch, 2d ed.,
vol. 2, p. 300.
[27] See also Proebst, Die
Grundlagen unseres Depositen-und Scheckwesens (Jena, 1908), pp. 1 ff.
[28] It is only in very recent years
that views on this point in dominant circles have begun slowly to change.
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