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Tu Ne Cede Malis

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Chapter 20
Problems of Credit Policy (cont.)

III. Problems of Credit Policy in the Period Immediately After the War

9 The Gold-Exchange Standard[29]

Wherever inflation has thrown the monetary system into confusion, the primary aim of currency policy has been to bring the printing presses to a standstill. Once that is done, once it has at last been learned that even the policy of raising the objective exchange value of money has undesirable consequences, and once it is seen that the chief thing is to stabilize the value of money, then attempts are made to establish a gold-exchange standard as quickly as possible. This, for example, is what occurred in Austria at the end of 1922 and since then, at least for the time being, the dollar rate in that country has been fixed. But in existing circumstances, invariability of the dollar rate means invariability of the price of gold also. Thus Austria has a dollar-exchange standard and so, indirectly, a gold-exchange standard. That is the currency system that seems to be the immediate aim in Germany, Poland, Hungary, and many other European countries. Nowadays, European aspirations in the sphere of currency policy are limited to a return to the gold standard. This is quite understandable, for the gold standard previously functioned on the whole satisfactorily; it is true that it did not secure the unattainable ideal of a money with an invariable objective exchange value, but it did preserve the monetary system from the influence of governments and changing policies.

Yet the gold-standard system was already undermined before the war. The first step was the abolition of the physical use of gold in individual payments and the accumulation of the stocks of gold in the vaults of the great banks-of-issue. The next step was the adoption of the practice by a series of states of holding the gold reserves of the central banks-of-issue (or the redemption funds that took their place), not in actual gold, but in various sorts of foreign claims to gold. Thus it came about that the greater part of the stock of gold that was used for monetary purposes was gradually accumulated in a few large banks-of-issue; and so these banks became the central reserve banks of the world, as previously the central banks-of-issue had become central reserve banks for individual countries. The war did not create this development; it merely hastened it a little. Neither has the development yet reached the stage when all the newly produced gold that is not absorbed into industrial use flows to a single center. The Bank of England and the central banks-of-issue of some other states still control large stocks of gold; there are still several of them that take up part of the annual output of gold. Yet fluctuations in the price of gold are nowadays essentially dependent on the policy followed by the Federal Reserve Board. If the United States did not absorb gold to the extent to which it does, the price of gold would fall and the gold prices of commodities would rise. Since, so long as the dollar represents a fixed quantity of gold, the United States admits the surplus gold and surrenders commodities for gold to an unlimited extent, a rapid fall in the value of gold has hitherto been avoided. But this policy of the United States, which involves considerable sacrifices, might one day be changed. Variations in the price of gold would then occur and this would be bound to give rise in other gold countries to the question whether it would not be better in order to avoid further rises in prices to dissociate the currency standard from gold. Just as Sweden attempted for a time to raise the krone above its old gold parity by closing the mint time gold, so other countries that are now still on the gold standard or intend to return to it might act similarly. This would mean a further drop in the price of gold and a further reduction of the usefulness of gold for monetary purposes. If we disregard the Asiatic demand for money, we might even now without undue exaggeration say that gold has ceased to be a commodity the fluctuations in the price of which are independent of government influence. Fluctuations in the price of gold are nowadays substantially dependent on the behavior of one government, namely, that of the United States. [30]

All that could not have been foreseen in this result of a long process of development is the circumstance that the fluctuations in the price of gold should have become dependent upon the policy of one government only. That the United States should have achieved such an economic predominance over other countries as it now has, and that it alone of all the countries of great economic importance should have retained the gold standard while the others (England, France, Germany, Russia, and the rest) have at least temporarily abandoned it—that is a consequence of what took place during the war. Yet the matter would not be essentially different if the price of gold was dependent not on the policy of the United States alone, but on those of four or five other governments as well. Those protagonists of the gold-exchange standard who have recommended it as a general monetary system and not merely as an expedient for poor countries, have overlooked this fact. They have not observed that the gold-exchange standard must at last mean depriving gold of that characteristic which is the most important from the point of view of monetary policy—its independence of government influence upon fluctuations in its value. The gold-exchange standard has not been recommended or adopted with the object of dethroning gold. All that Ricardo wanted was to reduce the cost of the monetary system. In many countries which from the last decade of the nineteenth century onward have wished to abandon the silver or credit-money standard, the gold-exchange standard rather than a gold standard with an actual gold currency has been adopted in order to prevent the growth of a new demand for gold from causing a rise in its price and a fall in the gold prices of commodities. But whatever the motives may have been by which the protagonists of the gold-exchange standard have been led, there can be no doubt concerning the results of its increasing popularity.

If the gold-exchange standard is retained, the question must sooner or later arise as to whether it would not be better to substitute for it a credit-money standard whose fluctuations were more susceptible to control than those of gold. For if fluctuations in the price of gold are substantially dependent on political intervention, it is inconceivable why government policy should still be restricted at all and not given a free hand altogether, since the amount of this restriction is not enough to confine arbitrariness in price policy within narrow limits. The cost of additional gold for monetary purposes that is borne by the whole world might well be saved, for it no longer secures the result of making the monetary system independent of government intervention.

If this complete government control is not desired, there remains one alternative only: an attempt must be made to get back from the gold-exchange standard to the actual use of gold again.

10 A Return to a Gold Currency

A return to the actual use of gold would be certain to have effects that would scarcely be welcomed. It would lead to a rise in the price of gold, or, what is the same thing, to a fall in the prices of commodities. The fact that this is not generally desired, and the reason why it is not, have already been dealt with. We may confidently suppose that such a fall in prices would cause just as much dissatisfaction as was caused by the process of expelling gold from circulation. And it hardly demands an excessive amount of insight to be able to predict that in such circumstances it would not be long before the gold standard was again accused of responsibility for the bad state of business. Once again the gold standard would be reproached with depressing prices and forcing up the rate of interest. And once again proposals would be made for some sort of "modification" of the gold standard. In spite of all these objections, the question of the advisability of a return to an actual gold standard demands serious consideration.

One thing alone would recommend the abandonment of the gold-exchange standard and the reintroduction of the actual use of gold; this is the necessity for making a recurrence of inflationary policies if not impossible at least substantially more difficult. From the end of the last century onward it was the aim of etatism in monetary policy to restrict the actual circulation of gold for three reasons: first, because it wished to inflate, without repealing the existing banking laws, by concentrating gold reserves in the central bank-of-issue; second, because it wished to accumulate a war chest; and third, because it wished to wean the people from the use of gold coins so as to pave the way for the inflationary policy of the coming Great War.

Admittedly it will not be possible to prevent either war or inflation by opposing such endeavors as these. Kant's proposal to prohibit the raising of loans for war purposes is extremely naive;[31] and it would be still more naive to bring within the scope of such a prohibition the issue of fiduciary media too. Only one thing can conquer war—that liberal attitude of mind which can see nothing in war but destruction and annihilation, and which can never wish to bring about a war, because it regards war as injurious even to the victors. Where liberalism prevails, there will never be war. But where there are other opinions concerning the profitability and injuriousness of war, no rules and regulations, however cunningly devised, can make war impossible. If war is regarded as advantageous, then laws regulating the monetary systems will not be allowed to stand in the way of going to war. On the first day of any war, all the laws opposing obstacles to it will be swept aside, just as in 1914 the monetary legislation of all the belligerent states was turned upside down without one word of protest being ventured. To try to oppose future war policies through currency legislation would be foolish. But it may nevertheless be conceded that the argument in favor of making war more difficult cannot be neglected when the question is being debated whether the actual domestic circulation of gold should be done away with in the future or not. If the people are accustomed to the actual use of gold in their daily affairs they will resist an inflationary policy more strongly than did the peoples of Europe in 1914. It will not be so easy for governments to disavow the reactions of war on the monetary system; they will be obliged to justify their policy. The maintenance of an actual gold currency would impose considerable costs on individual nations and would at first lead to a general fall of prices; there can hardly be any doubt about that. But all its disadvantages must be accepted as part of the bargain if other services are demanded of the monetary system than that of preparing for war, revolution, and destruction.

It is from this point of view that we should approach the question of the denominations of notes. If the issue of notes which do not make up a multiple of at least the smallest gold coins is prohibited, then in the business of everyday life gold coins will have to be used. This could best be brought about by an international currency agreement. It would be easy to force countries into such an agreement by means of penal customs duties.

11 The Problem of the Freedom of the Banks

The events of recent years reopen questions that have long been regarded as closed. The question of the freedom of the banks is one of these. It is no longer possible to consider it completely settled as it must have been considered for decades now. Unfortunate expe riences with banknotes that had become valueless because they were no longer actually redeemable led once to the restriction of the right of note issue to a few privileged institutions. Yet experience of state regulation of banks-of-issue has been incomparably more unfavorable than experience of uncontrolled private enterprise. What do all the failures of banks-of-issue and clearing banks known to history matter in comparison with the complete collapse of the banking system in Germany? Everything that has been said in favor of control of the banking system pales into insignificance beside the objections that can nowadays be advanced against state regulation of the issue of notes. The etatistic arguments, that were once brought forward against the freedom of the note issue, no longer carry conviction; in the sphere of banking, as everywhere else, etatism has been a failure.

The safeguards erected by the liberal legislation of the nineteenth century to protect the bank-of-issue system against abuse by the state have proved inadequate. Nothing has been easier than to treat with contempt all the legislative provisions for the protection of the monetary standard. All governments, even the weakest and most incapable, have managed it without difficulty. Their banking policies have enabled them to bring about the state of affairs that the gold standard was designed to prevent: subjection of the value of money to the influence of political forces. And, having arrogated this power to themselves, the governments have put it to the worst conceivable use. But, so long as the other political and ideological factors were what they were, we cannot conclude that the mere freedom of the banks would or could have made things different.

Let us suppose that freedom of banking had prevailed throughout Europe during the last two generations before the outbreak of the Great War; that banknotes had not become legal tender; that notes were always examined, not only with respect to their genuineness, but also with respect to their soundness, whenever they were tendered, and those issued by unknown banks rejected; but that the notes of large and well-known banking firms nevertheless were just as freely current as the notes of the great central banks-of-issue in the period when they were not legal tender. Let us further suppose that since there was no danger of a world banking cartel, the banks had been prevented, by the mere necessity for redeeming their notes in cash, from making immoderate endeavors to extend their issue by charging a low rate of interest; or at least, that the risk of this was no greater than under legislative regulation of the note system. Let us suppose, in short, that up to the outbreak of the war, the system had worked no better and no worse than that which actually existed. But the question at issue is whether it would have held its own any better after July 28, 1914. The answer to this question seems to be that it would not have done so. The governments of the belligerent—and neutral—states overthrew the whole system of bank legislation with a stroke of the pen, and they could have done just the same if the banks had been uncontrolled. There would have been no necessity at all for them to proceed to issue Treasury notes. They could simply have imposed on the banks the obligation to grant loans to the state and enabled them to fulfill this obligation by suspending their obligation to redeem their notes and making the notes legal tender The solution of a few minor technical problems would have been different, but the effect would have been the same. For what enabled the governments to destroy the banking system was not any technical, juristic, or economic shortcoming of the banking organization, but the power conferred on them by the general sentiment in favor of etatism and war. They were able to dominate the monetary system because public opinion gave them the moral right to do so. "Necessity knows no law" was the principle which served as an excuse for all the actions of all governments alike, and not only that of Germany, which was much blamed because of the candor with which it confessed its adherence to the maxim.

At the most, as has been explained, an effective if limited protection against future etatistic abuse of the banking system might be secured by prohibiting the issue of notes of small denominations. That is to say, not by uncontrolled private enterprise in banking, but on the contrary by interference with the freedom of the note issue. Apart from this single prohibition, it would be quite possible to leave the note issue without any legislative restrictions and, of course, without any legislative privileges either, such as the granting of legal tender to the notes. Nevertheless, it is clear that banking freedom per se cannot be said to make a return to gross inflationary policy impossible.

Apart from the question of financial preparation for war, the arguments urged in favor of the centralization, monopolization, and state control of banks-of-issue in general and of credit-issuing banks in particular are thoroughly unsound. During the past twenty or thirty years, the literature of banking has got so thoroughly lost among the details of commercial technique, has so entirely abandoned the economic point of view and so completely surrendered itself to the influence of the most undisguised kinds of etatistic argument, that in order to discover what the considerations are that are supposed to militate against the freedom of the banks it is necessary to go back to the ideas that dominated the banking literature and policy of two or three generations ago. The bank-of-issue system was then supposed to be regulated in the interests of the poor and ignorant man in the street, so that bank failures might not inflict loss upon those who were unskilled and unpracticed in business matters—the laborer, the salaried employee, the civil servant, the farmer. The argument was that such private persons should not be obliged to accept notes whose value they were unable to test, an argument which only needs to be stated for its utter invalidity to be apparent. No banking policy could have been more injurious to the small man than recent etatism has been.

The argument, however, that was then supposed to be the decisive one was provided by the currency principle. From the point of view of this doctrine, any note issue that is not covered by gold is dangerous, and so, in order to obviate the recurrence of economic crises, such issues must be restricted. On the question of the theoretical importance of the currency principle, and on the question of whether the means proposed by the Currency School were effective, or could have been effective, or might still be effective, there is nothing that need be added to what has been said already. We have already shown that the dangers envisaged by the currency principle exist only when there is uniform procedure on the part of all the credit-issuing banks, not merely within a given country but throughout the world. Now the monopolization of the banks-of-issue in each separate country does not merely fail to oppose any hindrance to this uniformity of procedure; it materially facilitates it.

What was supposed to be the decisive argument against freedom of banking in the last generation before the war is just the opposite to that which was held by the Currency School. Before the war, state control of banking was desired with the very object of artificially depressing the domestic rate of interest below the level that considerations of the possibility of redemption would have dictated if the banks had been completely free. The attempt was made to render as nugatory as possible the obligations of cash redemption, which constitutes the foundation stone of all credit-issuing bank systems. This was the intention of all the little expedients, individually unimportant but cumulatively of definite if temporary effect, which it was then customary to call banking policy. Their one intent may be summed up in the sentence: By hook or by crook to keep the rate of discount down. They have achieved the circumvention of all the natural and legal obstacles that hinder the reduction of the bank rate below the natural rate of interest. In fact, the object of all banking policy has been to escape the necessity for discount policy, an object, it is true, which it was unable to achieve until the outbreak of the war left the way free for inflation.

If the arguments for and against state regulation of the bank-of-issue system and of the whole system of fiduciary media are examined without the etatistic prejudice in favor of rules and prohibitions, they can lead to no other conclusion than that of one of the last of the defenders of banking freedom: "There is only one danger that is peculiar to the issue of notes; that of its being released from the common-law obligation under which everybody who enters into a commitment is strictly required to fulfill it at all times and in all places. This danger is infinitely greater and more threatening under a system of monopoly." [32]

12 Fisher's Proposal for a Commodity Standard

The more the view regains ground that general business fluctuations are to be explained by reference to the credit policy of the banks, the more eagerly are ways sought for by which to eliminate the alternation of boom and depression in economic life. It was the aim of the Currency School to prevent the periodical recurrence of general economic crises by setting a maximum limit to the issue of uncovered banknotes. An obvious further step is to close the gap that was not reckoned with in their theory and consequently not provided for in their policy by limiting the issue of fiduciary media in whatever form, not merely that of banknotes. If this were done, it would no longer be possible for the credit-issuing banks to underbid the equilibrium rate of interest and introduce into circulation new quantities of fiduciary media with the immediate consequence of an artificial stimulus to business and the inevitable final consequence of the dreaded economic crisis.

Whether a decisive step such as this will actually be taken apparently depends upon the kind of credit policy that is followed in the immediate future by the banks in general and by the big central banks-of-issue in particular. It has already been shown that it is impossible for a single bank by itself, and even for all banks in a given country or for all the banks in several countries, to increase the issue of fiduciary media, if the other banks do not do the same. The fact that tacit agreement to this effect among all the credit issuing banks of the world has been achieved only with difficulty, and, even at that, has only effected what is after all but a small increase of credit, has constituted the most effective protection in recent times against excesses of credit policy. In this respect, we cannot yet[33] know how circumstances will shape. If it should prove easier now for the credit-issuing banks to extend their circulation, then failure to adopt measures for limiting the issue of fiduciary media will involve the greatest danger to the stability of economic life.

During the years immediately preceding the Great War, the objective exchange value of gold fell continuously. From 1896 onward, the commodity price level rose continuously. This movement, which is to be explained on the one hand by the increased production of gold and on the other hand by the extended employment of fiduciary media, became still more pronounced after the outbreak of the war. Gold disappeared from circulation in a series of populous countries and flowed into the diminishing region within which it continued to perform a monetary function as before. Of course, this resulted in a decrease in the purchasing power of gold. Prices rose, not only in the countries with an inflated currency, but also in the countries that had remained on the gold standard. If the countries that nowadays have a paper currency should return to gold, the objective exchange value of gold would rise; the gold prices of commodities and services would fall. This effect might be modified if the gold-exchange variety of standard were adopted instead of a gold currency; but if the area within which gold is employed as money is to be extended again, it is a consequence that can hardly be eliminated altogether It would only come to stop when all countries had again adopted the gold standard. Then perhaps the fall in the value of gold which lasted for nearly thirty years might set in again.

The prospect is not a particularly pleasant one. It is hardly surprising in the circumstances that the attention of theorists and politicians should have been directed with special interest to a proposal that aims at nothing less than the creation of a money with the most stable purchasing power possible.

The fundamental idea of Fisher's scheme for stabilizing the purchasing power of money is the replacement of the gold standard by a "commodity" standard. Previous proposals concerning the commodity standard have conceived it as supplementing the precious-metal standard. Their intention has been that monetary obligations which did not fall due until after a certain period of time should be dischargeable, by virtue either of general compulsory legislation or of special contractual agreements between the parties, not in the nominal sum of money to which they referred, but by payment of that sum of money whose purchasing power at the time when the liability was discharged was equal to the purchasing power of the borrowed sum of money at the time when the liability was incurred. Otherwise they have intended that the precious metal should still fulfill its monetary office; the tabular standard was to have effect only as a standard of deferred payments. But Fisher has more ambitious designs. His commodity standard is not intended merely to supplement the gold standard, but to replace it altogether. This end is to be attained by means of an ingenious combination of the fundamental concept of the gold-exchange standard with that of the tabular standard.

The money substitutes that are current under a gold-exchange standard are redeemable either in gold or in bills on countries that are on the gold standard. Fisher wishes to retain redemption in gold, but in such a way that the currency units are no longer to be converted into a fixed weight of gold, but into the quantity of gold that corresponds to the purchasing power of the monetary unit at the time of the inauguration of the scheme. The dollar—according to the model bill worked out by Fisher for the United States—ceases to be a fixed quantity of gold of variable purchasing power and becomes a variable quantity of gold of invariable purchasing power. Calculations based on price statistics are used month by month for the construction of an index number which indicates by how much the purchasing power of the dollar has risen or fallen in comparison with the preceding month. Then, in accordance with this change in the value of money, the quantity of gold that represents one dollar is increased or diminished. This is the quantity of gold for which the dollar is to be redeemed at the banks entrusted with this function, and this is the quantity of gold for which they have to pay out one dollar to anybody who demands it.

Fisher's plan is ambitious and yet simple. Perhaps it is unnecessary to state that it is in no way dependent upon Fisher's particular theory of money, whose inadequacy as regards certain crucial matter has already been indicated. [34]

There is no need to criticize Fisher's scheme again with reference to the considerable dubiety attaching to the scientific correctness of index numbers and to the possibility of turning them to practical account in eliminating those unintended modifications of long-term contracts that arise from variations in the value of money. [35] In Fisher's scheme, the function of the index number is to serve as an indicator of variations in the purchasing power of the monetary unit from month to month. We may suppose that for determining changes in the value of money over very short periods—and in the present connection the month may certainly be regarded as a very short period—index numbers could be employed with at least sufficient exactitude for practical purposes. Yet even if we assume this, we shall still be forced to conclude that the execution of Fisher's scheme could not in any way ameliorate the social consequences of variations in the value of money.

But before we enter upon this discussion, it is pertinent to inquire what demands the proposal makes concerning business practice.

If it is believed that the effects of variations in the value of money on long-term credit transactions are compensated by variations in the rate of interest, then the adoption of a commodity standard based on the use of index numbers as a supplement to the gold standard must be regarded as superfluous. But, in any case, this is certainly not true of gradual variations in the value of money of which neither the extent nor even the direction can be foreseen; the depreciation of gold which has gone on since toward the end of the nineteenth century has hardly found any expression at all in variations in the rate of interest. Thus, if it were possible to find a satisfactory solution of the problem of measuring variations in the value of money, the adoption of a tabular for long-term credit transactions (the decision as to the employment of the index being left to the parties to each particular contract) could by no means be regarded as superfluous. But the technical difficulties in the way are so great as to be insurmountable. The scientific inadequacy of all methods of calculating index numbers means that there can be no "correct" one and therefore none that could command general recognition. The choice among the many possible methods which are all equally inadequate from the purely theoretical point of view is an arbitrary one. Now since each method will yield a different result, the opinions of debtors and creditors concerning them will differ also. The different solutions adopted, in the law or by the administrative authority responsible for calculating the index numbers, as the various problems arise will constitute a new source of uncertainty in long-term credit transactions—an uncertainty that might affect the foundations of credit transactions more than variations in the value of gold would.

All this would be true of Fisher's proposals also insofar as they concern long-term credit transactions. Insofar as they concern short-term credit transactions, it must be pointed out that even under the present organization of the monetary system future fluctuations of the value of money are not ignored. The difficulty about taking account of future variations in the value of money in long-term credit transactions lies in the impossibility of foreknowing the direction and extent of long-period variations even with only relative certainty. But for shorter periods, over weeks and even over periods of a few months, it is possible to a certain extent to foretell the movement of the commodity-price level; and this movement consequently is allowed for in all transactions involving short-term credit. The money-market rate of interest, as the rate of interest in the market for short-term investments is called, expresses among other things the opinion of the business world as to imminent variations in commodity prices. It rises with the expectation of a rise in prices and falls with the expectation of a fall in prices. In those commercial agreements in which interest is explicitly allowed for there would be no particular difficulty under Fisher's scheme in making the necessary adjustment of business technique; the only adjustment that would be necessary in the new circumstances would be to leave out of account all considerations of variations in the commodity-price level in future calculations of the rate of interest. But the matter is somewhat more complicated in those transactions in which an explicit rate of interest does not appear, but is allowed for implicitly in some other terms of the agreement.

An example of a case of purchase on credit will assist the discussion of this point. Let us assume that in such a case the index number over a period of five successive months rises each month in arithmetical progression by one percent of the index number proper to the first month, as shown in the following table:

Month Index No. Quantity of fine gold for which a dollar may be redeemed, in hundredths of a gramme
I 100 160.0
II 101 161.6
III 102 163.2
IV 103 164.8
V 104 166.4

A person who had bought commodities in February on three months' credit would have to pay back in May .048 of a gram of fine gold for every dollar over and above the gold content of the dollars in which he had made the bargain. Now according to present practice, the terms of the transaction entered into in February would make allowance for the expected general rise of prices; in the purchase then determined the views held by the buyer and the seller as to immediate probabilities concerning future prices would already be expressed. Now since under Fisher's plan the purchase price would still have to be settled by payment of the agreed number of dollars, this rise of prices would be allowed for a second time. Clearly this will not do. In other words, the present ordinary practice concerning purchases on credit and other credit transactions must be modified.

All that a person will have to do after the introduction of the commodity standard, who would have bought a commodity in January on three months' credit at $105 under a simple gold standard, is to take account of the expected fluctuations in the value of gold in a different way in order not to buy dearer than he would have bought in gold dollars. If he correctly foresees these fluctuations as amounting to three dollars, then he would have to agree to pay a purchase price of only (160 × 105)/164.8 dollars = 101.94 dollars. Fisher's project makes a different technique necessary in business; it cannot be claimed that this technique would be any simpler than that used under the pure gold standard. Both with and without Fisher's plan it is necessary for buyers and sellers to allow for variations in the general level of prices as well as for the particular variations in the prices of the commodities in which they deal; the only difference is in the method by which they evaluate the result of their speculative opinion.

We can thus see what value Fisher's scheme has as far as the consequences of variations in the value of money arising in connection with credit transactions are concerned. For long-term credit transactions, in which Fisher's scheme is no advance on the old and oft-discussed tabular standard which has never been put into execution because of its disadvantages, the use of the commodity standard as a supplement to the gold standard is impracticable because of the fundamental inadequacy of all methods of calculating index numbers. For short-term credit transactions, in which variations in the value of money are already taken account of in a different way, it is superfluous.

But variations in the objective exchange value of money have another kind of social consequence, arising from the fact that they are not expressed simultaneously and uniformly with regard to all commodities and services. Fisher's scheme promises no relief at all from consequences of this sort; Fisher, indeed, never refers to this kind of consequence of variations in the value of money and seems to be aware only of such effects as arise from their reactions on debt relationships contracted in terms of money.

However it may be calculated, an index number expresses nothing but an average of price variations. There will be prices that change more and prices that change less than the calculated average amount; and there will even be prices that change in the opposite direction. All who deal in those commodities whose prices change differently from the average will be affected by variations in the objective exchange-value of gold in the way already referred to (part 2, chap. 12, secs. 3 and 4), and the adjustment of the value of the dollar to the average movement of commodity prices as expressed in the chosen index number will be quite unable to affect this. When the value of gold falls, there will be persons who are favored by the fact that the rise in prices begins earlier for the commodities that they sell than for the commodities that they have to buy; and on the other hand there will be persons whose interests suffer because of the fact that they must continue to sell the commodities in which they deal at the lower prices corresponding to earlier circumstances although they already have to buy at the higher prices. Even the execution of Fisher's proposal could not cause the variations in the value of money to occur simultaneously and uniformly in relation to all other economic goods.

Thus, the social consequences of variations in the value of money could not be done away with even with the help of Fisher's commodity standard.

13 The Basic Questions of Future Currency Policy

Irving Fisher's scheme is symptomatic of a tendency in contemporary currency policy which is antipathetic to gold. There is an inclination in the United States and in Anglo-Saxon countries generally to overestimate in a quite extraordinary manner the signifi cance of index methods. In these countries, it is entirely overlooked that the scientific exactness of these methods leaves much to be desired, that they can never yield anything more than a rough result at best, and that the question whether one or other method of calculation is preferable can never be solved by scientific means. The question of which method is preferred is always a matter for political judgment. It is a serious error to fall into to imagine that the methods suggested by monetary theorists and currency statisticians can yield unequivocal results that will render the determination of the value of money independent of the political decisions of the governing parties. A monetary system in which variations in the value of money and commodity prices are controlled by the figure calculated from price statistics is not in the slightest degree less dependent upon government influences than any other sort of monetary system in which the government is able to exert an influence on values.

There can be no doubt that the present state of the market for gold makes a decision between two possibilities imperative: a return to the actual use of gold after the fashion of the English gold standard of the nineteenth century, or a transition to a fiat-money standard with purchasing power regulated according to index numbers. The gold-exchange standard might be considered as a possible basis for future currency systems only if an international agreement could impose upon each state the obligation to maintain a stock of gold of a size corresponding to its capacity. A gold-exchange standard with a redemption fund chiefly invested in foreign bills in gold currencies is in the long run not a practicable general solution of the problem.

The first German edition of this work, published in 1912, concluded with an attempt at a glimpse into the future history of money and credit. The important parts of its argument ran as follows:

"It has gradually become recognized as a fundamental principle of monetary policy that intervention must be avoided as far as possible. Fiduciary media are scarcely different in nature from money; a supply of them affects the market in the same way as a supply of money proper; variations in their quantity influence the objective exchange value of money in just the same way as do variations in the quantity of money proper. Hence, they should logically be subjected to the same principles that have been established with regard to money proper; the same attempts should be made in their case as well to eliminate as far as possible human influence on the exchange ratio between money and other economic goods. The possibility of causing temporary fluctuations in the exchange ratios between goods of higher and of lower orders by the issue of fiduciary media, and the pernicious consequences connected with a divergence between the natural and money rates of interest, are circumstances leading to the same conclusion. Now it is obvious that the only way of eliminating human influence on the credit system is to suppress all further issue of fiduciary media. The basic conception of Peel's Act ought to be restated and more completely implemented than it was in the England of his time by including the issue of credit in the form of bank balances within the legislative prohibition.

"At first it might appear as if the execution of such radical measures would be bound to lead to a rise in the objective exchange-value of money. But this is not necessarily the case. It is not improbable that the production of gold and the increase in the issue of bank credit are at present increasing considerably faster than the demand for money and are consequently leading to a steady diminution of the objective exchange value of money. And there can be no doubt that a similar result follows from the apparently one-sided fixing of prices by sellers, the effect of which in diminishing the value of money has already been examined in detail. The complaints about the general increase in the cost of living, which will continue for a long time yet, may serve as a confirmation of the correctness of this assumption, which can be neither confirmed nor refuted statistically. Thus, a restriction of the growth of the stock of money in the broader sense need not unconditionally lead to a rise in the purchasing power of the monetary unit; it is possible that it might have the effect of completely or partly counteracting the fall in the value of money which might otherwise have occurred.

"It is not entirely out of the question that the monetary and credit policy of the future will attempt to check any further fall in the objective exchange value of money. Large classes of the population—wage and salary earners—feel that the continuous fall in the value of money is unjust. It is most certain that any proposals that promise them any relief in this direction will receive their warmest support. What these proposals will be like, and how far they will go, are matters that it is difficult to foresee. In any case, economists are not called upon to act as prophets."

Elsewhere in the course of the argument it was claimed that it would be useless to try and improve the monetary system at all in the way envisaged by the tabular standard. "We must abandon all attempts to render the organization of the market even more perfect than it is and content ourselves with what has been attained already; or rather, we must strive to retain what has been attained already; and that is not such an easy matter as it seems to appear to those who have been more concerned to improve the apparatus of exchange than to note the dangers that implied its maintenance at its present level of perfection.

"It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown. Once common principles for their circulation-credit policy are agreed to by the different credit-issuing banks, or once the multiplicity of credit-issuing banks is replaced by a single world bank, there will no longer be any limit to the issue of fiduciary media. At first, it will be possible to increase the issue of fiduciary media only until the objective exchange value of money is depressed to the level determined by the other possible uses of the monetary metal. But in the case of fiat money and credit money there is no such limit, and even in the case of commodity money it cannot prove impassable. For once the employment of money substitutes has superseded the employment of money for actual employment in exchange transactions mediated by money, and we are by no means very far from this state of affairs, the moment the limit was passed the obligation to redeem the money substitutes would be removed and so the transition to bank-credit money would easily be completed. Then the only limit to the issue would be constituted by the technical costs of the banking business. In any case, long before these limits are reached, the consequences of the increase in the issue of fiduciary media will make themselves felt acutely."

Since then we have experienced the collapse, sudden enough, of the monetary systems in a whole series of European states. The inflation of the war and postwar periods, exceeding everything that could have been foreseen, has created an unexampled chaos. Now we are on the way to mastering this chaos and to returning to a new organization of the monetary system which will be all the better the less it differs from the system in force before the war.

The organization of exchange that will thus be achieved again will exhibit all the shortcomings that have continually been referred to with emphasis throughout the present book. It will be a task for the future to erect safeguards against the inflationary misuse of the monetary system by the government and against the extension of the circulation of fiduciary media by the banks.

Yet such safeguards alone will not suffice to avert the dangers that menace the peaceful development of the function of money and fiduciary media in facilitating exchange. Money is part of the mechanism of the free market in a social order based on private property in the means of production. Only where political forces are not antagonistic to private property in the means of production is it possible to work out a policy aiming at the greatest possible stability of the objective exchange value of money.

[29] [The reader will remember that this was written in 1924. H.E.B.]

[30] See Keynes, A Tract on Monetary Reform (London, 1923), pp. 163 ff.

[31] See Kant, Werke, vol. 5, Zum ewigen Frieden (Insel-Ausgabe), pp. 661 f.

[32] See Horn, Bankfreiheit (Stuttgart, 1867), pp. 376 f.

[33] [It should be remembered that this was written in 1924. H.E.B.]

[34] See pp. 143 f. above. Fisher particularly refers to this independence (Stabilizing the Dollar [New York, 1920], p. 90) and Anderson similarly affirms it, although in his book The Value of Money he has most severely criticized Fisher's version of the quantity theory of money. See Anderson, The Fallacy of "The Stabilized Dollar" (New York, 1920), pp. 6 f.

[35] See pp. 187 ff. and 201 ff. above.

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