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Part Two: The Value of Money > Chapter 13. Monetary Policy

4. Restrictionism or Deflationism

That policy which aims at raising the objective exchange value of money is called, after the most important means at its disposal, restrictionism or deflationism. This nomenclature does not really embrace all the policies that aim at an increase in the value of money. The aim of restrictionism may also be attained by not increasing the quantity of money when the demand for it increases, or by not increasing it enough. This method has quite often been adopted as a way of increasing the value of money in face of the problems of a depreciated credit-money standard; further increase of the quantity of money has been stopped, and the policy has been to wait for the effects on the value of money of an increasing demand for it. In the following discussion, following a widespread custom, we shall use the terms restrictionism and deflationism to refer to all policies directed to raising the value of money.

The existence and popularity of inflationism is due to the circumstance that it taps new sources of public revenue. Governments had inflated from fiscal motives long before it occurred to anybody to justify their procedure from the point of view of monetary policy. Inflationistic arguments have always been well supported by the fact that inflationary measures not only do not impose any burden on the national exchequer, but actually bring resources to it. Looked at from the fiscal point of view, inflationism is not merely the cheapest economic policy; it is also at the same time a particularly good remedy for a low state of the public finances. Restrictionism, however, demands positive sacrifices from the national exchequer when it is carried out by the withdrawal of notes from circulation (say through the issue of interest-bearing bonds or through taxation) and their cancellation; and at the least it demands from it a renunciation of potential income by forbidding the issue of notes at a time when the demand for money is increasing. This alone would suffice to explain why restrictionism has never been able to compete with inflationism.

Nevertheless, the unpopularity of restrictionism has other causes as well. Attempts to raise the objective exchange value of money, in the circumstances that have existed, have necessarily been limited either to single states or to a few states and at the best have had only a very small prospect of simultaneous realization throughout the whole world. Now as soon as a single country or a few countries go over to a money with a rising purchasing power, while the other countries retain a money with a falling or stationary exchange value, or one which although it may be rising in value is not rising to the same extent, then, as has been demonstrated above, the conditions of international trade are modified. In the country whose money is rising in value, exportation becomes more difficult and importation easier. But the increased difficulty of exportation and the increased facility of importation, in brief the deterioration of the balance of trade, have usually been regarded as an unfavorable situation and consequently been avoided. This alone would provide an adequate explanation of the unpopularity of measures intended to raise the purchasing power of money.

But furthermore, quite apart from any consideration of foreign trade, an increase in the value of money has not been to the advantage of the ruling classes. Those who get an immediate benefit from such an increase are all those who are entitled to receive fixed sums of money. Creditors gain at the expense of debtors. Taxation, it is true, becomes more burdensome as the value of money rises; but the greater part of the advantage of this is secured, not by the state, but by its creditors. Now policies favoring creditors at the expense of debtors have never been popular. Lenders of money have been held in odium, at all times and among all peoples.6

Generally speaking, the class of persons who draw their income exclusively or largely from the interest on capital lent to others has not been particularly numerous or influential at any time in any country. A not insignificant part of the total income from the lending of capital is received by persons whose incomes chiefly arise from other sources, and in whose budgets it plays only a subordinate part. This is the case, for instance, not only of the laborers, peasants, small industrialists, and civil servants, who possess savings that are invested in savings deposits or in bonds, but also of the numerous big industrialists, wholesalers, or shareholders, who also own large amounts of bonds. The interests of all of these as lenders of money are subordinate to their interests as landowners, merchants, manufacturers, or employees. No wonder, then, that they are not very enthusiastic about attempts to raise the level of interest.7

Restrictionistic ideas have never met with any measure of popular sympathy except after a time of monetary depreciation when it has been necessary to decide what should take the place of the abandoned inflationary policy. They have hardly ever been seriously entertained except as part of the alternative: "Stabilization of money at the present value or revaluation at the level that it had before the inflation."

When the question arises in this form, the reasons that are given for the restoration of the old metal parity start from the assumption that notes are essentially promises to pay so much metallic money. Credit money has always originated in a suspension of the convertibility into cash of Treasury notes or banknotes (sometimes the suspension was even extended to token coins or to bank deposits) that were previously convertible at any time on the demand of the bearer and were already in circulation. Now whether the original obligation of immediate conversion was expressly laid down by the law or merely founded on custom, the suspension of conversion has always taken on the appearance of a breach of the law that could perhaps be excused, but not justified; for the coins or notes that became credit money through the suspension of cash payment could never have been put into circulation otherwise than as money substitutes, as secure claims to a sum of commodity money payable on demand. Consequently, the suspension of immediate convertibility has always been decreed as a merely temporary measure, and a prospect held out of its future rescission. But if credit money is thought of only as a promise to pay, "devaluation" cannot be regarded as anything but a breach of the law, or as meaning anything less than national bankruptcy.

Yet credit money is not merely an acknowledgment of indebtedness and a promise to pay. As money, it has a different standing in the transactions of the market. It is true that it could not have become a money-substitute unless it had constituted a claim. Nevertheless, at the moment when it became actual money—credit money—(even if through a breach of the law), it ceased to be valued with regard to the more or less uncertain prospect of its future full conversion and began to be valued for the sake of the monetary function that it performed. Its far lower value as an uncertain claim to a future cash payment has no significance so long as its higher value as a common medium of exchange is taken into account.

It is therefore quite beside the point to interpret devaluation as national bankruptcy. The stabilization of the value of money at its present—lower—level is, even when regarded merely with a view to its effects on existing debt relations, something other than this; it is both more and less than national bankruptcy. It is more, for it affects not merely public debts, but also all private debts; it is less, for one thing because it also affects those claims of the state that are in terms of credit money while not affecting such of its obligations as are in terms of cash (metallic money) or foreign currency, and for another thing because it involves no modification of the relations of the parties to any contract of indebtedness in terms of credit money made at a time when the currency stood at a low level, without the parties having reckoned on an increase of the value of money. When the value of money is increased, then those are enriched who at the time possess credit money or claims to credit money. Their enrichment must be paid for by debtors, among them the state (that is, the taxpayers). Yet those who are enriched by the increase in the value of money are not the same as those who were injured by the depreciation of money in the course of the inflation; and those who must bear the cost of the policy of raising the value of money are not the same as those who benefited by its depreciation. To carry out a deflationary policy is not to do away with the consequences of inflation. You cannot make good an old breach of the law by committing a new one. And as far as debtors are concerned, restriction is a breach of the law.

If it is desired to make good the injury which has been suffered by creditors during the inflation, this can certainly not be done by restriction. In the simpler circumstances of an undeveloped credit system, the attempt has been made to find a way out of the difficulty by conversion of the debts contracted before and during the period of inflation, every debt being recalculated in the devaluated money according to the value of the credit money in terms of metallic money on the day of origin. Supposing, for instance, that the metallic money had been depreciated to one-fifth of its former value, a borrower of 100 gulden before the inflation would have to pay back after the stabilization, not 100 gulden, but 500, together with interest on the 500; and a borrower of 100 gulden at a time when the credit money had already sunk to half of its nominal value, would have to pay interest on and pay back 250 gulden.8 This, however, only covers debt obligations which are still current; the debts which have already been settled in the depreciated money are not affected. No notice is taken of sales and purchases of bonds and other claims to fixed sums of money; and, in an age of bearer bonds, this is a quite particularly serious shortcoming. Finally, this sort of regulation is inapplicable to current-account transactions.

It is not our business here to discuss whether something better than this could have been thought of. In fact, if it is possible to make any sort of reparation of the damage suffered by creditors at all, it must clearly be sought by way of some such methods of recalculation. But in any case, increasing the purchasing power of money is not a suitable means to this end.

Considerations of credit policy also are adduced in favor of increasing the value of money to the metal parity that prevailed before the beginning of the period of inflation. A country that has injured its creditors through depreciation brought about by inflation, it is said, cannot restore the shattered confidence in its credit otherwise than by a return to the old level of prices. In this way alone can those from whom it wishes to obtain new loans be satisfied as to the future security of their claims; the bondholders will be able to assume that any possible fresh inflation would not ultimately reduce their claims, because after the inflation was over the original metal parity would presumably be returned to. This argument has a peculiar significance9 for England, among whose most important sources of income is the position of the city of London as the world's banker. All those who availed themselves of the English banking system, it is said, ought to be satisfied as to the future security of the English deposits, in order that the English banking business should not be diminished by mistrust in the future of the English currency. As always in the case of considerations of credit policy like this, a good deal of rather dubious psychology is assumed in this argument. It may be there are more effectual ways of restoring confidence in the future than by measures that do not benefit some of the injured creditors at all—those who have already disposed of their claims—and do benefit many creditors who have not suffered any injury—those who acquired their claims after the depreciation began.

In general, therefore, it is impossible to regard as decisive the reasons that are given in favor of restoring the value of money at the level that it had before the commencement of the inflationary policy, especially as consideration of the way in which trade is affected by a rise in the value of money suggests a need for caution. Only where and so far as prices are not yet completely adjusted to the relationship between the stock of money and the demand for it which has resulted from the increase in the quantity of money, is it possible to proceed to a restoration of the old parity without encountering a too violent opposition.

  • 6. See Bentham, Defense of Usury, 2d ed. (London, 1790), pp. 102 ff.
  • 7. See Wright and Harlow, The Gemini Letters (London, 1844), pp. 51 ff.
  • 8. See Hofmann, "Die Devalvierung des österreichischen Papiergeldes im Jahre 1811," Schriften des Vereins für Sozialpolitik 165, Part I.
  • 9. [It should be remembered that the German edition from which the present version is translated was published in 1926. See, however, the discussion of British policy, p. 14 above. H.E.B.]