Interest and Prices

CHAPTER 12

PRACTICAL PROPOSALS FOR THE STABILISATION OF THE VALUE OF MONEY

IF there is any truth whatever in the above considerations, they must enormously influence our opinion of the practical proposals that have hitherto been put forward for stabilising the value of money. Let us begin with the best known of these proposals, that of so-called bimetallism, by which is to be understood the system under which both gold and silver are legally recognised as means of payment and are freely accepted for coinage at a certain fixed ratio in terms of value.

The discussion of bimetallism has proceeded for many years, but from a practical point of view it has up to the present been rather unfruitful. The upshot, in my opinion—and this is becoming more and more generally admitted—is that the bimetallists have succeeded in providing a theoretical proof of one of their main assertions. They have succeeded in demonstrating the possibility of maintaining a constant ratio between the two metals by means of international co-operation, which need not necessarily comprise every country (leaving out of account the casual and inconsiderable agio which may appear in favour of the less bulky metal on account of the greater ease with which it can be transported—an agio which in any case may sometimes appear between gold and notes redeemable in gold, in favour of the notes).

Extreme monometallists would deny this possibility. A fixed ratio between gold and silver is to them “as unnatural and unthinkable” as, for instance, a fixed ratio between copper and iron or between beef and corn. These extreme opponents of bimetallism have two alternatives. They can resort to the conception of an intrinsic value inherent in gold or in silver. This view must to-day be regarded as out of date. Or they have to ascribe to the proposed measures an enormously strong influence on the conditions of production and consumption of the precious metals. They have to imagine that the production of the under-valued metal (gold for the moment) ceases almost completely while its consumption enormously increases; so that it must soon disappear from circulation, while the over-valued metal is thrust into circulation by the opposite tendencies. In other words, the bimetallic system would, according to this view, pass over sooner or later to a monometallic silver system.

It cannot be denied that bimetallism would be associated with some such tendency. It is impossible to say how this tendency would work out if the legal ratio deviated too much from the actual ratio in exchange of the two metals. The whole thing depends enormously on factors about which we know nothing, the future conditions of production of the precious metals, the attitude of Asiatic races in regard to hoarding gold instead of silver or in regard to keeping up their present habits of hoarding in general, and finally the general causes which determine the relative amount of so-called industrial consumption. In so far as its use in industry can be regarded, not simply as consumption of the precious metal, but at the same time as a kind of hoarding, it may perhaps be supposed that under a bimetallic system it would be largely diverted to silver (the value of which would now be guaranteed).

The closer the approximation between the ratio that is introduced and the present ratio of the values of uncoined gold and silver, the smaller, of course, is the fear of a diminution, not to mention a complete disappearance within a measurable space of time, of the world’s stock of monetary gold.

All such anxiety is dispelled by the stability which past experience shows this ratio to have maintained, particularly in the present century until the demonetisation of silver of 1873 and the following years. This stability was maintained in spite of several important changes in the conditions of production of the precious metals.

A substantial advantage of bimetallism, and of any fixed ratio established by law, lies in the fact that considerable portions of the world still base their currency on silver. A fixed ratio between gold and silver is thus calculated to make a significant contribution towards the introduction of order and security into the ever growing trade relations with the more remote portions of the world. But this argument would be deprived of much of its strength if other silver countries were to follow the example of India and decide to give up the free coinage of silver.

That, it seems to me, is about all that can be said in favour of the bimetallists’ proposals. As regards the practical difficulties of the transition, these have been discussed so fully by the monometallists that they need not occupy much of our attention.

It is only reasonable to rule out a restoration, or at any rate a sudden restoration, of the old ratio of 15 ½ : 1, in other words, a doubling of the present exchange value of uncoined silver in terms of gold. Such a restoration would inevitably involve a real price revolution, not only in silver countries but in gold countries too. For it has to be realised that a rehabilitation of silver would to-day have an entirely different significance from its former demonetisation. Its demonetisation may be illustrated by the closing of a sluice at a moment when the water level is the same on both sides, while its rehabilitation would be like opening (or rather demolishing) the sluice when the levels are unequal.

It is remarkable that so distinguished a monetary expert as W. Lexis does not appear to have realised the consequences correctly. He maintains1—curiously enough, he is arguing against the bimetallists—that it is “very likely that an increase in the quantity of silver money” (brought about by the introduction of bimetallism) “would, in the course of years, have as little influence on prices as the increase in gold production of recent years”. The new silver could simply be stored up in the vaults of the banks, just as the gold has been hitherto.

This could occur only if there were no silver countries at all in the narrow sense of the term. The effect of suddenly doubling the value of a kilogram of silver in European markets would clearly be to cause an enormous rise in the demand for European products on the part of the silver countries. The flow of silver to the East would cease altogether or be reversed. Equilibrium would not be restored until prices had risen in Europe, or had fallen in the silver countries, or, more probably, both—to such a degree that gold prices in Europe had doubled in terms of silver prices in the silver countries.2

It is possible that, owing to the undeveloped state of the monetary and credit systems, prices in the silver countries are more stable. If that is the case, the greater part of the relative change in prices would have to be borne in Europe, and the rise in European prices would be very great. To Europe as a whole this would be of no advantage; on the contrary, we should be obtaining for our valuable products merely a mass of useless silver. Certain classes of producers would obtain considerable profits during the period of transition (but not beyond), and the real burden of all debts expressed in terms of money would be permanently diminished. In particular, the change would be enormously beneficial to “the agricultural debtors” (Lexis seems to me to be wrong in questioning this), while their creditors, great and small, would suffer a corresponding loss.

Thus it appears likely that a return to the so-called bimetallic parity would bring about a rise of prices in the gold countries. It must not be concluded that the suspension of free coinage of silver has been the cause of the fall in prices of recent years. A rather different point of view must be adopted. If the link between the two metals were replaced, the level of gold prices in gold countries relatively to that of silver prices in silver countries would return to about the position that existed at the beginning of the seventies. As gold prices have fallen since that time and silver prices have risen, the two price levels might also be restored to somewhere near their former absolute levels. But the movements in prices that have actually taken place since the link between the two metals was severed depend essentially on independent influences that have applied alike to both sets of prices. Their nature was indicated above with reference to the gold countries. The change in the ratio between gold and silver must, as has been emphasised above, be regarded, at any rate in part, as an effect rather than a cause of these changes in prices.

The introduction of a ratio which was much closer to the one which prevails in practice need not, of course, give rise to any considerable qualms. But it would almost certainly involve melting down and increasing the size of the silver coins that circulate to-day. The cost would be enormous, and the advantages, apart from those which we have referred to, would not be very great.

And when the change had been accomplished, what then? Would we now have attained the ideal monetary system, and would the stability promised by supporters of bimetallism really be provided? Such a point of view, derived from the assumption of free coinage of silver, is quite untenable—though free coinage of silver would now be necessary in order to maintain good relations with the silver countries. We are told that if two commodities are employed as a measure of prices, their value in conjunction must be more stable than of either taken separately. That may be true, but it is improper to proceed by way of the “Law of Large Numbers” when it is a question purely of the transition from the number one to the number two. Circumstances can easily arise under which the bimetallic standard of prices would be less stable than gold. Let us imagine—what is, after all, not unthinkable—that we have now reached the lowest point of the downward movement of prices, and that the continual production of gold and the excess of bank reserves must necessarily tend to depress the money rate of interest and force up prices. In the immediate future, however, fairly stable prices might be attained, inasmuch as new countries, such as Austria, Russia,3 and perhaps finally India, may turn over to gold coinage. But the introduction of bimetallism, even at a moderate ratio, would under such conditions bring about a continual, and perhaps very considerable, rise in prices, with all the associated disadvantages.

The same essential considerations apply to the “composite standard” or “symmetalism” proposed by Marshall, Edgeworth, and others. Under this system, a country’s, or the world’s, coinage would consist of a mixture in certain proportions of gold and silver. The system would not even have the merit of avoiding fluctuations in the rate of foreign exchange with silver countries.

L. Walras has proposed a method,4 not really bimetallism at all, which theoretically is less objectionable. He would maintain the use of gold as a standard, and he would not permit the free coinage of silver; but silver is to be used as a billon régulateur, the size of the stock of monetary silver being managed according to circumstances, with the object of achieving the highest possible degree of constancy of the value of money in terms of commodities. Un-fortunately, Walras has not, so far as I know, ever entered into the details of his proposal, but, unless I am mistaken, it does not in its essence come to more than that when prices are falling the banks should buy silver (at the market price) in exchange for bank notes, and sell silver when prices are rising. It does not appear to matter very much whether this silver is used for the purpose of coinage or not. The important point lies in the variation of the total quantity of means of exchange as a result of notes being issued or withdrawn against silver.

It seems to me very probable that such a plan would be successful if it were set in operation on a sufficiently energetic scale by a fairly large number of gold countries, though it is necessary to assume that analogous measures in regard to gold would not be adopted by the silver countries. But individual attempts in this direction cannot achieve very much. The history of the Bland and Sherman Bills indicates that even a country as large as the United States cannot accomplish much if it is acting alone.

Lexis goes too far, I think, when he maintains that “the regulation of prices by Walras’ plan . . . is impracticable”.5 Lexis’ objection is derived from his view that “the effect on prices of an increase or diminution in the quantity of money cannot be determined a priori, and may vary greatly both in magnitude and in direction”. It is hard to see how the direction of this effect can be open to doubt, though opinions may vary as to its magnitude. Lexis does not succeed in proving his assertion 6 that the accumulation of gold in the vaults of the banks during recent years has had no influence on prices. It is impossible to say how high the market rate of interest would have been, and how far it would have depressed prices, if this accumulation had not forced the banks to lower their rates of discount.

Silver purchases by banks or governments in accordance with Walras’ plan would have two effects. It would increase the quantity of monetary instruments available for lending, and so bring about a fall in the rate of interest; and it would raise the price of silver, and so increase the silver countries’ demand for commodities. Both effects would tell in the direction of raising European prices. The sale of silver would, of course, lead to the opposite result. It has, however, to be supposed that the silver countries maintain throughout a completely passive attitude. It is, in particular, assumed that a cheapening of gold in Europe will not cause an efflux to the East. These assumptions are bold ones, and they constitute a weak point, not only in Walras’ plan, but in bimetallism itself.

A plan proposed before the English Gold and Silver Commission7 by J. Barr Robertson goes deeper than Walras’ project, with which it has considerable affinity, though it too is somewhat confused. Robertson was of the opinion that the total amount of gold and silver in the world was insufficient for the price level of the future to be maintained either under the present monetary system or after the introduction of simple bimetallism. This view was possibly more justifiable in 1887 than appears to be the case to-day.

Robertson estimated, from sources which are unknown to me, that the total quantity of circulating medium (gold, silver, and paper) was about £900 million in the gold countries and about £450 million in the silver countries (the silver being valued at its old ratio to gold of 15½ : 1). The Economist’s index numbers of that time (1887) indicate that English prices had fallen since 1875 in the ratio of 100 : 69, and in India in the ratio of 100 : 91. (This corresponds fairly exactly to the ratio that then existed between gold and silver.) According to Robertson, the introduction of bimetallism at a ratio of 15½ : 1 would lead to a rise in the monetary stock 8 of the gold countries to £987¼ million, and to a fall in that of the silver countries to £362¾ million. The general index number for both countries would now stand at 75⅔. Robertson then worked out the consequences of introducing bimetallism on the basis of the ratio of about 21:1, which at that time prevailed. Silver coins would now have to be increased in size, and as a result there would be a considerable fall in the nominal value of the total stock of money. The aggregate of circulating medium in gold countries would contract to £856 million and in silver countries to £428 million. The index numbers would stand at 65¾ and 86¾ respectively, so that both price levels would have fallen.

These calculations can, of course, be accepted only in a very broad sense. To-day, when prices in India have risen very definitely, they do not apply at all.

Robertson proposed that in addition to the adoption of a fixed ratio between gold and silver, the total quantity of circulating medium in all countries should be expanded by the addition of a certain amount of irredeemable notes. The extent of this addition would be a matter for constant international arrangement, and the object would be to stabilise the general level of prices. These notes were not to serve as international means of payment, the provision of which would continue to be reserved for the precious metals, gold and silver.

I do not entirely comprehend the plan. If the notes are not to be redeemable, how can it be certain that gold or silver will always be available at par for the purpose of international payments? According to Robertson’s own view, unduly pessimistic though it is, the output of gold was insufficient even to meet industrial consumption. The result would be that if the price level was kept constant (and still more if it was raised), an agio would finally emerge on gold or metal as against the irredeemable notes.

But Robertson’s fears were, of course, exaggerated. Soetbeer’s estimate indicates that even at that time the consumption of gold did not exceed two-thirds of the annual production. Even this figure may be too high. Lexis maintains9 that at the present time industrial consumption amounts to scarcely more than a quarter of the production, which has meanwhile, it is true, greatly increased.

It is, however, necessary to recognise the possibility of the industrial demand for precious metals permanently exceeding production. If this were to happen, it would certainly call for the introduction of irredeemable paper money, unless the whole monetary and economic situation of the world were to be left to the caprices of the production and consumption of gold. Measures would then have to be devised to enable notes to serve as an international means of payment; and paper, rather than metal, would become the standard of value.

A proposal put forward by Hertzkas10 takes us one step further. According to this suggestion, gold coinage would be retained, but the transport of gold would be avoided by means of the introduction in all countries of “gold certificates” as legal tender, the gold itself being kept in some central depository. The practicability of this proposal essentially depends, it seems to me, on the willingness of each central bank to pledge itself to redeem these certificates, when it is asked to do so, at their par value in the country’s currency, gold or notes. But if such willingness could be relied on, then the same end could, I think, be attained in a far simpler and at the same time very much more effective manner. It would only be necessary for the central banks to accept, without charging any agio, the notes of one another for redemption or in payment, as is already the case among the Scandinavian banks (of Denmark, Norway, and Sweden). From time to time foreign notes could be exchanged between the banks by means of an international clearing, and any outstanding differences could be paid in gold or met by arrangement through the accepting of deposits, the exchange of securities, etc.

An arrangement has existed since 1885 (in one case since 1888) between the Scandinavian Central Banks by means of which sums of more than 10,000 kronen (£550) can always be transferred without any charge for interest or costs. But each Bank is under an obligation to remit any balance in gold on demand, and it has no right to exercise this power on its own account. The Banks can utilise the claims that arise in this way, and indeed the whole of their net claims on foreign countries, as a basis for their note issue. Their stocks of gold 11 thus constitute to some extent a single reserve, and gold is actually transported between them only on a very limited scale.

Such an arrangement would be the logical sequel to the constantly growing importance of the part played by the banks in equalising the balance of international payments. Even to-day there are certain countries which very rarely send gold abroad, though their coinage is of gold and they rigorously maintain the redeemability of their notes. Their banks prefer to deliver bills on account of their foreign commercial activities, and if necessary to pay interest on them. We have already noticed the example of Sweden, though here gold is never employed even in domestic business, notes being issued in small denominations (down to 5 kronen), and the stocks of gold in the private banks of issue remain untouched for years on end, though like the Reichsbank they are under an obligation to redeem their notes on demand in gold.

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One general observation is applicable to all the above proposals for stabilising the value of money, or for raising prices or preventing their further fall. According to our line of approach, they can attain their objective only in so far as they exert an indirect influence on the money rate of interest, and bring it into line with the natural rate, or below it, more rapidly than would otherwise be the case.

The possibility of equalising prices between gold and silver countries provides in its essence nothing more than an illustration of this general principle. A rise in the demand of the silver countries for European products resulting from a rise in the price of silver would mean surplus profits to European entrepreneurs. The diminution in importers’ profits, which would result from the decrease in the supply of the products of the silver countries and from the rise in their costs of production, is of no great consequence, for importers play a relatively small part in the provision of such commodities (production, transport, etc.).

(It is by now superfluous to remark that profit to the entrepreneur is in no way identical with profit to the economic system. In this particular case it would be bound up with a net loss to society.12)

Suppose for example, though it seems scarcely possible, that under Walras’ scheme the issue of notes in exchange for silver (or the expansion in the issue of silver coin) merely resulted in a corresponding amount of gold or of notes being deposited at the banks, without providing any stimulus to the banks to reduce their rates of interest. Clearly then the policy would be perfectly useless (apart from its effect on the price of silver and the consequent reactions).

The question thus arises whether the object in view could not be obtained far more simply, far more cheaply, and far more securely through the monetary institutions of the various countries agreeing among themselves to undertake directly that alteration in their rates of interest which is necessary and which alone is effective—the whole purpose, according to our theory, being to bring the average money rate into coincidence with the natural rate.

Under Walras’ system silver would not serve as a standard nor as an international means of payment; even if prices were to rise, very little more silver would be required for the purpose of transactions. Why then burden the banks with useless stocks of silver? Why not let them issue notes (or credits) against government bonds, debentures, or—bills? In other words, why not take direct measures to lower the banks’ rate of interest?

This does not mean that the banks ought actually to ascertain the natural rate before fixing their own rates of interest. That would, of course, be impracticable, and would also be quite unnecessary. For the current level of commodity prices provides a reliable test of the agreement or diversion of the two rates. The procedure should rather be simply as follows: So long as prices remain unaltered the banks’ rate of interest is to remain unaltered. If prices rise, the rate of interest is to be raised; and if prices fall, the rate of interest is to be lowered; and the rate of interest is henceforth to be maintained at its new level until a further movement of prices calls for a further change in one direction or the other.

The more promptly these changes are undertaken the smaller is the possibility of considerable fluctuations of the general level of prices; and the smaller and less frequent will have to be the changes in the rates of interest. If prices are kept fairly stable the rate of interest will merely have to keep step with such rise or fall in the natural rate as is inevitable.

In my opinion, the main cause of the instability of prices resides in the inability or failure of the banks to follow this rule.

A different jargon has become common in recent times, and it is sad to find a man like Lexis, in his recent discussion in Schönberg’s Handbuch, maintaining that “the money (in the banks) lies there at the disposal of everybody on the most favourable conditions obtainable”. As a proof of this, we are told that, for example, “the Bank of France has at last given up the principle” (it should rather be called the routine) “of not lowering its official rate below 2½ per cent., and has accommodated itself to a rate of 2 per cent.”13

But a rate of 2 per cent, does not imply “the most favourable conditions obtainable”. It is favourable only if the borrower can earn more than 2 per cent, per annum on the capital that he borrows; it is very unfavourable, indeed ruinous, if after deductions for costs and risk there remains a profit of only 1⅞, 1¾, or 1½ per cent, on the capital.

The objection that a further reduction in rates of interest cannot be to the advantage of the banks may possibly in itself be perfectly correct. A fall in rates of interest may diminish the banks’ margin of profit more than it is likely to increase the extent of their business. I should like then in all humility to call attention to the fact that the banks’ prime duty is not to earn a great deal of money but to provide the public with a medium of exchange—and to provide this medium in adequate measure, to aim at stability of prices. In any case, their obligations to society are enormously more important than their private obligations, and if they are ultimately unable to fulfil their obligations to society along the lines of private enterprise—which I very much doubt—then they would provide a worthy activity for the State.

It has now to be asked whether a policy of co-operation between the banks of the whole world (or of the gold-standard countries) lies within the realm of possibility. The banks of any single individual country, and above all its central bank, must in fixing their rates of discount allow themselves to be directed by the state of foreign trade, of the balance of payments, and of the rates of exchange. How then could they allow their rates of interest to be prescribed by others? This difficulty would still remain even though the central banks of the various countries accepted one another’s notes at par. An unfavourable balance of payments would then make itself felt, not primarily by an efflux of precious metal, but by the balance of the domestic banks at the international clearing becoming more and more passive. This balance would eventually have to be liquidated by a transfer of gold or would have to be converted into some form of interest-bearing debt. The bank or banks of the country concerned would thus be subject to a direct pressure to raise their rates of discount. They must then in all circumstances retain a free hand to be used in the last resort, if not earlier, over bank-rate policy.

This is a serious difficulty, which has to be met in deciding the manner in which our policy should be put through, without constituting any logical objection to its practicability.

It is frequently observed that the difficulties which arise through a highly one-sided balance of payments or through a large difference in the price levels of two or more countries can be overcome by measures undertaken, not only by the “unfavourably” situated country, but also by the “favourably” situated country or countries. Suppose that money is flowing from country A to country B. This flow can be stemmed and reversed not only by a rise in the rate of interest in country A, but also by a fall in the rate of interest in country B, and also, of course, by a simultaneous movement in both countries. It is only the difference between the two rates of interest which is of consequence. And a change in the rate of interest which was undertaken by both countries in the same direction, and to about the same extent, would have no influence on their mutual trade relations. In other words, to adopt once again a mechanical metaphor, international prices, like prices in general, can be compared to a system which possesses not one but “two degrees of freedom”: they can be moved in opposition to one another, but they can also be moved in conjunction. There is first of all the individual regulation of relative rates of interest, which aims at maintaining the rates of exchange, the balance of payments, and the relative level of prices, and which, by the nature of the case, must proceed in opposite directions in different countries or groups of countries. At the same time, and more important, there can, and should, on occasion come into being a co-operative regulation of the rate of interest, proceeding everywhere in the same direction with the object of maintaining the average level of prices at a constant height.

Co-operation between the banks of a single country for the regulation of rates of interest is already, of course, a matter of everyday procedure. Co-operation between the banks of different countries could easily take place, at any rate in times of peace, as soon as it was clear what objective was being aimed at. It would be sufficient if a scheme of co-operation were accepted, and fairly loyally adhered to, by a majority of countries; any individual country would deviate from the ruling rate of interest, unless for some pressing cause, only to its own disadvantage.

It would still remain to provide a satisfactory measure of the average level of prices and its fluctuations. The problem is a difficult one but cannot to-day be regarded as insoluble. Its nature is such that it would be clearly best to hand it over to an international commission on the lines of the Metric Commission. As soon as this body had discovered a divergence of the world price level from its normal level (which would, of course, be fixed quite arbitrarily), it would be the duty of the banks to pool their efforts and restore equilibrium. This suggestion may sound strange, and perhaps comic (reminiscent of the Astronomical Society of Laputa), but it represents the logical development of the idea underlying the deliberations, until to-day at any rate quite ineffective, of all monetary commissions.

With their present stocks of gold, which could be enormously reinforced by the issue of notes in small (though not too small) denominations, the banks would be able fully to maintain the present level of prices for a reasonable space of time. That is not a matter for doubt. It is rather to be feared that if gold continues to be produced on the present or on a higher scale, the monetary institutions will be finally compelled to lower their rates of interest to such an extent that a rise in prices will be unavoidable. For my part (for reasons which I have already given), I regard such an eventuality as no less un-desirable than a further fall in prices. If the banks are not to suffer too obvious losses (through failing to make use of interest-bearing deposits), it would be possible to avoid such a rise of prices only by the suspension of the free coinage of gold. This would mark the first step towards the introduction of an ideal standard of value. Monetary discussions of recent years have made us more and more familiar with such an international paper standard. While it is usually regarded as a means of meeting a growing scarcity of gold, it might just as well, I think, and must, come into being as a consequence of an over-abundance of gold.

In any case, such a prospect need not, on closer investigation, provide cause for consternation. On the contrary, once it had come into being it would perhaps be the present system which would sound like a fairy tale, with its rather senseless and purposeless sending hither and thither of crates of gold, with its digging up of stores of treasure and burying them again in the recesses of the earth. The introduction of such a scheme offers no difficulty, at any rate on the theoretical side. Neither a central bureau nor international notes would be necessary.14 Each country would have its own system of notes (and small change). These would have to be redeemable at par by every central bank, but would be allowed to circulate only inside the one country. It would then be the simple duty of each credit institution to regulate its rate of interest, both relatively to, and in unison with, other countries, so as both to maintain in equilibrium the international balance of payments and to stabilise the general level of world prices. In short, the regulation of prices would constitute the prime purpose of bank rate, which would no longer be subject to the caprices of the production and consumption of gold or of the demand for the circulation of coins. It would be perfectly free to move, governed only by the deliberate aims of the banks.

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The possibility of establishing a stable measure of value and of maintaining prices at a constant average level was questioned by Ricardo but is to-day affirmed by many outstanding economists. The upshot of our own investigations is that such an aim is attainable, not only in theory but in practice. Its fulfilment calls for every effort on the part of statesmen and thinkers. It is a thing unworthy of our generation that without pressing cause the most important economic factors are left to pure chance.

But it must not be supposed that stabilisation of prices would overcome the economic depression which for more than twenty years has provided a constant source of complaint on the part of certain classes of the community; nor would economic progress again resume that very rapid pace to which we have become accustomed since the middle of the century. This depression must be regarded as the cause rather than the effect of the fall in prices. It has its own peculiar relations to the popular catch-phrase “economic depression”. The productivity of labour and land has, in our portion of the globe, quite definitely not fallen off. Wages have not fallen; in fact they have on the average, taken in relation to the prices of the most important articles of consumption, undoubtedly risen. Even rents have definitely risen; while agricultural rents have had to give way (in western Europe) to the competition in the production of corn exercised by various parts of the world, the rise and expansion in other kinds of rents, including urban ground-rents, have been all the more tremendous. The enormous growth in national and communal budgets provides an unmistakable sign of increasing welfare. What has fallen is the rate of interest on liquid capital and the thing that is usually termed entrepreneur profit, i.e. the surplus profit, over and above the remuneration for services rendered, which accrues to the entrepreneurs at times of prosperity.

We have already recognised the main cause for this phenomenon. The transformation into fixed capital of the new liquid capital which comes into being has now to follow a far less profitable course, and the increase in the amount of capital has in part to serve to raise wages and rents.

It is true that, on a purely quantitative view of the expansion of population and of output as a whole, progress has been somewhat less rapid in recent decades than earlier in the century. It is, however, premature, and indeed ridiculous, to indulge in the hope that the conditions of earlier times will again return. Such a hope is derived from nothing but the short-sighted desires of mankind.

The economic development which has characterised the present century, particularly in the older European countries, is in this respect to be regarded as anything but a regular phenomenon. It is a peculiar and rare exception to a general rule. The unlearned multitude may fail to comprehend, and many educated people may be unwilling to comprehend. But the economist should shun the popular prejudice, and should attempt to fight it with all the power at his command. For by the nature of his studies he can view these matters in a better light, and he, more than anybody else, is under an obligation to proclaim the truth concerning them.

Progress in the qualitative sense, increase in economic welfare, is possible, or at least conceivable, to an almost unlimited extent, but only on the assumption that progress in the quantitative sense, expansion of population, is very severely restricted. The assumption of even a slow growth of population and output leads in the last analysis to a reductio ad absurdum. It is clear that a constant rate of growth, in accordance with the familiar geometrical progression, is in many degrees absurdius; while the idea of endless, and above all accelerating, progress, both quantitative and qualitative, can only be described as absurdissimum. Those who expect monetary measures to perform miracles might well remind themselves of the well-known fact that coins do not give birth to offspring, and that even if they did, precious metal and bank notes would constitute neither sustenance nor clothing.

But liberated from all unhealthy fantasies, the question of monetary reform on rational lines definitely remains among the most important of economic problems. That its realisation depends on international co-operation, which would have to be both permanent and somewhat thorough in nature, is to my mind a positive recommendation. I joyfully welcome every fresh step towards the uniting of nations for economic or scientific ends, for it adds one more safeguard for the preservation and strengthening of that good on which the successful attainment of all other goods, both material and immaterial, ultimately depends—international peace.

 

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15 “Die Währungsfrage in der neuesten Zeit”, Schönberg’s Handbuch, 4th ed., p. 407.

16 Let us begin with both prices denoted by 100, in terms of gold in the one case and of silver in the other case. Then they would subsequently have to stand as 150 : 75, or 133⅓ : 66⅔, etc.—at any rate in the ratio of 2 : 1.

17 Russia’s transition to a gold standard is, of course, now [1898] complete.

18 Théorie de la monnaie, p. 75 ff.

19 Jahrbücher für Nationalökonomie und Statistik, vol, 51, 1888, p. 74.

20 Schönberg’s Handbuch, loc. cit.

21 Second Report, p. 24 ff., Q. 6287-6304.

22 [Goldvorrat of original is presumably a misprint for Geldvorrat.]

23 Jahrbücher für Nationalökonomie und Statistik, vol. 66, 1896.

24 Ibid., vol. 65, 1895.

25 [Geldvorräte of original is presumably a misprint for Goldvorräte.]

26 Cf. p. 181, above.

27 Schönberg’s Handbuch, 4th ed., p. 406.

28 On the grounds of convenience, it would be very desirable to adopt a uniform unit of value or at any rate to modify the existing units (in the manner of Laveley’s proposal) so as to simplify their arithmetical relationships.

• 1See, for instance, his preface to the German edition of his Vorlesungen, II.: Geld und Kredit, 1922.
• 2Lectures, II.: On Money and Credit, 3rd Swedish ed., p. 197.
• 3See the following papers in the Ekonomisk Tidskrift: (i) Davidson, “On the Concept of the Value of Money”, 1906; (ii) Wicksell, “The Stabilisation of the Value of Money, a Means of Preventing Crises”, 1908; (iii) Davidson, “On the Stabilisation of the Value of Money”, 1909; (iv) Wicksell, “Money Rate of Interest and Commodity Prices”, 1909. Cf. also Brinley Thomas, “The Monetary Doctrines of Professor Davidson”, Economic Journal, March 1935.
• 4Ibid., p. 198.
• 5Loc. cit., 1908, p. 211.
• 6In Wicksell’s opinion the money rate should be raised to ensure equilibrium on the capital market and prevent a rise of the price level; see Wicksell’s answer.
• 7Statsökonomisk Tidskrift, Oslo, 1917.
• 8Loc. cit., pp. 65, 66.
• 9An analysis of these questions is to be found in my Swedish book, Monetary Policy, Public Works, Subsidies and Tariffs as Remedies for Unemployment, 1934. A revised English version will appear in 1936 under the title The Theory of Expansion.
• 10Loc. cit., 1909, p. 64.
• 11Preface.
• 12Lectures, 2nd Swedish ed., p. 202. See also Cassel, Theory of Social Economy, § 48.
• 13Ibid., p. 393.
• 14“The Monetary Problem of the Scandinavian Countries,” Ekonomisk Tidskrift, 1925; translated below, p. 199 ff.
• 15Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
• 16Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
• 17As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
• 18Wicksell always insisted that this reasoning did not mean more than an amplification of the old quantity theory. Moreover, he always regarded his own contribution as a doubtful hypothesis and never became as convinced of its tenability as did some of his pupils. He explicitly rejected the idea that his theory provided an explanation of the business cycle. He was critical of Mises’ idea that mistaken credit policy is the origin of the tendencies towards booms and depressions. A brief quotation will indicate his position: “Our conclusion is, therefore, that although the changes in the purchasing power of money, caused by credit policy, are under present conditions intimately bound up with the business cycle and without any doubt also influence the latter, above all by giving rise to crises, yet it does not seem essential to assume that there is, by the nature of things, any necessary connection between these two phenomena. The main cause of the business cycle, and a sufficient cause, seems to be the fact that technical and commercial progress cannot by its very nature give rise to a series which proceeds as evenly as the growth in our time of human needs—due above all to the organic increase in population—but is now accelerated now retarded. In the former case ... a mass of circulating capital is transformed into fixed capital, a process which, as I have said, accompanies every rising business cycle: it seems as a matter of fact to be the one really characteristic sign, or one in any case which it is impossible to conceive as being absent.”. . . “If the banks already at the beginning of a rising period sufficiently raised their interest rates, but on the other hand reduced them energetically when the depression was about to set in”, then the price level would probably remain stable, although raw materials for fixed capital would rise in price during periods of good trade and fall during times of bad trade. “Under such circumstances the chief crises-causing factor would probably have disappeared, and what remained would be only a quiet wave movement between periods of accelerated formation of fixed capital and periods when the new capital assumed . . . other forms.” . . . “Increase in commodity stocks is probably the most important form of real investment during so-called bad trade.”
• 19As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
• 20As Wicksell worked on monetary problems for almost three decades after the publication of the Geldzins, it may be worth while to say something here about the changes which his views underwent. These were not, as a matter of fact, considerable. Although he was always ready to question his own reasoning, his lively discussions with other Swedish economists do not seem to have left many traces on his theory. Take, for instance, his discussion with Professor Davidson. In 1906 Davidson, whom Wicksell held in the highest esteem, suggested that during periods of rapid technical progress and increasing productive efficiency a greater stability of business would be ensured if commodity prices fell in proportion to the increase in output than if they remained stable. Davidson asserted that if the money rate of interest and business profits (Wicksell’s natural rate) stood in a normal relation to one another before the increase in efficiency, then they would continue to do so if prices fell in proportion to the latter. There would be no need for a change in the money rate of interest. If it were reduced to prevent a fall in the price-level, it would be too low in relation to profits, and a process of an inflationary character would start. To this Wicksell replied: “In the case which Davidson has chosen it may appear that the increase in profits due to increased productivity and the reduction in profits due to the fall in prices, caused on his assumption by the former, would offset one another. But surely this would only happen if the price movement could be anticipated beforehand and estimated, or if it were so even and had lasted for so long that it had come to be generally regarded as something constant? In general, however, the individual business man will make his calculations for the future, and so fix his demand for labour, raw materials, and credit on the basis of current prices.” Hence, prices would rise if the money rate were not immediately raised, and when some time later the increase in productivity had led to a greater supply of finished goods, so that prices would fall, business men would make losses and the situation would be disturbed.
• 21Wicksell’s opinion of the character of the business cycle is perhaps most clearly presented in his paper “The Riddle of Crises”. Here he pointed out that there are two entirely different methods of explaining the comparatively regular ups and downs of business. One is to assume that some extraneous forces work intermittently and so cause oscillations. The other makes use of the hypothesis that the present economic system will, by its very nature, react in an oscillatory manner to any irregular forces which tend to make it move. It might be imagined to be like a rocking-horse. Wicksell undoubtedly inclined towards the latter view, while maintaining that intelligent credit policy—at least under most conditions—could prevent the rocking tendency from growing violent.
• 22In his rejoinder Wicksell admitted that this case required more attention than he had so far given to it. Davidson’s reasoning depended, however, on “the tacit assumption that the supply of real capital has been increased in the same proportion as productivity. Davidson is obviously of the opinion that money wages remain unaltered; thus if commodity prices have fallen, real wages would have been subject to an increase, but how can they be raised without an increased supply of real capital?” Making reference to Böhm-Bawerk’s theory of capital, Wicksell asserted that this is impossible, and continued: “If the quantity of real capital is increased the real rate of interest will fall even if prices remain unaltered and thus money wages rise. . . . Naturally, however, my assumption is that ‘other things remain equal’; i.e. that real capital and real wages are not subject to any change. . . . An increase in productivity when the supply of real capital is unaltered must necessarily mean a rise in the real rate of interest, and equilibrium on the market can never exist unless the money rate is made to coincide with the latter, i.e. unless it is in this case raised.” Although it was possible that prices might temporarily fall, a tendency for a cumulative rise in prices would set in unless the money rate was raised.
• 23I have come to regard this side of the Wicksellian theory as more important than his other attempt to combine price theory and monetary theory—by his identification of the rate of interest which would maintain the price level constant with the rate as determined in the theory of pricing and distribution, the latter being termed alternatively natural rate, i.e. the marginal productivity of capital, and normal rate, i.e. the rate which equalises supply and demand of savings. The general theory of pricing and distribution is, after all, static in character and its concepts are not likely to lend themselves to the more dynamic analysis of, say, problems of inflation. Rather than build monetary theory on this static analysis, it would seem more natural to pursue the monetary analysis of the actual determinants of the various rates of interest in a dynamic world and then, in the light of such analysis, to revise the theory of distribution. Work along this line seems to me to be the natural consequence of the first-mentioned innovation of Wicksell’s. It would bring monetary theory into harmony with price theory by making the latter more dynamic and would probably give up not only concepts like the natural rate of interest but the whole idea of a monetary equilibrium and thus also the concept of a normal rate of interest defined in equilibrium terms.
• 24In his rejoinder Wicksell admitted that this case required more attention than he had so far given to it. Davidson’s reasoning depended, however, on “the tacit assumption that the supply of real capital has been increased in the same proportion as productivity. Davidson is obviously of the opinion that money wages remain unaltered; thus if commodity prices have fallen, real wages would have been subject to an increase, but how can they be raised without an increased supply of real capital?” Making reference to Böhm-Bawerk’s theory of capital, Wicksell asserted that this is impossible, and continued: “If the quantity of real capital is increased the real rate of interest will fall even if prices remain unaltered and thus money wages rise. . . . Naturally, however, my assumption is that ‘other things remain equal’; i.e. that real capital and real wages are not subject to any change. . . . An increase in productivity when the supply of real capital is unaltered must necessarily mean a rise in the real rate of interest, and equilibrium on the market can never exist unless the money rate is made to coincide with the latter, i.e. unless it is in this case raised.” Although it was possible that prices might temporarily fall, a tendency for a cumulative rise in prices would set in unless the money rate was raised.
• 25Let me return now to the third modification, introduced by Wicksell in the first Swedish edition of his Vorlesungen (1906). It concerns the influence of gold production on prices: “I had formerly, in close accordance with the opinion of the classical school, imagined that this influence is mainly exercised chiefly through the intervention of the rate of interest; gold production in excess of needs ought in the first place to cause an increase in the gold stocks of banks and thereby a reduction of their interest rates, which in its turn should cause a rise in prices. . . . After further reflection I have, however, come to the conclusion that the main emphasis ought rather to be placed on the demand for commodities from the gold-producing countries; if this demand is not offset by an equally large supply of goods from other countries—in other words, by a need for new gold—it must necessarily lead to a rise in prices, and this immediately; thus the money rate of interest is perhaps not at all affected or possibly affected even in the opposite direction.” “The increasing gold stocks would then serve as a sort of ‘hook’ behind the price movement, preventing it from receding again . . . i.e. not as the first cause of the rise in prices but as a foundation which has been inserted after the beginning of the price movement. ... I mention this only in passing as a conceivable hypothesis. ... A similar treatment seems to be called for by the rapid reduction of the value of money which is as a rule the consequence of successive issues of paper currency.” “In this case, too, the rise in prices is, strictly speaking, the primary factor, the increase in the quantity of means of payment the secondary factor, and it is at least conceivable that under such conditions no real surplus of paper currency and consequent fall in the rate of interest emerges.” Two years later, however, in a discussion with Davidson, Wicksell seems to have returned to his old position; he made an attempt to deal with the case of gold production as a mere special instance of a discrepancy between the normal rate and the money rate of interest. “In so far as the new gold does not exercise a depressing influence on the interest rates of the banks, it will instead increase business profits, by enabling business men to sell in a market with higher prices after having bought in one with lower prices; in this way the discrepancy between the two factors, the money rate and the natural rate, will remain about the same.”
• 26In the second Swedish edition of the Lectures (1915), Wicksell introduced a modification of more far-reaching character, although he did not himself regard it as important. In the Preface he writes: “I have not found myself called upon to modify my general standpoint, if one does not count as such a certain concession to my critics concerning the mutual effect on one another of the money rate and the natural rate of interest”. This concession reads as follows: “It has been objected that a reduction of the money rate ought to have a depressing effect on the real (natural) rate; thus, the stimulus to a further rise in prices would disappear. This possibility cannot in general be denied. A reduction of the real rate requires, other things being equal, new real capital, i.e. increased savings.” Wicksell admits that the tendency towards an increase in savings may be much stronger than the opposite tendency, so that the rise in prices which has begun may stop. However, he regards this reaction between savings and the real rate of interest as a “secondary factor”.
• 27In my opinion, the bearing of this objection is much wider than Wicksell supposed. The analysis of Lindahl and of Myrdal has demonstrated that the existence of “credit and of money rates of interest are included as elements in the construction by which the natural rate is determined”. “It is impossible to conceive of relative barter terms whose development is independent of the absolute monetary units in which credit contracts are concluded.” In other words, Wicksell’s concept of a natural rate of interest proves to be of little use in dynamic analysis.
• 28During his last years Wicksell came more and more to doubt the solidity of what had been regarded as the cornerstone of his monetary theory:—the idea that if the money rate coincided with a normal rate of interest, which brought about equality between savings and investment, the commodity price level would remain constant. To what extent his earlier discussion with Davidson influenced him we cannot say. To judge from his last paper, it was discussions with business men on the causes of war inflation, especially the influence of a reduction in the supply of commodities, which caused the alteration in his views.