International Monetary Economics

CHAPTER IV

PRINCIPLES OF THE GOLD-PRICE RELATIONSHIP RESTATED. THE GOLD PROBLEM

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THE preceding chapter has been, in a sense, a digression. It was necessary in order to test the points of view adopted in Chapter II; if it had been discovered that the “inductive” investigations yield conclusive results about the relation between changes of the gold stock and changes in prices, it might have become necessary to revise the thesis previously advanced that the relation between gold and prices is mediate and indirect whenever gold is not the only circulating medium. But we have seen that these statistical inquiries do not yield such results. The correlations obtained are based on the use of statistical methods more or less open to objection and upon more or less doubtful theoretical assumptions or simplifications. In my criticism I tried to limit myself to fundamentals. One could discuss many other aspects of the methods adopted, which, important though they are, lose most of their interest if the very basis of the methods used is faulty. Thus Kitchin1 bases his estimates on monetary gold only, not, like Cassel, on the total gold stock and production, while Mlynarski2 introduces silver also into his calculations. In this way Kitchin obtains the rate of 3.1 per cent instead of Cassel’s 2.8 per cent, and Mlynarski the rate of 0.78 per cent. It is suggested however, on the basis of the long analysis that precedes, that no discussion along these lines can be fruitful. It is to be regretted that, for a number of years, the discussion of the rôle of gold has been sidetracked upon this fruitless line, and that this gave rise to policies which we shall discuss in a later chapter when speaking of what might be termed a “gold economy standard”; policies which preceded the collapse of monetary internationalism after the World War.

The question whether there is enough gold or not has hitherto always been answered with reference to such “inductive” studies and to such simple statements about what constitutes an “adequate gold production” as those due to Cassel or Kitchin. Rist might have drawn similar inferences, were it not for his view that the supply of gold is always adequate, being the principal criterion itself, and that it is for prices to be fixed upon a level corresponding to the gold situation. “Gold cannot be wrong, prices can”, might be a résumé of Rist’s argument against Cassel quoted at the end of the last chapter. Cassel would answer to this with an accusation “Gold has been always wrong since the middle of last century and probably earlier”. As we have seen Rist and Cassel are very close to one another in their estimation of the effect of gold upon prices under the gold standard. If Rist fights Cassel’s theory about the effect of the rate of interest upon prices, he does not provide any alternative theory; gold mysticism takes its place. I have quoted a certain number of Rist’s views in that connection; they are far more common on the Continent than many British, American and Scandinavian economists may realize, and they explain certain monetary controversies and certain profound divergencies of views about policies. If Cassel believes in the possibility of maintaining stable prices through monetary management and considers that this is unattainable under the gold standard; and if Rist considers price stabilization as impossible and deflation as necessary under certain conditions in order to maintain the gold standard, which he considers to correspond to the very nature of things, then it is clear that policies they advocate must clash. And everybody who remembers the Monetary and Economic Conference of London, 1933, knows how dramatically the two conceptions did clash, and with what disastrous effects. It is therefore necessary that it should be realized how deep are the differences of views that still exist between leading economists about the very nature of money; this is the principal reason why so much space has been devoted to the discussion of two theories which may appear to be incidental to the main line of argument represented in this book.

Let us go one step further. Neither the diagnosis of Cassel nor that of Rist appears to stand up to a careful examination; and if it is incorrect then their conclusion may be wrong also.3 This implies, in the first place (concerning Cassel), that the maintenance of reasonably stable prices does not necessarily conflict with the maintenance of the gold standard, and, in the second place (concerning Rist), that the adjustment between the production of gold and the “price level” does not necessarily have to be made by the means of a sharp or protracted deflation (or, in the opposite situation, by the means of a price inflation).

As regards the first point it will be observed that there is a more or less considerable margin between the minimum reserve requirements (by which both central banks and commercial banks are limited in their issuing activities) and the actual reserves held against notes or “bank money” respectively. Within this margin banks have full discretionary powers for their policy. It is therefore only, if, after having expanded to the maximum, banks (central and commercial) fail to maintain stable prices, that the argument about the incompatibility of the gold standard and the stability of prices can be upheld. Cassel argues, quite consistently, that in the long run the possibilities of expansion are always exhausted, but the claim has hitherto been left unproven, particularly since the ideas about adequate reserves change and in the long run gold serves as basis for an ever-increasing circulating medium. Still, the fact remains, that at any given moment there is a limit to monetary expansion on the basis of given stocks of gold. When one approaches this limit, the “gold problem” arises.

It is of importance to point out in the present context: (1) that the various national monetary systems allow for the issue of a larger or smaller volume of circulating medium on the basis of a given quantity of gold; so that gold movements between countries may increase or diminish the maximum of monetary circulation for the whole gold-standard world;4 (2) that various countries may pursue different policies with regard to the amount of currency and bank money their monetary institutions issue on the basis of the gold stock they hold; thus the result of the differences of policy may be that certain countries reach the limit of expansion which they can carry out, while other countries fall far short of the maximum. Thus the distribution of gold as between the different countries may create a gold situation which amounts to a real scarcity of gold in certain countries without there being a real scarcity of gold in the world. The problem of maldistribution of gold is as important in practice as that of “absolute scarcity”.

The same is true for the reverse situation. Gold may be (or may appear to be) plentiful, as it may be (or appear to be) scarce. And this abundance may be the effect of “maldistribution” of gold or of a real plethora of gold, according to the situation.

The phenomenon called “maldistribution of gold” is, of course, the effect of the state of international commercial and financial relations, and can be placed in its proper perspective only after a careful study of the problems connected with these relations and with their outcome—balances of payments. We shall only note here that if the “gold problem” is due to “maldistribution” the situation is essentially different from that which exists if gold is everywhere abundant or scarce.

If the latter is the case we must turn to the second of the two points mentioned on page 69 above. Is it necessary then, in order to maintain the gold standard, to cause or to accelerate a deflation of prices, if gold is scarce, or an inflation, if gold is plentiful? I have pointed out in earlier parts of my analysis that the assumption of the constancy of the price of gold, and the limitation of the discussion to physical output, is misleading. The quantity of gold is much less important for the monetary system than is its money-value. And the value of a given physical volume of gold (expressed in terms of money-units, of course) varies with that volume, but varies also with the price of gold. Therefore the situation of scarcity or abundance may be changed by changing the price of gold. A simultaneous change of the price of gold in the different countries, leaving intact the parities between the various monetary units, may be an alternative to either a deflation or to an inflation. However, in order to avoid disturbances, action must be taken concurrently by the various countries. Rist should have considered that possibility before declaring deflation as inevitable; for if all the rest of his theory is correct, then a world-wide change of the price of gold would have restored “equilibrium” more quickly and more smoothly than the deflationary process, without playing havoc with the whole economic activity.5 One important qualification must be made however: if the monetary situation is due to maldistribution of gold and not to an absolute scarcity or superabundance, then the change of the price of gold may cure nothing and be the source of new difficulties. As long as the causes of the maldistribution continue to act, the “equilibrium” obtained by changing the price of gold will be precarious. On the other hand it may well be that after forces making for maldistribution have ceased to operate, an absolute scarcity or superabundance of gold may appear as a result of changing the price of the metal. If we thus distinguish between an international gold problem, consisting in maldistribution, and a world gold problem, consisting in absolute scarcity or plethora of gold, we may well conclude that changing the price of gold may be a solution for the latter; as long, however, as the former problem exists it is difficult to diagnose the “world situation”.

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Two notions employed in the preceding section require a careful definition: one of them is “maldistribution of gold”, the other, “scarcity or superabundance of gold” (that is, “adequacy of gold supply”). Both, but particularly the former, are (along with so many other economic concepts) more frequently used than carefully defined, so that there results a great deal of misunderstanding and idle discussion.

The notion of an insufficient or excessive supply of gold presents itself in the first place nationally, because monetary organization and policy are primarily national; in the second place, the notion may apply to the world at large if the situation is everywhere one of scarcity or plethora. Now what does the notion itself mean? It is a relative notion of course, since gold can be either less or more plentiful than that which is considered as being its adequate supply. One can say that the supply of gold is adequate if it allows the monetary authorities of the various countries to adopt whatever policy with regard to issuing currency they regard as necessary for the maintenance of stability in the economic process. Gold is considered as scarce if its supply, combined with the customary or legal reserve requirements (whichever are larger), imposes on the monetary authorities an undesired restrictive policy; its supply is superabundant, on the other hand, if it imposes an undesired policy of monetary expansion.6 The notion, as we see, is relative and furthermore includes not only the absolute gold situation but also the views of monetary authorities on the nature of policies which could ensure the stability of economic development. As long as the supply of gold does not directly influence policies, there is no clash between the maintenance of the gold standard and the maintenance of economic stability (inasmuch as that maintenance depends upon monetary policy!). Considering, furthermore, how indirect the relation between the gold stocks and the volume of circulating medium is in modern monetary systems (vide Chapter II), how it differs between one system and another, and how these relations are changing throughout time, it appears entirely vain to lay down any definite figure for the rate of growth of the stocks of gold that is necessary if that metal is to be adequately supplied. Other factors, and factors subject to continuous changes and variations, affect the situation, and only the examination of such actual situations can make it clear whether gold is plentiful or scarce. Only in extreme situations does the gold-supply affect directly the issue of money and hence, indirectly, prices. Whenever this happens, i.e. whenever the supply of gold interferes with monetary management, we hear of “the gold problem”, and of solutions to it: economizing gold, sterilizing gold, changing the price of gold.7

Let us now turn to the concept of “maldistribution of gold”. What is the precise meaning of that term? It implies that the distribution of gold in the world is wrong, that there is too much of it in certain countries and too little in others. This sounds plausible but is not sufficient as a definition. For what is to be the criterion of the “too much” or “too little”?

The fact that a large proportion of the world stocks of monetary gold is held in a very small number of countries can be considered, of course, as a presumption in favour of the idea that “something is wrong somewhere”. As we cannot determine however a priori in what proportions gold should be distributed between the various countries, we cannot infer the existence of maldistribution of gold merely from the statistics of its distribution. We need further criteria, and we may well use those which we discussed in the earlier part of this chapter. We shall say therefore that there is too much gold in countries where no corresponding expansion of money in circulation is considered as necessary or opportune and where either an undesirable monetary expansion takes place, or, more frequently in practice, additions to the gold stock are not followed by an expansion of currency. In these countries, therefore, we have what is called “sterilization of gold”.8 Similarly there is too little gold in a country where the central bank is prompted by the gold reserve situation to adopt a restrictive monetary policy, or new means of “economizing” gold,9 which weakens the stability of the national monetary system in question, and makes it less shock-proof.

We have now in hand all the elements needed for the definition. We call maldistribution of gold a situation which exists when a shortage of gold in certain countries is co-existent with a redundancy of gold in other countries.

Thus defined, the maldistribution of gold is the result of the state of international commercial and financial relations and of cumulative gold movements towards some, and away from other, countries. When discussing the equilibrium of balances of international payments we shall see the conditions under which such a situation arises.

It must be noted that it would be wrong to say that the maldistribution of gold is the cause of a situation where gold is superabundant in certain countries and not sufficiently plentiful in others. To say that is to commit an error which is not infrequent in economic literature and which consists in (a) describing a certain situation; (b) giving that situation a name (independently of its description); and (c) calling (b) the cause of the situation described under (a). The only way to determine whether there is maldistribution of gold or not is to see whether gold is simultaneously scarce in some countries and redundant in others. No other criterion of maldistribution exists. Therefore “maldistribution” is the name and not the cause of the described situation.

In order to avoid any misunderstandings, let us stress the fact that “maldistribution” occurs only when gold movements are cumulative and not self-reversible. Wherever the “classical” mechanism of adjustment of balances of payments under the gold standard operates, movements of gold cause a temporary scarcity or redundancy of gold in countries which respectively lose or gain gold, but forces are set in motion which tend to restore a balanced situation. “Maldistribution” is the result of a situation in which the compensating forces, tending to restore “equilibrium”, do not work.10

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Let us now turn to the problem of “gold prices”. The definition given in Chapter II differs from the generally adopted use of the term, and, in particular, from the notion of “gold prices” employed by the authors of the inductive studies discussed in Chapter III. Its advantage is that it is clear-cut and non-equivocal. By adopting the current definition according to which gold prices are prices expressed in units of a gold-standard currency, Rist is conducted to the somewhat vague distinction between “world gold prices” and gold prices which are not “world” prices. In the light of the preceding definitions, we could say that after the war there existed a maldistribution of gold, and that in the United States there was a redundancy of gold which partly expressed itself in a higher level of prices as compared with the 1914 prices. According to my definitions, these prices were not gold prices, since the monetary system of the United States, though attached to a gold base, included a substantial note circulation and a still more substantial volume of “bank money”. Rist, as has been pointed out before, does not define the two notions of gold prices which he uses; we could probably say however, without misrepresenting his thought, that gold prices are “world gold prices” whenever there is no maldistribution of gold in the world. It will be observed that a certain degree of “maldistribution” exists whenever there is no absolute freedom in the movements of goods between countries and whenever some other conditions are not satisfied; so that for practical purposes we can hardly ever speak of “world gold prices”. This contributes to the weakness of theories based on that notion and makes it preferable not to use it. It is even preferable to be careful in using the expression of “world prices”, since this apparently clear term covers a very vague and non-constructible concept.11 The following very judicious comments by Professor Mlynarski are worth quoting in this connection:12

“Gold never possesses a general purchasing power uniform in the whole world. Actually its purchasing power varies from country to country, being regulated by local production of commodities and money. The level of world prices is not and cannot be a uniform level in all countries, but signifies only an average level; that is, it is a statistical fiction. If we speak about a level of world prices we state merely that there exists an interdependence between the local levels of prices and this dependence is in a state of equilibrium, i.e., the divergences do not exceed the natural limits resulting from differences in the costs of production, transport, customs-duties, etc. The level of prices in that country which plays the most important rôle in the international exchange of commodities, services and capital is a centre towards which the prices of all other countries must gravitate. The maintenance of this international equilibrium is a very complicated process and an average index of economic progress and of the inflow of gold cannot be regarded as a practical guide.”

The discussion of the meaning of “gold prices” is not merely a terminological hair-splitting. Economic policy often suffers from the terminological inaccuracy of economic theory; furthermore ill-chosen terms occasionally cover imprecise concepts—and this is fatal for any science! If one speaks of “gold prices” one is, very naturally, led to think of “prices expressed in gold”.13 Hence my definition of “gold prices” limits the use of that term to a system where all money in circulation is gold. In a system in which there are notes and “bank money”, prices are expressed in terms of “abstract” monetary units, not in terms of gold, even if the actual monetary system is that of the gold standard.

When one speaks of “gold prices” one is inclined to link prices to gold even in systems where gold does not act directly upon prices. The conceptions discussed and criticized in Chapter III are the outcome of the use of inadequate concepts, while the use of the term “gold prices” in the sense rejected here, easily results in further inaccuracies in the definition of the “gold standard”. The detailed discussion of the problem “Gold and Prices” is indeed a necessary preamble to discussing the nature of the monetary system attached to (or based on) gold. A further preamble to the study of that system, as indeed of any system realizing “monetary internationalism”, is an investigation of the notion and significance of the balance of payments.

Comparing Cassel’s and Kitchin’s estimates, Professor Mlynarski comes to the conclusion that they are fundamentally different, owing to the fact that the former considers the total supply of gold and the latter merely the supply of monetary gold. The argument though elaborate and interesting does not carry conviction. See The Functioning of the Gold Standard by Dr. Feliks Mlynarski, being a Memorandum submitted to the Gold Delegation, Geneva, League of Nations, 1931, particularly pp. 41–46.

• 1There is much difference between the views that are widely held in this matter in Great Britain and the United States, and views that are commonly accepted on the Continent. This explains the emphasis laid on that issue. Vide infra, pp. 68 and 69.
• 2The reader may find it useful in this context to contrast the United States’ unified monetary system, now embodying a Federal Reserve System, with what would have existed had each of the 48 States of the Union sovereign powers over its particular monetary system.
• 3The word “international” is used, of course, with utter disregard of its etymological significance; but this usage is universally recognized.
• 4F. A. von Hayek, Monetary Nationalism and International Stability, London, 1937.
• 5loc. cit., p. 4.
• 6Except when a World State exists.
• 7i.e., “real” factors of production (goods), monetary factors (capital) and, thirdly, labour.
• 8“In the last analysis . . . it is the political factor which gives rise to the economic problem of international monetary transfer. If historical accident had not created independent sovereign states . . . no such ‘problem’ would have arisen”. Lionel Robbins, Economic Planning and International Order, London, 1937, pp. 279–80.
• 9To change the weight of a coin (“debasement”) is analogous to the modern forms of devaluation. While, as we shall see presently, the expression “changes in the gold contents of a currency unit” is open to criticism, it shows at least clearly the analogy in question. But what Sovereign Prince of the days gone by would have accepted an international undertaking never to debase the currency? And even if he did accept it, this would be an analogous matter to the type of international monetary convention mentioned in an earlier part of this chapter. The Latin Union was to some extent an example of a limited convention of this kind. But it all goes to show that not even a general limitation of monetary circulation to precious metals would automatically insure a system which would work internationally in the same manner as a monetary system works within a country in regulating the supply of money in the different regions.
• 10loc. cit., pp. 270–80.
• 11Cf. my “Monetary Internationalism and its Crisis”, a chapter in The World Crisis, London, 1938, pp. 348 et seq.
• 12I expect to discuss it at considerable length in my book on the Theory of Banking which is in the course of preparation.
• 13For example England, the United States, etc. Vide infra, chap. ix.