The Stock Market, Credit and Capital Formation

CHAPTER X

A DIGRESSION ON INTERNATIONAL SPECULATION

69. We are all familiar with the important rôle assigned to national boundaries in the analysis of economic matters. Trade in commodities, loan transactions and transfers of property between the citizens of different countries are usually treated separately, and from quite a different angle, from the same economic relationships between citizens of one and the same country. It is natural then that we should usually think of transfers of securities between domestic holders and foreign holders as being different from transfers between co-nationals. Incidentally, it would be advantageous for purposes of analysing economic relationships if we were to drop the habit—much fostered by nationalistic propagandists—of talking about actions of “this country” and the “foreign country,” when what is meant is the business operations of citizens of the countries concerned.

International transactions are treated differently from domestic ones,—

The rôle played by national boundaries in the existing body of economic doctrine hinges on two different points: The first is the view that international trade functions according to certain special laws of its own, a view which has led to the belief that the laws governing exchange in general are inapplicable to international exchange. The second point consists in a value judgment according to which the welfare or wealth of communities separated by state boundaries is to be evaluated in a different manner, and the exchange between two nationals of different countries has to be considered in the light of whether it is “advantageous” to the country concerned. The second point is not open to dispute on scientific grounds, because the purpose of science is to analyse interrelationships independently of value judgments and merely to formulate propositions which apply, no matter what system of political or ethical values may be introduced. The first point reduces itself to the proposition that in international trade certain conditions are present which are not present in the case of trade between nationals of the same country. The most important of these conditions are obstacles that are placed in the way of international trade by state intervention, e.g., restrictions on immigration, import restrictions, currency and credit manipulation. What has made problems concerning financial transactions between countries increasingly complicated is the special techniques of manipulating the monetary and credit system which have been developed to cope with various pseudo-problems of international monetary theory. I am thinking here mainly of the famous international transfer problem.1

—partly because of value judgments,—

—partly because of obstacles to international transactions,—

—which are most often due to state intervention.

Financial journalists find something to criticize in every possible aspect of international capital movements. Every investment abroad—even when it yields profits—is held guilty of robbing industry at home; every investment by foreigners—even if it does not always yield profits—is denounced on the grounds that foreigners are getting hold of too much financial control. Objections are raised both against the citizens of the home country who “gamble their capital away” on foreign stock exchanges and against speculation by foreigners who carry profits away from the home stock market.

International capital movements arouse much critical comment.

Here we can only make a few brief remarks on these views. If there were no questions of income distribution involved, we should be able to say at once that the investment of capital in the most profitable2 uses, no matter whether at home or abroad, can never be harmful to the collective well-being of the “economy” concerned. But it is practically impossible to avoid these questions of income distribution in considerations of this kind, and it is then impossible to find an “index of welfare” which is free of value judgments or which is unconnected with political aims. As regards the gains or losses that are made in international speculation, all that we can say is that the chances which domestic owners of capital have of making profits or losses on foreign stock exchanges are fundamentally neither smaller nor greater than the chances which foreign owners of capital have of winning or losing on the stock exchange of “our” country.

70. There are, however, two objections against international speculation and international lending to stock exchanges, which merit closer examination.

The first of these objections runs in the following terms. Even if we are assured that the funds placed at the disposal of the stock exchange really do flow into industry and so are neither lost nor absorbed nor held up on the stock exchange, it must be admitted that when funds are used for speculation abroad it is not industry at home that receives them.

Objections are raised against an outflow of funds for speculation abroad.

This is not necessarily so. The funds which flow to a foreign stock exchange are not under all circumstances taken away from home investment, for the reason that stock exchange speculation is not always limited to “domestic” securities. It is perfectly conceivable that short-term funds belonging to Germans (prior to the introduction of capital punishment, of course) may be employed on the New York securities exchange, and if there is an active demand for German securities on this exchange new issues may be floated for German account. This process—“short-term lending to foreigners” accompanied by simultaneous “long-term investment by foreigners”—is not only conceivable but is an everyday occurrence, and the extent to which money goes abroad in the form of stock exchange loans and comes back as long-term investments is not small as can be seen from the statistics of the capital exporting countries (e.g., the pre-depression statements of the balance of payments published by the United States Department of Commerce). Of course, it need not happen that the long-term investments will be made in just the same places as those from which the short-term funds came. The money capital which flowed from the German money market to the New York securities markets may be invested in South American stocks. It all depends on the relative earnings prospects. In principle it is no different from the case where stock exchange credits originating in Sussex are used to finance industry in Middlesex: industrialists in Sussex might then complain that lending on the stock exchange had taken money capital away from them. If industry in Sussex had previously been accustomed to receive a steady flow of money capital and this capital started to flow to other places, then the volume of production in Sussex would most probably be affected: this would, however, be not because the stock exchange had greater powers of attraction but because the stock exchange estimated that earnings prospects were better in Middlesex than in Sussex. To extend the example again to the case of larger geographical areas: it would not be the New York Stock Exchange which competed with German industry, but South American industry which was able to attract German funds via the New York investment market.3

Money capital loaned out to foreign security markets may return—

—as sales proceeds from domestic securities sold abroad,—

If the funds which flowed onto a foreign stock exchange do not return in the shape of long-term investment by foreigners, they will sooner or later return in the form of a demand for goods or services. It is not, of course, quite immaterial which one of the two things takes place. In the one case the money capital is made available to a domestic producer who is thereby enabled to undertake investment and may buy machines, for example. In the other case the money capital goes to a foreign producer who also procures machines. Thus the new machines will be abroad rather than at home. However, they may be bought from the same factory. And from the point of view of the factory which produces the machines it may be the same whether an order comes from home or from abroad. But it is an old proposition of international trade theory that the money may “come back” from abroad in the form of payments for entirely different things, e.g., consumers’ goods or raw materials, or through a decline in imports. In this case the machine factory in our example will not get an order. Furthermore, the possibility that the “return trip” of the money from abroad may be delayed, and that the circulation may in consequence be reduced for many months, is the one circumstance which gives the objection its justification though less than is usually assumed.

—on as sales proceeds from exported capital goods,—

—on any other exports,—

—but its return may be delayed.

71. The second objection, in contrast to the first, concerns the import of capital. It is directed against the effect of the inflow of short-term foreign capital in strengthening the tendencies towards a speculative boom on the home stock market. The boom which has been nourished by the foreign funds is, it is said, bound to break when the foreigners withdraw their funds. This is true whether the foreign funds have been used for stock purchases or for stock exchange credits. The withdrawal of stock exchange credits exerts a depressive effect on the securities market. The bulls find it hard to finance their holdings any longer and thus try to liquidate them by selling. The fact that some speculators or investors, whether foreigners or nationals, suffer capital losses in this way is as such of minor importance (in view of what has been said in Chapter V). If, however, the withdrawal is capable under certain circumstances of producing a setback in the volume of production this is a more serious problem. The credits lent to the stock exchange by foreigners did not remain on the stock exchange. They flowed into industry. The withdrawal of funds from the stock exchange cannot take the money capital that has once been invested in production out again; it has been absorbed in capital goods. The outflow of money capital cannot therefore proceed at the expense of the existing capital equipment; it can only be financed out of new supplies of money capital which are consequently prevented from entering into production. This may make it difficult for the producers’ goods industries to sell their products unless they are able to find a market in those places abroad to which the money capital recalled has flowed.4

Objections are also raised against an inflow of foreign funds;—

—which may first feed the boom and later, when withdrawn, starve the capital market,—

—thus precipitating crash and depression.

The sudden withdrawal of foreign funds is usually objected to most strongly on the grounds of its deflationary effects. It is true that at least in the short run the quantity of circulating media will be reduced. In any case the sudden withdrawal will cause a diminution in the available supply of loanable funds. Since the level of production is sensitive to diminutions in the supply of money capital it is understandable that a “short visit” of foreign capital will not be particularly welcome. After a period of abundance of money capital, current investment would suddenly be reduced to a smaller scale and it is likely that this would be accompanied by wide disturbances and real losses.

The withdrawal may reduce both the supply of money and the supply of money capital.

Central banks have repeatedly made the attempt to follow a monetary policy which is more or less consciously aimed at compensating such sudden inflows or outflows of speculative foreign funds by measures of credit policy. Quite recently5 this “offsetting” policy has been attempted systematically by the United States Treasury in its “gold sterilization” programme. The gold which was imported in connexion with the inflow of speculative foreign funds was bought not with newly printed gold certificates (or, more specifically, with deposits obtained for gold certificates), but with borrowed money. Thus the Treasury Department met the increased supply of money capital with an increased demand for money capital. If a sudden withdrawal of foreign funds occurs and the Treasury sells gold, it can use the sales proceeds of the gold to buy back or redeem its debts, and thus put funds at the disposal of the money market. The money capital which is paid out to the foreign creditors (investors or speculators) is in this way replaced by the funds supplied by the Treasury in repaying its debts. Analogous operations are performed by the British Exchange Equalization Account.

Monetary authorities try sometimes to offset the flow of foreign balances;—

—the sterilisation policy of the U.S. Treasury neutralized the effects on the money market.

The possibility of speculative movements of short-term capital occurring, and producing disturbing fluctuations in the quantity of money, was often used as an argument against the gold standard and against stable exchange rates. A number of writers have advocated flexible exchange rates on this ground. The circumstance that movements of capital would raise the exchange rates of the country to which the capital was flowing and lower the exchange rates of the country from which it was flowing seemed to these writers to be a lesser disturbance. They greatly underestimated the importance of exchange stability in international trade and of foreign trade itself to the economy as a whole.

The new policy of offsetting what are presumed to be temporary “visits” of foreign capital is an interesting compromise between the mechanism of the nationally managed currency and that of the gold standard. Under the so-called “automatic” gold standard an inflow of capital leads to an increase in the circulation while exchange rates are kept stable; under the “independent paper currency” an inflow of capital leads to a rise in the exchange rate while the quantity of money remains constant; under the new system the attempt is made to keep the exchange rates stable and to keep the quantity of money constant, or rather to make it independent of the movement of capital. The repatriation of foreign capital leads under the automatic gold standard to a diminution of the monetary circulation, and under the independent paper standard to a fall in the exchange rate; under the new system both the monetary circulation and the foreign exchange rates are held constant.

The modern offsetting policies seek to combine features of the gold standard and of independent currencies:—

—both exchange rates and circulation are kept immune against the effects of capital flows.

The chief weakness of this “offsetting system” is that it is impossible to know beforehand whether the capital which flows in is going to remain for a short time or a long time. Interference with the normal reactions to movements of capital when investments of longer term are concerned would probably call forth more serious disturbances than those which would be connected with the unhampered reactions to capital which moves in and out again within a short period. Moreover, the size of the movements of short-term capital will be much greater under the offsetting system than they would otherwise be, because the normal reactions produce price adjustments which tend to bring the flow of capital to an end, or even to reverse the flow. Yet, when the presumption is very strong that the inflowing foreign capital is “hot money,” which is apt to be withdrawn at any moment, then the offsetting operations of the exchange equalization funds are clearly suited to their purpose.

Another policy which has recently been discussed is the proposed application of fiscal measures. It is suggested that special taxes be levied on profits or even on the amount (turnover) of capital invested on the home securities market by foreigners, with the object of diminishing the attractiveness of speculating over the short period. Whereas the monetary measures mentioned previously aim at compensating the effects of capital movements, fiscal measures are designed to diminish the volume of capital movements by frightening off foreign owners of capital. This policy would be in harmony with most of the state intervention philosophy of the last decades: the mobility and flexibility of economic factors is diminished in the interests of what is hoped will be greater stability.

It has been suggested that foreign short-term capital should be frightened off by special taxation.

If, however, we inquire into the causes of the inflow of speculative capital from abroad which is so much objected to, we shall often find that it was the boom tendencies that were already present on the stock exchange which attracted the foreign funds. La hausse amène la hausse. The beginnings of the speculative boom originated in a flow of money from domestic sources. And as it is extremely difficult to conceive of a sudden epidemic of saving, we are once again driven back to credit expansion by the banks. It is the “domestic” creation of credit which usually produces that sentiment on the stock exchange and that movement of stock prices, which act as an invitation to foreign funds.

Usually the boom is started by domestic credit inflation,—

—and merely accentuated by foreign participation.

The occasions when the short-term foreign funds flowing onto the stock exchange are to be regarded with real mistrust are when these funds owe their existence to a credit inflation abroad. In this case they bring the foreign “business cycle germ” into the home country.

It may happen, however, that a boom is started by foreign inflation.

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