Bankers and Credit/Chapter 5
December 31, 1919 was the real turning point in our war finance, for it was the date on which our rulers went back to the good old habit of providing for expenditure out of revenue. It is true that for some years more they had to be very generous to themselves in their interpretation of the word revenue in order to achieve this feat, because included in their receipts were huge sums realized by the sale of assets that had been bought with money that had been borrowed during the war; and anyone who likes to be pedantic in book-keeping can argue that these sums were not revenue at all but receipts on capital account, the whole of which ought to have been devoted to debt redemption. Whereas, in fact, out of the £724,000,000 received from special receipts during the financial years ending March 31, 1920, 1921 and 1922, only £276,000,000 were available as surplus to redeem debt and the balance went to the relief of taxation.
It was not until the fiscal year 1922-23 that the amount of debt redeemed was greater than the sum produced by the sale of war assets, and then only by accident. For that was the year in which Sir Robert Horne played a glorious farce with the nation's finances by first proposing, in order to reduce taxation, to pay off debt with borrowed money, and then being smothered by a surplus of £120,000,000, owing to enormous errors in estimating for which he, of course, was not responsible.
But whether the Government paid its way out of revenue, or by selling capital assets, the fact remains that after the end of 1919 it followed the sound doctrine of the Cunliffe Committee and committed no further borrowings, and indeed redeemed debt rapidly. The result was that there was no more expansion of currency and credit due to loans from banks to the Government or to customers wha borrowed money to lend to the Government. A certain amount of temporary inflation happened from time to time, especially at dates when very large interest payments had to be made, because the Treasury, being unable to finance its needs out of ordinary receipts or by the sale of Treasury Bills, had to raise money by Ways and Means advances from the Bank of England, so producing an extra supply of "cash at the Bank of England" for other banks, and expanding not only credit but the basis of credit. But these expansions were soon corrected as revenue came in and the newly made credit was soaked up by the sale of Treasury Bills, and the Bank of England and the Treasury evolved ingenious dodges for modifying their extent and effect. In fact, deflation may be said to have begun by the reduction of the Government's indebtedness to the Bank of England on temporary advances to zero, and by endeavours to keep it there as far as possible. Henceforward if inflation happened, it was not because of bad finance by the Government, but only because of demands for credit by industry and commerce, and other private borrowers.
So here we are at a turning point and may well stop to consider what was the right thing to do with our money in view of the way in which, during and after the war, its buying power had been lessened by the increase in its quantity. Ought it to have been brought back, if possible, to its pre-war value by being drastically and rapidly reduced, or ought it to have been "stabilized"—to use the new word that appeared about this time—or ought we to have joined the ranks of those who quite seriously argued that a depreciating currency is good for trade and makes everybody happy, that Germany was driving us out of the markets of the world because the mark was falling in value, and that more inflation was the statesman-like prescription?
I think there was a feeling among us men in the street, especially those of us who were hoary headed and old-fashioned, that the British pound of which we had been perhaps ridiculously proud, had suffered a most unworthy outrage at the hands of politicians who ought never to have been allowed to meddle with it, and that it was due to the British pound's dignity to try to put it back to something like its old purchasing power, and at least to make it once more a gold certificate and not a mere Governmental shin plaster, with its value at the mercy of political dishonesty and cowardice. It was only by bringing back the gold standard that we could hope to give to our money that degree of steadiness in value that had won our confidence before the war and had encouraged us to lend or invest it in the expectation that when it was repaid or we turned the investment into money again, the money would not cheat its owners by fetching only half as much as before, because the Government had debased it by making too much of it.
Steadiness was what we wanted in the buying power of our money, modified by a very gradual return towards its pre-war value and the restoration of the gold standard. This desire for a return towards pre-war value of money—or pre-war level of prices—was based on the view that the rise in prices had inflicted a great injustice on salary earners and wage earners and owners of fixed incomes who had not been able to expand their incomes as fast as it went, and that the rise had also put unearned and often unsought profits into the pockets of those who from the nature of their business, had to keep a stock of goods in hand. In other words it had, instead of laying the war sacrifice on the shoulders of all in accordance with their ability to bear it, as is roughly done by graduated direct taxation, made its burden unequal, and especially heavy for those least able to carry it. Since this injustice had been done, there was something to be said for the view that it should be partially amended by a reversing of the process by a fall in prices.
My own opinion was that a very gradual fall in prices was wanted for these reasons, but that anything like violent measures was the last thing that the occasion needed. It seemed to me that all that was needed was for the Government to forswear financial sack and live cleanly, paying off debt out of revenue; that artificial efforts to deflate in a hurry might do as much harm as inflation; and that what was wanted was that the volume of currency and credit should be kept steady and that the gradual fall in prices, for which justice seemed to call, should be brought about by an increase in the volume of goods, which should very slowly restore the proportion between goods and money to something like that which had ruled before the war. To Professor Cassel, a Swedish economist who has won world-wide fame by his handling of after-war monetary problems, this method seemed to be a "particularly vain expectation." (World's Monetary Problems, page 63.) But he comes on our scene later.
In the meantime much more drastic measures seemed good to the powers that ruled us, and to an important body of lofty browed opinion among the economic theorists. It has already been recorded, at the end of the last chapter, that in November 1919 the Bank Rate was suddenly put up from 5 per cent. to 6 per cent., with a corresponding advance in the rate of discount at which purchases were invited of Treasury Bills, which were then put up for sale in weekly batches at a rate fixed by the Treasury. No special demands for credit from the Bank of England accounted for an increase in its price for accommodation; no shyness on the part of buyers of Treasury Bills made it necessary to tempt them with the bait of the lower price that is implied by the higher rate of discount. The export of gold having been forbidden, save under licence, fear of a foreign drain on the Bank of England's Reserve could not be alleged as the cause of this eccentric movement.
Bank Rate was thus recognized as a moral weapon to bring back to its senses a country given over to an unwholesome fever of speculation. Rapid deflation was the order of the day. Contraction of credit and currency was to be secured by rising rates for money and was to bring about a rapid fall in prices that seemed to great minds to be the logical sequel and correction of the previous rise. The ideal aimed at had been very forcibly expressed by one of our most distinguished economists, Professor Cannan, who had observed in the Introduction to his Paper Pound of 1797—1821, published in 1919, that "when the scales at last fall from the eyes of the people of Europe, groaning under the rise of prices, they will no longer cry to their Government, 'Hang the profiteers,' but 'Burn your paper money and go on burning it till it will buy as much gold as it used to do!'"
To minds mathematically inclined and accustomed to weighing abstract problems in the perhaps rarefied atmosphere of an economist's armchair, this conclusion would naturally seem to be impregnable. Inflation and the increase of money by the printing press and the consequent rise in prices had produced chaos. Therefore the way to bring back order was to reverse the process and bring in deflation, the destruction of money by bonfire and a consequent fall in prices.
There were, it is true, some awkward details to be filled in before the scheme could become practical; for instance we had to be told how the Government was to be sure that it would not be obliged to issue new notes as fast as it burnt the old ones, because the consequent stringency in the Money Market was obliging holders of maturing Treasury Bills to insist on their being paid in legal tender. And those of us who had objected to inflation on the ground, among others, that it produced a disease, the cure of which might be as dangerous as its progress, might well ask our theoretical dictators to pause before applying logic too ruthlessly to real life.
The logic of the matter was very ably put by Professor Pigou of Cambridge, who in a letter to the Times printed in its issue of February 12, 1920, urged that the Bank Rate, which was then 6 per cent., should be immediately raised to, and held at, 8 per cent., and that steps should be taken to make this rate effective in the market. He showed that we were suffering from the effects of speculation, credit expansion and high prices and that dear money was a check on all these evils. "That European nations, and England among the number, with the enormous losses they have sustained should have money at 5 per cent. and 6 per cent. while the United States and Japan with an incomparably smaller need for new capital should have very much higher rates is a financial paradox which it is impossible to sustain." And he maintained that "it is useless for the Government to squeeze out the part of the credit expansion for which public borrowing is responsible if money is kept so cheap that a reduction in credits created for Government is balanced by an increase in credits created for private persons." Against the suggestion that the contraction of credit, if necessary, could be much more cheaply brought about if the banks would agree to ration their customers, Professor Pigou urged that it was not possible to expect the banks, at the expense of their own profits to refuse credit to customers of good standing who offered sound security.
Theoretically it was a strong case admirably put and practically the suggestion of a high Bank Rate was a great improvement on Professor Cannan's bonfire, to be continued till the Bradbury was as good as gold. Nevertheless, there was on the other hand a case to be made for the view that violent action through Bank Rate meant the application, at a time when violent measures were not at all wanted, of a remedy which had been, when gently used, a successful cure for overtrading in different days and under different circumstances. Any bill broker's clerk could have told the Professor that the sudden rise of 2 points in Bank Rate which he desired to see, during the last quarter of the financial year when the big tax payments always leave the market cold and shivery like a fleeced lamb, might very likely have produced panic. A rise of more than a point in Bank Rate was quite abnormal, and might easily have led the City to suppose that all kinds of horrors were upon it. He may have thought that panic was the only way to save us, and this was certainly the view at that time, of certain eminent theorists. But panic is easier to start than to stop.
Without panic Bank Rate seemed at that time most unlikely to produce the desired effect. In old days it had been effective in small doses because profits were finely calculated, and all the conditions that entered into the consideration of those who were carrying on business were so well balanced that a marked change in any one of them was sufficient to divert the course of trade and traffic. Then, a rise in Bank Rate from 5 per cent. to 6 per cent. and then to 7 per cent. might really have been an important factor in the calculations of producers and merchants. But in 1919, and in the first quarter of 1920, the rise in prices was so quick and looked so unending, and the profits that it was pouring into the pockets of all who produced or handled goods were so fat, that a rise of a few points in Bank Rate and consequently in the price of the credit that they wanted, was almost an irrelevant detail in the calculations of those who were conducting enterprise.
They had to have money, or thought so, whatever it might cost them, because "the pace was too good to inquire" about a minor item in the prospective balance sheet like the cost of money, when whatever they bought with it soared up fast enough to cover its cost and leave plenty of margin, and when orders were so plentiful at any price that they chose to name that many of them found it necessary to invent ingenious devices for avoiding customers whose needs they could not satisfy.
Later on when the wind blew on the other cheek and prices were falling like a stone, and buyers were not in battalions or even in single spies, but had vanished from the face of the earth, the price of money was equally irrelevant for a different reason. Producers and merchants had to have it then, because they could not sell their goods and in all countries the buyers who had bought so gaily were repudiating contracts and refusing to take delivery, and an insatiable demand had given way to glutted stagnation. And so those who had goods in hand had to have money whatever it cost, because they simply could not sell them and were forced to carry them on credit. And so Bank Rate and the Treasury Minute, which was supposed to set a limit on the note issue, had no visible effect according to the testimony of available figures, in contracting credit, because credit could not be contracted until the stock of unsaleable goods was gradually worked off.
Professor Pigou's grievance against the banks they were expanding credits for private persons and so defeating the effect of the Government's action in squeezing out part of the credit expansion due to Government borrowing, was one of which the unfortunate bankers, who had so often before been told that they must cultivate a spirited and venturesome policy during the transition period from war to peace, now heard a good deal. This action of theirs really had a good deal to be said for it. Credit expansion created for the Government's use is, except as a purely temporary measure, bad and cowardly finance, because the Government is not engaged in production and so fresh money made for it cannot, from the nature of the borrower, lead to the making of fresh goods to restore the balance between goods and money, and so is certain to swindle all owners of the money already existing. But when credit made for Government is paid off and the banks' balance sheets are to that extent cleaned and lightened on both sides, it is not necessarily a bad thing for new credits to be given by the banks to private borrowers because there is a good chance that most of the new money will be used in enterprise and production, and this is especially so at a time of abounding trade prosperity when producers are making big profits. By this process deflation of credit is certainly defeated, but on the other hand trade is kept active and the fall in prices which was the object of the deflation is produced in a much more satisfactory manner by an increase in goods accompanied by no increase in money, since the new money merely replaces the Government money that had been cancelled.
Bankers, however, were severely lectured at the time by politicians and officials who thought they knew best about the needs of business, and contrasted, as did Professor Pigou, the highly meritorious action of the Government in reducing, as it began to do after the end of 1919, the credits that had been created for it during and after the war, with the nefarious policy of bankers who made the Government's action "useless" by giving fresh credit to customers. One day a banker turned on one uf these official lecturers and showed that not only were the bankers justified in their policy but if they had not carried it out the Government could not have effected the much boasted contraction. For the margin of revenue over expenditure which enabled the Government to redeem debt and cancel credits was not produced by genuine taxation, but, as shown above, by the sale of assets; and the Government could not have sold these assets if the bankers had not lent their customers the wherewithal to pay for them. So that all these scoldings of the bankers were based on ignorance of what was really happening.
As to Professor Pigou's demonstration that it was hardly possible to produce a contraction of credit by means of rationing, since bankers could not refuse the demands of good customers for advances, especially when it was against their own interests to do so, the fact nevertheless remains that it was just this process which first checked and finally reversed the expansion of credit. There was no definite system of rationing but the banks did succeed in bringing home to their customers the need for moderating their demands for credit and for contracting the accommodation that they had received by reducing advances, as soon as sales of goods began to be possible at a lower level of prices. It was this action by the banks in persuading their customers that unlimited expansion of credit had to stop, that stopped it far more than the rise of a couple of points in Bank Rate. Banking figures went on expanding long after the rise in Bank Rate and only contracted appreciably when Bank Rate was being reduced again. It was not dear money that put the brake on, but recognition by bankers, and their communication of this conviction to their customers, that a brake was needed: though it is quite possible that the rise in Bank Rate helped to produce a state of mind which enabled the banks and their customers to reach and act on these conclusions.
All this had to be recalled firstly because these things are very relevant in view of the now fashionable doctrine of economic salvation through Bank Rate and also because the Bank of England and the Government are often unjustly accused of having produced by means of their dear money policy the depression and unemployment from which we are still suffering. The only certain effect of their dear money policy was that the poor old taxpayer had to pay a few millions more than he need have done, because the authorities saw fit, in order to cure the country of a naughty fit of gambling, to issue Treasury Bills on terms which were more expensive than they need have been. What really stopped the feverish activity of trade and the mad rise in prices—which was partly due to the fact that in order to secure delivery people got into a habit of bidding for two or three times as much stuff as they wanted—was the discovery by the consuming public that it could not stand the pace, and its determination to stop buying until prices had stopped rising.
This "consumers' strike" began in America and was imitated, with less definite organization but with equal determination, in this country; but it was the Far East that first reminded the rest of the world that rising prices were not a necessary part of the scheme of the universe. The Chinese saw fit, on political grounds, to boycott Japanese goods, and there was a quick tumble in the Japanese silk market which reacted on America and brought hope to the hearts of millions of consumers, who for years had been fleeced by the bad finance which had debased the currencies of the world, and now at last saw that lower prices were a possibility. But the trade relations of China and Japan certainly were not influenced by the Bank Rate policy of the Bank of England or the United States Federal Reserve Board.
Very interesting evidence on this point was given by the Hon. Benjamin Strong, Governor of the Federal Reserve Board of New York, before a United States Congress inquiry, held in August 1921, apparently because it was claimed that the policy of the Federal Reserve Board had been injurious to American agriculture. Governor Strong told the inquiring Commission how the speculative tendency had, in 1919, worked up into "a veritable orgy of extravagance, waste and speculation; there was in fact competition to buy anything at almost any price. This culminated in the early summer of 1920. Now the first rumblings of a coming break appeared in March and April of 1920, in Japan, where I happened to be travelling. I was there at the height of their period of liquidation and distress and had opportunity to observe on the ground exactly what was transpiring. It has frequently been said that the percussion cap which started distress in Japan was the sudden cessation of the demand for silk in the United States. I do not think that is quite accurate. The Japanese exporters had suffered misfortune through various causes and a very wide and effective propaganda in China, boycotting Japanese goods. And I was told of vessels that were held up in Chinese ports, not being able to unload their goods; and that was also coincident with the cessation of the buying of silk in this country. This reaction extended from Japan into China, the Dutch Indies, India and Egypt, and the same conditions prevailed generally throughout the East."
This evidence given by the Governor of the New York Federal Reserve Board is, in fact, by far the most interesting and effective defence of the monetary policy which was followed at this critical period, both by the American and British financial authorities. It was usually asserted in the City that New York led the way and that London supported and followed its policy, but I have always inclined to the belief that New York and London acted in concert throughout. However this may be, it is most fortunate that the American inquiry produced this evidence of Governor Strong's which will, I think, some day take its place with our Bullion Report of 1810 as an historical document of quite exceptional interest. On our side of the water, we were satisfied with the majestic reticence which at the half-yearly meetings of the Bank of England provides
Where reeking London's smoky cauldron simmers,
and Parliamentary discussion of the Treasury Minute of December 15, 1919, was confined to a few back-bench bleatings. Fortunately, our American cousins "wanted to know," and Governor Strong told them all about it. Everyone interested in these matters should read his evidence in full in the "Hearing before the Joint Commission of Agricultural Inquiry, Seventy-Seventh Congress, First Session, Under Senate Concurrent Resolution 4."
Here he must be all too briefly summarized. He said that during the period of speculation and rising prices the Federal Reserve Bank's policy was to endeavour by every means at its command to arrest this development, but the atmosphere of those days created difficulties. "The people had economized for two-and-a-half years and they wanted now to enjoy themselves." Moreover in finance the war was far from over "because we had still ahead of us a loan which at that time we felt would be about $6,000,000,000—the Victory Loan." Governor Strong went on ta describe how in the summer of 1920 when the public stopped buying it was just like closing the outlet of an elastic pipe, with the water being constantly forced in at the other end. "The pipe will certainly expand," and it did. Consumption stopped at the point of retail distribution but production at the point of origin still continued and "during this period goods piled up all along the line." Raw materials immediately fell and "that is the characteristic of periods of depression that the first to suffer collapse in prices is the producer of raw materials." During this period of decline and of "backing up of goods" the loans of the Federal Reserve Bank did not decline. "The curve of prices dropped quite markedly, but the volume of bank loans continued to rise for some time before it began to go down, indicating that the first result of this curtailment of consumption was a pressure upon the banking system for credit to carry these goods and a decline of the curve representing bank loans could only be expected when consumption began and debts were paid." And this continued rise in bank loans was actually encouraged by the Federal Reserve Board. It had to be so because if the banks had not given the necessary helping hand to industry and commerce there must have been widespread disaster. Governor Strong states frankly that during this period of declining prices "our policy was designed to encourage the extension of needed credits."
Thus out of the mouth of this witness whose knowledge of the whole course of events is from the nature of his office unrivalled, we learn that the tumble in prices began in the Far East and spread to the rest of the world, which does not look as if advances in money rates in London and New York had much to do with it; and further, that when the tumble was in progress the New York Federal Reserve Bank was busily encouraging the extension of credits. And this shows very clearly that the fall in prices was not caused by any contraction of credit because credit was officially encouraged to expand, certainly in New York, and probably in London also.
We thus have very valuable evidence for the view that the rise in money rates here and in New York at the end of 1919 and the beginning of 1920 did not cause the fall in prices and the check to speculation, or if it did, it did so through psychological suggestion and not by any means of credit contraction, because credit contraction did not happen. And this evidence is all the more important because it is given by a banker who nevertheless believes that the policy of raising rates was right. He admits that "in many directions we were like prophets crying in the wilderness. We could not stop that rage of speculation by any means at our command, at least so it appeared at that time." Nevertheless, "I believed then, and I believe now, that the basis, the fundamental basis of restraint upon speculation rests upon the cost of credit, and that the policy of raising our rates was necessary and justified, and without the adoption of that policy this expansion which took place would have gone to unparalleled levels."
But surely cost of credit can only restrain speculation by making speculators think that if they have to pay so much for credit the game is not worth the candle and consequently closing their commitments and reducing credit by paying off their loans. But this did not happen either here or in America. As long as prices rose, speculators did not want to close their commitments. When prices fell, they could not close them. And we must always remember when we take measures for checking speculators by means of money rates that we run the risk of checking, at least as effectively, the real producer. If we take the heart out of him, it means a lessening in the effort which increases the real wealth of the world, and he with the strict attention to business details which means so much for his success, seems much more likely to be put off his stroke by an item like the cost of money, than the free and easy speculator who is used to making big guesses on broad lines, and then backing his opinion in glorious self-confidence.
Interesting as is Governor Strong's evidence on the course of events and the purposes aimed at by the Federal Reserve Board, he does not quite convince one that in the exceptional circumstances that prevailed at the end of 1919 and the beginning of 1920, the rise in money rates that was actually brought about was a serious factor in the calculations of business men, or even that at any time "the fundamental basis of restraint upon speculation rests upon the cost of credit." Surely if a man thinks that by buying a security or a commodity or a currency he gets a good chance of being able to sell it in a few months at double its present value, he will be quite ready to pay 20 per cent. or even 50 per cent. for any money that he wants to finance his gamble; and such a movement as a rise in Bank Rate from 5 per cent. to 6 per cent. and then from 6 per cent. to 7 per cent. would have been quite ineffective, had not other events caused speculators suddenly to remember that rising prices sometimes stop.
This point of view was very ably put by another eminent American authority, Mr. Albert Strauss, an ex-Member of the Federal Reserve Board. Speaking in May 1922 he said "Booms and depressions are caused by hope of higher and fear of lower prices, whether of commodities or of securities. The hope of higher prices leads to demands for funds for the purpose of purchasing in anticipation of a rise; the fear of lower prices leads to repayments of loans with the proceeds of sale in anticipation of a fall of prices. No rate, however low, will tempt borrowing for the purpose of purchasing a commodity whose price is believed too high—and broadly speaking, no rate, however high will, by reason of its being high, restrain borrowing intended for the purchase of commodities which are believed certain to rise. A high interest rate will often deter borrowers because it is taken as a warning that commodity prices are regarded as too high or that money may become unobtainable at any price. It will serve as a concrete expression of opinion by those best qualified to judge as to the reasonableness of the general level of prices."
Quite so, and this being so, it should surely have been possible to warn speculators and the public and all other parties concerned that prices are regarded as too high, by some less expensive method than the one which involved selling cheap Treasury Bills at the expense of the taxpayer and making the real producer and trader pay more for money in order to convey a roundabout warning to the speculator which he blandly ignored until a Chinese boycott of Japanese goods upset the silk market and tumbled over the whole house of cards. In old days when Bank Rate went up it meant that a gold drain was occurring or expected and a gold drain meant that there was less money in the country, and that borrowers whatever price they liked to pay, would have to have less. And so it was a very real warning. In 1919 and 1920 there was no question of a gold drain, and rises in Bank Rate, whatever other effects they may have had, certainly did not cause contraction of credit.
Just consider these few facts. Bank Rate was 5 per cent. when the war ended in November 1918. It rose to 6 per cent. in November 1919, 7 per cent. in April 1920 and stayed there until April 1921, then declining by easy stages to 3 per cent., which it reached in July 1922. Prices of commodities reached their highest point in March 1920 and then fell with unparalleled quickness, but gradually slackening pace, until September 1922. The decline, during the last eighteen months of its course, was thus accompanied by a fall in Bank Rate from 7 per cent. to 3 per cent. Bank deposits in the United Kingdom—the nearest approach that we have to a test of the extent of credit—stood at £1,032,000,000 at the end of 1913, according to the Economist's tables, and were £1,988,000,000 in 1918, £2,356,000,000 in 1919, and continued to expand until the end of 1921 when they stood at £2,527,000,000 utterly refusing to obey the behest of Bank Rate and contract when it went up. Contraction happened in 1922, when they came down to £2,362,000,000. And this was the year when they were being urged to expand by Bank Rate, which came down from 5 per cent. to 3 per cent. Surely these facts and figures looked at together make it most difficult to believe that prices and credit, industry and enterprise are merely "a pipe for Bank Rate's finger to sound what stop she please."
Nevertheless, in trying to show that the United States Federal Reserve Board and the Bank of England and the British Treasury had, in raising rates, done something which was largely ineffective, very costly and rather futile, we are much kinder to them than the critics who think that Bank Rate is in fact all powerful and that it was the main cause of the after-war gamble by not having been put up, and of the subsequent depression by not having been put down again. In February 1922 a paper was read before the Royal Statistical Society by Mr. R. G. Hawtrey, distinguished even among the brilliant band of our Treasury officials by reason of his eminent abilities which he has applied to the elucidation of monetary problems in works which are classics as soon as they are published. His paper was headed "The Federal Reserve System of the United States" and has now been republished in a volume entitled Monetary Reconstruction. It was an attack, suave and courteous, but almost impassioned in its earnestness, on the handling of the monetary situation by the Federal Reserve system. He charges it with having tried to cope, in 1919, with a menacing situation by tentative and hesitating steps, and though he thinks that the raising of its rediscount rate to 7 per cent. in June 1920 was at last successful and turned the tide, yet "the ebb had to be proportioned to the flow. In so far as the expansion had got out of hand, the subsequent contraction had to be more severe." Later on he says that "the whole world has been plunged into the most appalling distress for nearly two years by the strain of raising the commodity value of the dollar 80 per cent. . . . How did such a mistake ever come to be made? The explanation is, I think, simply that the working of the 'vicious circle' of deflation was not understood. It was not realized that a deterrent discount rate, once it had taken effect, can safely be reduced."
This is surely a most interesting example of the success with which a really philosophical mind can detach itself from the facts of life, and can isolate certain items that interest it and subject them as if in an imaginary test tube to experiments that have no connexion with practical existence. Anyone reading Mr. Hawtrey's paper might suppose that the war had only inflicted loss on humanity by disarranging the currency system and that all the miseries of the after-war period were due, not to bad temper, a bad peace and the failure of European politicians to let their countries get back to work, but to the slow and tentative steps with which the United States Federal Reserve Board raised its rediscount rate and its failure to see that the rate might come down again much sooner than it did. Surely Mr. Strauss was much nearer the truth when he said "no rate, however low, will tempt borrowing for the purpose of purchasing a commodity whose price is believed too high": and the appalling distress in which the world has lately been plunged was much more due to the bungling of politicians in this hemisphere than to the price of money in the other. If the other countries of the world had been in a normal condition with their industry and finance working smoothly and in good health, no action or inaction with regard to its rate of rediscount on the part of the United States Federal Reserve Board could have plunged them into "the most appalling distress" for nearly two years.