Bankers and Credit/Chapter 9
Finished and delivered by the end of August 1923, the foregoing chapters, for very good reasons over which the writer had no control, went into cold storage for four months. Usually, cold storage has an even worse effect on the freshness of financial script than on that of chilled beef. But in this case the delay in publication brought with it several advantages. It enables me to record certain interesting developments in the stabilization theory and to show that, at least in one instance, the plea for stabilization looks very like our old friend inflation in disguise; and to refer, though briefly and after necessarily inadequate study, to Mr. Keynes's Tract on Monetary Reform published by Messrs. Macmillan early in December. And above all, the intervening period has provided a most timely and striking example of the effect on the minds of men, both at home and abroad and perhaps more especially abroad, of a mere mistaken suspicion which made them believe that in order to cure unemployment, this country was going to adopt a policy of inflation.
This misapprehension was caused by some observations made by Sir Montague Barlow, Minister of Labour, in a speech at Nottingham on October 9. As reported by the Daily Telegraph of the following day he said: "I see it was announced in one of the papers yesterday that I was going to inaugurate and press on an immense scheme of inflation of one hundred millions sterling, and so on. Such a scheme has been put forward by no less an authority than the Chairman of Barclay's Bank, bearing the honoured name of Goodenough, and such a scheme is worth consideration, but I cannot myself plead guilty to being its author. All I can pledge you is this—that we are at work," etc. etc. It should at once be noted on the authority of Barclay's Bank's monthly review for November, that "Mr. Goodenough had not at any time made any such suggestion. Mr. Goodenough has been a persistent and steady opponent of inflation since the Armistice."
Commenting on October 17 on the sharp and sudden fall in the dollar value of the pound sterling that had followed the publication of Sir Montague's remarks, the City Editor of the Times observed that "although the occasion of the speech was not an important one, its substance was telegraphed immediately to all the chief foreign centres, and a 'flight from the pound' on a small scale began immediately." And the Economist of October 20 pointed out that "through the indiscretions of a Minister, the foreign exchange market has been able to give a very useful lesson this week of the effects of a deliberate policy of inflation. To those, among whom the Minister in question appears to be included, unaware of the sensitiveness of this market and of the basis of confidence upon which the predominance of London as a monetary centre rests, the immediate removal of funds in some cases, and the thousands of anxious inquiries from every part of the world, showed very clearly what might be expected from such a policy."
Such was the effect of a hint by a Minister, who had not hitherto been an outstanding figure in British politics, that the Cabinet proposed to drop the policy of working back to the gold standard, and to dose unemployment with inflation. In a letter to the Times dated October 16 Sir Montague repeated a statement that he had made on that day to the effect that he had been misunderstood and that no such change was contemplated; and in his speech at Plymouth on October 25 the Prime Minister dealt, in his hearty and outspoken manner, with the inflation scare. "You will," he said, as reported in next day's Times, "have seen, as I have, suggestions for creating out of nothing artificial money to finance this, that, and the other. It is not in that way that the problem of unemployment is to be tackled. There is no truth whatever in any stories that you may hear from any quarter that any Government of which I am a member will depart from what is understood in this country to be sound financial policy. It is well that this should be understood clearly at home and abroad, as great harm is being done to British credit, on which so much depends, by loose talk about inflation. People are about as accurate when they talk about inflation and deflation as they are in the use of inverted commas. We are not in present circumstances, any more than we have been for many months, pursuing a policy of active deflation, and we certainly do not propose to proceed in the direction of inflation. No such project has ever been considered."
Mr. Baldwin ended his remarks on the subject by saying he hoped this would "lay the ghost," and he had certainly done his best for that purpose. But then came the General Election with the Labour Party putting a levy on capital into a prominent place in its programme, and so the sensitive nerves of foreign holders of sterling had another uncomfortable shock. It may be very tiresome that British financial prestige should be thus affected by mistaken apprehensions, but the fact being so, it is evidently necessary for prominent people who discuss our monetary policy to do so with most careful caution and in terms that cannot be misunderstood, unless they believe that financial prestige is an overrated asset that is less important than the objects that they hope to secure.
As it was there has been a good deal of loose talking, quite enough to make the apprehensive foreigner believe that though Mr. Baldwin has effectively laid the inflation ghost as far as he and his Government can control its appearances, there is nevertheless an important body of opinion in this country which would welcome its return, re-embodied in a live and full-blooded doctrine. On October 20, Mr. St. Loe Strachey published in the Spectator, which under his editorship has maintained its great name as a thoughtful and independent leader of English educated opinion, an article saying: "We hold with financial experts like Mr. McKenna, Mr. Keynes, and others, that a great deal of the present unemployment, possibly the whole of it, is directly due to the policy of deflation," and arguing that "as long as there is unemployment the Government may safely and without thinking about foreign buyers, help trade by not frittering their money away, as Sheridan put it, by paying their debts." Mr. Strachey also submitted the article before it was published to Mr. McKenna, and so was able to print before it a letter from him in which Mr. McKenna endorsed Mr. Strachey's analysis of the financial position and added: "I am glad that you do not minimize the evils of inflation, but there can be no question that deflation is not less injurious. A policy either of inflation or deflation should never be adopted, as you say, except as a corrective, and the degree of unemployment at any given time will always furnish a test of the right medicine to be applied."
In spite of Mr. McKenna's emphatic reference to the evils of inflation, the words last quoted from him can be easily read to mean that it is nevertheless a cure for unemployment, to be applied freely when the evil is rampant. In fact, if they do not mean this, it is hard to see what they do mean.
In an address that he delivered before the Belfast Chamber of Commerce on October 24, Mr. McKenna chose his words more carefully. He argued strongly against deflation, but disclaimed any desire for inflation. "When," he said, "unemployment is greatly in excess of the normal we should abandon unhesitatingly the deflationary policy which is a cause of unemployment. But let me not be misunderstood. I do not say that a change in official policy would have the same far-reaching effect in this country as in America. Neither do I say that we should pursue a policy of monetary inflation. . . . The evils of such inflation are present to all our minds. . . . Personally I have no fear of a recurrence of monetary inflation. The high traditions of the Bank of England were never in safer keeping than in the hands of the present Governor, Mr. Norman. Neither the Prime Minister, now the Chancellor of the Exchequer, nor the Governor of the Bank of England is likely to countenance such a policy."
In a previous passage in the same address, Mr. McKenna had contended that in this country "deflation was actively continued until three months ago and still nominally stands as our official policy. . . . Our bank deposits to-day show a decline of 10 per cent. This means a severe restriction of purchasing power and a consequent lowering of prices, which is indeed the declared purpose of a deflationary policy. . . . Very little argument is needed to show that a policy of driving or keeping down prices by a restriction of purchasing power must depress trade. . . . If the merchant or manufacturer thinks that prices are going to fall, he will restrict his orders for finished goods or raw materials. . . . What is the consequence? Men and women are thrown out of employment, less is paid in wages and the amount spent upon consumption is reduced." Mr. McKenna's authority on these matters is worthy of all the respect that it so widely commands, but I still venture to submit that there is strong ground, as shown in Chapter V above, for the view that deflation did not cause depression, but followed it and was caused by it. The collapse in trade began abroad, long before there had been in England any reduction in purchasing power as measured by the volume of bank deposits. Bank deposits shrank because trade was inactive and prices were lower and credit was not wanted. The deflation of which he complains, as having been actively continued until three months ago, was the system against which he argued so vigorously in his speech to the Midland bank shareholders at the end of January 1923, by which the Government sold Treasury bonds to investors and with the proceeds bought Treasury bills held by the banks, thus reducing the banks' investments or discounts, and likewise their deposits. But if trade had been active and the demand for credit keen, this process need not have produced deflation; because the banks might have replaced the Treasury bills paid off by discounting commercial bills or increasing their advances to customers, and so the level of their deposits would have been maintained, the purchasing power in the hands of the public would have been restored and the banks would have been doing their proper business of financing trade instead of providing credit for the Treasury.
In this country, which lives so largely on its foreign trade, trade depression and unemployment are usually produced by external matters which are little influenced by our monetary policy. This is especially so at present. In the same address Mr. McKenna told his Belfast audience that "when we turn to trade we have to deal with conditions, many of which are not under your control. . . . Your prosperity rises and falls with the prosperity of Great Britain and of the world generally, and an impoverished and disorganized Europe cannot fail to react upon Belfast and be reflected in unemployment and diminished profits. . . . You, like Great Britain, are dependent in an exceptional degree upon foreign trade. . . . If we are to recover the level of activity attained before 1914, we must first of all re-establish throughout Europe the conditions of peace and stability which then existed."
These weighty words are, as need hardly be said, as true of England as of Belfast. And they surely go a very long way to disprove the contention that "a great deal of the present unemployment, possibly the whole of it, is directly due to the policy of deflation."
Sir Eric Geddes, who has earned all our gratitude by lopping with his historic axe the extravagance of our official wasters, and now speaks with added authority as President of the Federation of British Industries, was the next "star turn" in this performance. Speaking at a meeting of the Scottish members of the Federation at Glasgow on October 23, he doubted whether we could support, in addition to all the other difficulties, "the effort and sacrifice involved in a continuous appreciation of our currency." (In fact, the value of our currency as measured by the Economist Index Number has shown very moderate fluctuations since December 1921.) "We had," he said, "now been deflating our currency very heavily for a number of years. . . . There should surely be some connection between the financial policy of the country and its trade situation. The bad trade of the world was not of our making; inflation in foreign countries we could not control, but our own financial policy we could control. . . . A large number of people were jumping to the conclusion that those who proposed a reconsideration of monetary policy desired to suggest 'inflation.' He rather suspected that most of those who jumped to this conclusion had very little notion of what inflation meant, and he would suggest that they might wait until the Federation had said what it did mean, instead of accusing it wildly of all sorts of things which had never entered its head." (Times, October 24, 1923.)
Next day the Federation said what it did mean in a report addressed to the Government on the subject of unemployment and published in the papers of October 25. It expressed, among many other interesting observations on our economic difficulties, its belief that "the interests of trade and of the country as a whole will be best served by a stable monetary policy which aimed at keeping the price level steady." But this sweet draught of the pure milk of stabilization was spiced, as so often happens, by the addition of a highly important ingredient. "At the moment," the report continued, "we are at the depth of an extremely serious depression of trade. Past experience shows that in such conditions a certain upward movement in prices is an invariable and inevitable accompaniment of the process of recovery. The object of a policy of price stabilization, therefore, should not be to stabilize prices at the abnormally low level shown by the index numbers at the bottom of a severe depression, but at such an increase on this level as normal trade activity would entail."
"But?" inquired the Economist, in commenting on this report, "are prices abnormally low, and, if so, on what standard?" What the Federation seemed to mean was a rise in prices brought about by monetary manipulation. But is not this something very like the inflation which according to its President had "never entered its head"? And who is to decide how much rise in prices normal trade activity would entail? And if the rise were brought about and cheered people up, would not there be an overwhelming clamour in favour of its continuance by the same method?
And now comes Mr. J. M. Keynes, clad in the shining armour of his outstanding ability and fame, and tells us in his Tract on Monetary Reform that "the gold standard is already a barbarous relic" and that "the Cunliffe Report belongs to an extinct and an almost forgotten order of ideas." He puts the case for the gold standard into one limpid sentence. "The advocates of gold, as against a more scientific standard, base their cause on the double contention, that in practice gold has provided and will provide a reasonably stable standard of value, and that in practice, since governing authorities lack wisdom as often as not, a managed currency will, sooner or later, come to grief." He admits the remarkable success with which "gold maintained its stability of value in the changing world of the nineteenth century," but he thinks that "we have no sufficient ground for expecting the continuance of the special conditions which preserved a sort of balance before the war." He shows that during the nineteenth century progress in the discovery of gold mines roughly kept pace with progress in other directions, but in his opinion, "this stage of history is now almost at an end. A quarter of a century has passed by since the discovery of an important deposit." If this be so, those who are seeking capital for the development of what is alleged to be a wonderful new field in Canada have lively imaginations. Moreover, if it be so, the disposal of the enormous mass of surplus gold now held by the United States, which seems to Mr. Keynes to be so great a menace to us if we return to the gold standard, becomes a much less formidable problem. If it be true that no new great discoveries can be looked for, its gradual scattering over the countries of the world, as they return to peace, sanity and sound currencies, should not be a matter of overwhelming difficulty.
With regard to the other argument in favour of a return to the gold standard—that it frees us from the fear of ill-considered interference by Parliament with our monetary arrangements—Mr. Keynes's argument seems to be still less convincing. He says most truly that "experience has shown that in emergencies Ministers of Finance cannot be strapped down"; but surely that is a bad reason for turning them loose to do their worst at all times. And he adds that "there is no escape from a 'managed' currency whether we wish it or not; convertibility into gold will not alter the fact that the value of gold itself depends on the policy of the Central Banks." But it may be suggested that the policy of the Bank of England, working on traditional lines which the whole business world understood, is a different matter from a policy which is to be complicated by the deliberate intervention of the Treasury, which would be dangerously open to pressure from interested parties in Parliament.
When he comes to positive suggestions for the future regulation of money, Mr. Keynes says that hitherto the Treasury and the Bank of England have "looked forward to the stability of the dollar exchange (preferably to the pre-war parity) as their objective." His scheme "would require that they should adopt the stability of sterling prices as their primary objective." If they did so, Mr. Keynes doubts the "wisdom and practicability" of so cut and dried a system as Professor Fisher's, which is to work merely by reference to an index number, without any play of judgment or discretion. "If," he says, "we wait until a price movement is actually afoot before applying remedial measures, we may be too late. . . . Actual price movements must of course provide the most important datum; but the state of employment, the volume of production, the effective demand for credit as felt by the banks, the rate of interest on investments of various types, the volume of new issues, the flow of cash into circulation, the statistics of foreign trade and the level of the exchanges must all be taken into account. The main point is that the objective of the authorities, pursued with such means as are at their command, should be the stability of prices."
I think it is probable that most of these considerations were not altogether overlooked by the Bank Court in old days under the goldstandard, when it was deciding whether it was necessary to move its official rate. Its object was to preserve its gold reserve with a view to the convertibility of its notes. By this method it maintained our prices roughly on a level with those in other countries and so secured stability both in prices and in rates of exchange. This is surely better than (possibly) stabilized prices, with unlimited fluctuations in exchange.
As to the means to be used to secure the contraction and expansion of credit needed to preserve stability, Mr. Keynes looks to joint control, exercised by the Treasury and the Bank of England. He says that the extent to which the Treasury draws money from the public to discharge floating debt depends on the rate of interest and the type of loan that it is prepared to offer; and that "the Bank of England is also, within sufficiently wide limits, mistress of the situation if she acts in conjunction with the Treasury. She can increase or decrease at will her investments and her gold by buying or selling the one or the other. In the case of advances and of bills, whilst their volume is not so immediately or directly controllable, here also adequate control can be obtained by varying the price charged, that is to say the bank rate." The Bank's buying and selling prices for gold would be announced every Thursday morning at the same time as its discount rate; and gold would be retained as a reserve against emergencies and "as a means of rapidly correcting the influence of a temporarily adverse balance of payments." How it would do so, if America and other countries also adopted Mr. Keynes's policy, is not clear. For they might put down their buying prices to a prohibitive level or refuse to buy gold altogether. One does not see why they should take it at all; for Mr. Keynes proposes that the gold reserve should be separated entirely from the note issue, the volume of which would depend on "the state of trade and employment, bank rate policy and Treasury bill policy." If everybody worked on these lines who but dentists and goldsmiths would want gold?
It is a most interesting and ingenious scheme, but I venture to think that it does not answer two objections, put forward in my previous chapters, to proposals to regulate prices by means of credit and currency management.
(1) Though it is possible to contract credit by raising its price, if those responsible are prepared to risk panic, it is not always possible to expand it by lowering the price or even by the Bank of England's making purchases of securities, unless producers and traders can see their way to using it profitably; and in a country like England, so subject to foreign influences on her trade outlook, depression might easily arise that could not be cured by domestic monetary devices. And even when credit is expanded prices do not always rise, aS was seen in the years 1890 to 1895.
(2) The intervention of the Treasury involved by Mr. Keynes's proposals, opens a door to interference by the House of Commons in a sphere in which its activities are far from desirable.
The gold standard frees us from muddling with our money by politicians, has worked right well in the past and may do so again, whenever the politicians succeed in doing their proper job, of giving us peace and security and confidence and good-will.