Those crazy Merchant Bankers - Part V
Banking & Credit – Reflation & Inflation (1897-1925)
… the resulting political structure was exposed to the stress of an economic storm which few had foreseen. Collective security was destroyed by the world economic depression more than by any other single cause. … For these reasons, a real understanding of the economic history of twentieth century Europe is imperative to any understanding of the events of the period. Such an understanding will require a study of the history of finance, commerce, and business activity, of industrial organization, and or agriculture.
The whole of this half-century may be divided into six subdivisions, as follows:
1. Reflation, 1897-1914
2. Inflation, 1914-1925
3. Stabilization, 1922-1930
4. Deflation, 1927-1936
5. Reflation, 1933-1939
6. Inflation, 1939-1947
These periods have different dates in different countries, and thus overlap if we take the widest periods to include all important countries. But in spite of the difference in dates, these periods occurred in almost every country and in the same order. It should also be pointed out that these periods were interrupted by haphazard secondary movements. Of these secondary movements, the chief were the depression of 1921-1922 and the recession of 1937-1938, both periods of deflation and declining economic activity.
Prices had been rising slowly from about 1897 because of the increased output of gold from South Africa and Alaska, thus alleviating the depressed economic conditions and agricultural distress which had prevailed, to the benefit of financial capitalists, from 1873. The outbreak of war in 1914 showed these financial capitalists at their worst, narrow in outlook, ignorant and selfish, while proclaiming, as usual, their total devotion to the social good. They generally agreed that the war could not go on for more than six to ten months because of the “limited financial resources” of the belligerents (by which they meant gold reserves). This idea reveals the fundamental misunderstanding of the nature and role of money on the part of the very persons who were reputed to be experts on the subject. Wars, as events have proved since, are not fought with gold or even money, but by the proper organization of real resources.
The attitudes of bankers were most revealed most clearly in England, where every move was dictated by efforts to protect their own economic position and to profit from it rather than by consideration of economic mobilization for war or the welfare of the British people. The outbreak of war on August 4, 1914, found the British Banking system insolvent in the sense that its funds, created by the Banking system for the profit and rented out to the economic system to permit it to operate, could not be covered by the existing volume of gold reserves or by collateral which could be liquidated rapidly. Accordingly, the bankers secretly devised a scheme by which their obligations could be met by fiat money (so-called Treasury Notes), but, as soon as that crisis was over, they then insisted that the government must pay for the war without recourse to fiat money (which was always damned by bankers as immoral), but by taxation and by borrowing at high interest rates from bankers.
At the outbreak of the war, most of the belligerent countries suspended gold payments and, to varying degrees, accepted their bankers’ advice that the proper way to pay for the war was by a combination of bank loans with taxation of consumption. The period within which, according to the experts, the war must cease because of limited financial resources eventually passed, and the fighting continued more vigorously than ever. The government paid for it in various ways: by taxation, by fiat money, by borrowing from banks (which created credit for the purpose), and by borrowing from the people by selling war bonds to them. Each of these methods of raising money had a different effect upon the two chief financial consequences of the war. These were inflation and public debt.
In the period 1914-1918, the various belligerents used a mixture of these four methods, but its was a mixture dictated by expediency and false theories, so that at the end of the war all countries found themselves with both public debts and inflation in amounts in no wise justified by the degree of economic mobilization which had been achieved. The situation was made worse by the fact that in all countries prices continued to rise, and in most countries public debt continued to rise, long after the Armistice of 1918.
The causes of the wartime inflation are to be found in both financial and economic spheres. In the financial sphere, government spending was adding tremendous amounts of money to the financial community, largely to produce goods which would never be offered for sale. In the economic sphere, the situation was different in those countries which were more completely mobilized that in those which were only partly mobilized. In the former, real wealth was reduced by the diversion of economic resources from making such wealth to making goods for destruction. In the others, the total quantity of real wealth may not have been seriously reduced (since much of the resources utilized in making goods for destruction came from resources previously unused, like idle mines, idle factories, idle men, and so on) but the increase in the money supply competing for the limited amounts of real wealth gave drastic rise in prices.
While prices in most countries rose 200 to 300 percent and public debt rose 1,000 percent, the financial leaders tried to keep up the pretense that the money of each country was a valuable as it had ever been and that as soon as the war was ended the situation existing in 1914 would be restored. For this reason they did not openly abandon the gold standard. Instead, they suspended certain attributes of the gold standard and emphasized the other attributes which they tried to maintain. In most countries, payments in gold and export of gold were suspended, but every effort was made to keep gold reserves up to a respectable percentage of notes, and exchanges were controlled to keep them as near as parity as possible. These attributes were achieved in some cases by deceptive methods. In Britain for example, the gold reserve against notes fell from 52 percent to 18 percent in the month July-August 1914; then the situation was concealed, partly by moving assets of local banks into the Bank of England and using them as reserves for both, partly by issuing a new kind of notes (called Currency Notes) which had no real reserve and little gold backing. In the United States the percentage of reserves required by law in commercial banks was reduced in 1914, and the reserve requirements both for notes and deposits were cut in June 1917; a new system of “depository banks” was set up which required no reserves against government deposits created in them in return for government bonds. Such efforts were made in all countries, but everywhere the ratio of gold reserves to notes fell drastically during the war: in France from 60 percent to 11 percent; in Germany from 59 percent to 10 percent; in Russia from 98 percent to 2 percent; in Italy from 60 percent to 13 percent; in Britain from 52 percent to 32 percent.
The inflation and increase in public debt continued after the war ended.
Unfortunately, this postwar inflation, which could have accomplished much good (by increasing output of real wealth) was wasted (by increasing prices of existing goods) and had evil results (by destroying capital accumulations and savings, and overturning economic class lines). This failure was caused by the fact that inflation, though unwanted everywhere, was uncontrolled because few persons in positions of power had the courage to take the steps necessary to curtail it. In the defeated and revolutionary countries (Russia, Poland, Hungary, Austria, and Germany), the inflation went so far that the former monetary units became valueless, and ceased to exist. In a second group of countries (like France, Belgium, and Italy), the value of the monetary unit was so reduced that it became a different thing, although the same name was still used. In a third group of countries (Britain, the United States, and Japan), the situation was kept under control.
As far as Europe was concerned, the intensity of the inflation increased as one moved geographically from west to east. Of the three groups of countries above, the second (moderate inflation) group was the most fortunate. In the first (extreme inflation) group the inflation wiped out all public debts, all savings, and all claims on wealth, since the monetary unit became valueless. In the moderate-inflation group, the burden of the public debt was reduced, and private debts and savings were reduced by the same proportion. In the United States and Britain the effort to fight inflation took the form of a deliberate movement toward deflation. This preserved savings but increased the burdens of the public debt and gave economic depression.
(Cont'd in Part VI) |
