Monetary Regime Transition – a Hypothesis – Part V
This post is the fifth in a series that is preceded by the following:
Part I – Message 20281952
Part II – Message 20282026
Part III - Message 20282088
Part IV - Message 20282112
And the original hypothesis:
Message 20277691
This post provides context for replying to TH's post:
Message 20280598
... and in particular the comment:
Care to elaborate on this statement, "I think the answer lies in the creation of an entire new incentive system outside the existing monetary regime."?
Monetary Policy surrounding the Great Depression
I have previously posted a series of posts providing Quigley's analysis of monetary policy and mechanics surrounding the Great Depression. They can be found at the following links:
Message 17855821
Message 17855825
Message 17855835
Message 17855846
Collectively, these posts discuss in significant detail the reluctance of monetary authorities to accommodate to a world of changing geopolitical power relations. I'm not going to elaborate on this in any great detail in this post, but please see the above posts if interested.
What I would like to focus on, however, is the disconnect between the economy of real goods and the monetary system & price structure (which provided incentive for the movement of real goods), and how the latter basically broke.
This post will focus on relevant Quigley commentary.
The Period of Stabilization, 1922-1930
As soon as the war was finished, governments began to turn their attention to the problem of restoring the prewar financial system. Since the essential element in that system was believed to be the gold standard with its stable exchanges, this movement was called “stabilization”. Because of their eagerness to restore the prewar financial situation, the “experts” closed their eyes to the tremendous changes which had resulted from the war. These changes were so great in production, in commerce, and in financial habits that any effort to restore the prewar conditions or even stabilize on the gold standard was impossible and inadvisable. Instead of seeking a financial system adapted to the new economic and commercial world which had emerged from the war, the experts tried to ignore this world, and established a financial system which looked, superficially, as much like the prewar systems as possible. This system, however, was not the prewar system. Neither was it adapted to the new economic conditions. …
Changes in the basic productive and commercial organization of the world in the period 1914-1919 were made more difficult to adjust by other less tangible changes in financial practices and business psychology. The spectacular postwar inflations in eastern Europe had intensified the traditional fear of inflation among bankers. In an effort to stop rises in prices which might become inflationary, bankers after 1919 increasingly sought to “sterilize” gold when it flowed into their country. That is, they sought to set it aside so that it did not become part of the monetary system. As a result, the unbalance of trade which had initiated the flow of gold was not counteracted by price changes. Trade and prices remained unbalanced, and gold continued to flow. Somewhat similar was a spreading fear of decreasing gold reserves, so that when gold began to flow out of a country as a result of an unfavorable balance of international payments; bankers increasingly sought to hinder the flow of restrictions on gold exports. With such actions the unfavorable balance of trade continued, and other countries were inspired to take retaliatory actions. The situation was also disturbed by political fears and by the military ambitions of certain countries, since these frequently resulted in the desire of self-sufficiency (autarchy) such as could be obtained only by the use of tariffs, subsidies, quotas, and trade controls. Somewhat related to this was the widespread increase in feelings of economic, political, and social insecurity. This gave rise to “flights of capital” – that is, to panic transfers of holdings seeking a secure spot regardless of economic return. Moreover, the situation was disturbed by the arrival in the foreign-exchange market of a very large number of relatively ignorant speculators. … Subject to the influence of rumors, hearsay, and mob panic, their activities had a very disturbing effect on the markets. Finally, within each country, the decline in competition arising from the growth of labor unions, cartels, monopolies, and so on, made prices less responsive to flows of gold or exchange in the international markets, and, as a result, such flows did not set into motion those forces which would equalize prices between countries, curtail flows of gold, and balance flows of goods.
As a result of all these factors, the system of international payments which had worked so beautifully before 1914 worked only haltingly after that date, and practically ceased to work at all after 1930. The chief cause of these factors was that neither goods nor money obeyed purely economic forces and did not move as formerly to the areas in which each was most valuable. The chief result was a complete misdistribution of gold, a condition which became acute after 1928 and which by 1933 had forced most countries off the gold standard.
Modifications of productive and commercial organization and of financial practices made it almost impossible after 1919 to restore the financial system of 1914. Yet this is what was attempted. Instead of seeking to set up a new financial organization adapted to the modified economic organization, bankers and politicians insisted that the old prewar system should be restored. These efforts were concentrated in a determination to restore the gold standard as it had existed in 1914.
As we have said, the stage of financial capitalism did not place emphasis on the exchange of goods or the production of goods as the earlier stages of commercial capitalism and industrial capitalism had done. In fact, financial capitalism had little interest in goods at all, but was concerned entirely with claims on wealth – stocks, bonds, mortgages, insurance, deposits, proxies, interest rates, and such.
It invested capital not because it desired to increate the output of goods or services but because it desired to float issues (frequently excess issues) of securities on this productive basis. It built railroads in order to sell securities, not in order to transport goods; it constructed great steel corporations to sell securities, not in order to make steel, and so on. But, incidentally, it greatly increased the transport of goods, the output of steel, and the production of other goods. By the middle of the stage of financial capitalism, however, the organization of financial capitalism had evolved to a highly sophisticated level of security promotion and speculation which did not require any productive investment as a basis. Corporations were built upon corporations in the form of holding companies so that securities were issued in huge quantities, bringing profitable fees and commissions to financial capitalists without any increase in economic production whatever. Indeed, these financial capitalists discovered they could not only make a killing out of the issuing of such securities, they could also make killings out of the bankruptcy of such corporations, through the fees and commissions of reorganization. A very pleasant cycle of flotation, bankruptcy, flotation, bankruptcy began to be practiced by these financial capitalists. The more excessive the flotation, the greater the profits, and the more immanent the bankruptcy. The more frequent the bankruptcy, the greater the profits of reorganization and the sooner the opportunity of another excessive flotation with its accompanying profits. This excessive stage reached its highest peak only in the United States. In Europe it was achieved only in isolated cases.
The growth of financial capitalism made possible a centralization of world economic control and a use of this power for the direct benefit of financiers and the indirect injury of all other economic groups. This concentration of power, however, could be achieved only by using methods which planted the seeds which grew into monopoly capitalism. Financial control could be exercised only imperfectly through credit control and interlocking directorates. In order to strengthen such control, some measure of stock ownership was necessary. But stock ownership was dangerous to banks, because their funds consisted more of deposits (that is, short-term obligations) than of capital (or long-term obligations). This meant that banks which sought economic control through stock ownership were putting short-term obligations into long-term holdings. This was safe only so long as these latter could be liquidated rapidly at a price high enough to pay short-term obligations as they presented themselves. But these holdings of securities were bound to become frozen because both the economic and financial systems were deflationary. The economic system was deflationary because power production and modern technology gave a great increase in the supply of real wealth. This meant that in the long run the control of banks was doomed by the progress of technology. The financial system was also deflationary because of the bankers’ insistence on the gold standard, and all that this implies.
Banking & Credit – The Period of Deflation (1927-1936)
The historical importance of the banker-engendered deflationary crisis of 1927-1940 can hardly be overestimated. It gave a blow to democracy an to the parliamentary system which the later triumphs of these in World War II and the postwar world were unable to fully repair. It gave an impetus to aggression by those nations where parliamentary government collapsed, and thus became the chief cause of World War II. It so hampered the Powers which remained democratic by its orthodox economic theories that these were unable to rearm for defense, with the consequence that World War II was unduly prolonged by the early defeats of the democratic states. It gave rise to a conflict between the theorists of orthodox and unorthodox financial methods which led to a sharp reduction in the power of the bankers. And, finally, it impelled the whole economic development of the West along the road from financial capitalism to monopoly capitalism and, shortly thereafter, toward the pluralist economy.
The controversy between the bankers and the theorists of unorthodox finance arose over the proper way to deal with an economic depression. We shall analyze this problem later, but here we should say that the bankers’ formula for treating a depression was by clinging to the gold standards, by raising interest rates and seeking deflation, and by insisting on a reduction of public spending, a fiscal surplus, or at least a balanced budget. These ideas were rejected totally, on a point-by-point basis, by the unorthodox economists (somewhat mistakenly called “Keynesian”). The bankers’ formula sought to encourage economic recovery by “restoring confidence in the value of money,” that is, their own confidence in what was the primary concern of bankers. … The unorthodox theorists sought to achieve this latter more quickly and more directly by restoring purchasing power, and thus prices, by increasing, instead of reducing, the money supply and by placing it in the hands of potential consumers rather in the banks or in the hands of investors.
Banking & Credit – Reflation and Inflation (1933-1947)
The period of inflation 1938-1947 was very similar to the period of inflation 1914-1920. The destruction of property and goods was much greater; the mobilization of resources for such destruction was also greater. As a result, the supply of real wealth, both producers' and consumers', was curtailed much more completely. ...
Much of the improvement in financing World War II in comparison with World War I arose from the fact that attention was concentrated on real resources rather than on money. This was reflected both in the way in which each country managed its domestic economy and in the relationship between countries. The latter can be seen in the use of Lend-Lease rather than commercial exchange as in World War I to provide America's allies with combat supplies. The use of commercial exchange and orthodox financing in the First World War had left a terrible burden of intergovernmental debts and ill-feeling in the postwar period. In World War II the United States provided Great Britain under Lend-Lease with $27,000 million in supplies, received $6,000 million in return, and wrote off the account with a payment of about $800 million in the postwar settlement.
In domestic economies even more revolutionary techniques were developed under the general category of centralized planning. This went much further in Great Britain than in the United States or Germany, and was chiefly remarkable for the fact that it applied to real resources and not to money flows. The chief of these controls were over manpower and materials. Both of these were allotted where they seemed to be needed, and were not permitted, as in World War I, to be drawn here and there in response to rising wages or prices. Rises in prices were controlled by sopping up excess purchasing power by compulsory or semicompulsary saving and by rationing of specific necessities. Above all, price rises in such necessities were prevented by subsidies to producers, which have them more payment for production without any increase in the final selling price.
… to be continued.
:) |
