18. Inter-bank Liquidity; Bank Reserves

CHAPTER

EIGHTEEN

Inter-bank Liquidity; Bank Reserves

Now we have another problem which is usually regarded as an ordinary monetary matter. Various government committees of professors and representatives of various central banks are studying a problem sometimes referred to as that of inter-bank liquidity, or as the problem of bank reserves. What exactly is this problem? I think the easiest way to understand this problem is to refer to the conditions as they existed in world money markets from the second half of the nineteenth century until the outbreak of the First World War. At that time the economically leading nations of the world were all on the gold or gold exchange standard and they were interested in preserving the gold parity of their domestic national currency. At the same time they wanted to maintain a low rate of interest in the money markets of their respective countries and to expand credit, to have credit expansion, in order to encourage business and bring about a “boom.”

The governments became interested in entering the market and destroying the market because the governments wanted to spend money, more money than the citizens were prepared to pay. I am not talking about the United States but about almost all other countries in the world. It was for the government always a problem to tell the citizens, especially if they already were paying high taxes: “We want more money.” And for what purpose? “To pay the deficits of our enterprises. Don’t forget the problem of the government enterprises.” In the second part of the 19th century, there was a great man, one of the most important and most influential statesmen in the world—the German Prince Bismarck, who favored nationalization. And Bismarck nationalized the Prussian railroads. Why? Because this was considered a simple thing. What do these railroad men do? The trains are running and the money was coming in. The government had said: “What a wonderful thing are the railroads. They are making lots of money. It is so easy, of course. Just set the trains running and everybody will want to go somewhere. Or they will want to ship some goods on this railroad. Therefore, the railroads are a wonderful thing. Let us nationalize the railroads and we, the government, will get their profits.” So they nationalized the railroads. Bismarck was not the only one to do this; he was only the most important man to do it. All other countries, or most other countries, tried to do the same thing. They nationalized the telegraph, the telephone, and so on. Then there appeared something very interesting. After the railroads, that had been making profits, were nationalized, they began making deficits. And the deficits had to be paid. The citizens said, “You are nationalizing more and more. You are taxing more and more. And what is the result? More deficits!”

In this regard, let us say only parenthetically that the United States did not nationalize the railroads. But the United States pays foreign aid, subsidies, to many countries that have nationalized their railroads. The United States government collects taxes from the American railroads which, after all, still have some surpluses and not deficits, like many foreign railroads.¹And these surpluses are used by foreign countries to pay the deficits of their nationalized railroads. Some may say it might have been better to nationalize the American railroads also and to have deficits than to pay the deficits of the foreign nationalized enterprises. We do have in this country one monument to this deficit system—the American Post Office: one billion dollars almost, or perhaps more—one doesn’t know. But the fact that the U.S. government Post Office makes deficits serves as a warning to the U.S. government against nationalizing other industries.

In the second half of the nineteenth century, if an individual country kept the interest rate lower than it ought to be in order to increase the quantity of money and spend more, the tendency was for short term capital to move, within a very short period of time, to a foreign country. For example, if Germany, so often the evil-doer preceding the First World War, kept a very low interest rate, short term capital moved out of Germany to other countries where the interest rate was not so low. This meant people were trying to withdraw gold from Germany in order to transfer it to England, France or the United States. The Reichsbank, seeing its gold reserves dwindling and fearing it would not be able to fulfill its obligations because of its shortage of gold, was forced to go up again with the interest rate in order to stop the withdrawal of gold, i.e., its “gold reserves.”

Not all countries inflate, or if they do inflate, they do not inflate to the same extent. Switzerland is considered a “bad” country because it does not inflate sufficiently. Therefore, there are continual problems with the flow of money from countries which have more inflation to others which have not inflated to the same extent. If the various governments and central banks do not all act in the same way, if some banks or governments go a little farther than the others, the situation develops that I have just described; those who expand more are forced to return to the market rate of interest in order to preserve their solvency through liquidity; they want to prevent funds from being withdrawn from their country; they do not want to see their reserves in gold or foreign money dwindling. And one calls this the “international problem.”

In the nineteenth century one spoke of “the war of the banks.” This term was not a good one. It would have been more correct to refer to the useless attempts of central banks, from time to time, to maintain a lower rate of interest within their own country than actual conditions permitted. Nevertheless, this expression, “the war of the banks,” was most popular during the first decade of the present [20th] century when the Peace Conference at the Hague was in vogue. One day the Italian Minister of Finance even suggested a “peace conference” of the central banks in order to end “the war of the banks.” However, there was neither a “war of the banks” nor a “peace conference” of the banks.

All countries in the past had only metallic money, no paper money, and they used the metallic money according to weight—you know the metallic weight of money still remains in the names of some monetary units, for instance the “pound sterling.” Money was then valued according to its content of metal, and governments were not in a position to increase the quantity of money. But the problem of money connected with a purely metallic currency is not the problem of our age. The problem we have to meet today, what we have to face today, is that the governments pretend that they have the right to increase the quantity of money if they want to spend more. And the governments that do this, to the extent that they do, become very angry if somebody says it has adopted an inflationary policy. They say inflationary conditions are what businessmen cause by asking higher prices. But the question is not that the businessmen ask for higher prices, you know; the question is why did they not ask higher prices yesterday before the government increased the quantity of money? If they had asked higher prices yesterday, people would not have paid the higher prices because they did not have the money, and the businessmen would have been forced to lower their prices if they wanted to sell their commodities. All these things have only one cause. And all these things can be cured in only one way, by not inflating, by not supplying additional quantities of money, of the medium of exchange.

There is a proverb that says: “One doesn’t talk about the gallows in the home of a family, one of whose members was executed.” In this way, one doesn’t talk about the international problem in terms of inflation. When one talks about an international monetary problem, one says there is not enough “liquidity,” not enough “reserves.”

The international monetary system of the nineteenth century, which ended with the catastrophe of the First World War, was, by and large, practically re-established after the war was over and again after the Second World War. The central banks today still want to preserve the stability of exchange rates. Therefore, their attempts to lower interest rates will create a situation which leads them to fear an external drain, with withdrawal of funds in order to transfer them to foreign countries. At such times, the Bank, the so-called monetary authorities, are faced with an alternative: either to devalue, which they do not want to do, or to go up again with the rate of interest. But the central banks like neither alternative. They complain, saying there is insufficient “liquidity” in international monetary affairs.

In order to cure this evil, to make more “liquidity,” many experts have suggested the creation of a new reserve currency. If people in Belgium, let us say, want to withdraw funds from that country to transfer to Paris, they need foreign exchange—French francs or the exchange of other countries belonging to this group of several countries, not some reserve currency. A reserve currency, of course, might be a very good way out. It would mean printing more money and forcing people to accept it. And the International Monetary Fund did it, you know.² It is beside the point that those who attend International Monetary Fund meetings, who serve on the committees, join in discussions and write books, announce almost every week some new project or invent some new method in the hope of increasing liquidity or adding to the reserves. It is characteristic that many new names have been invented for such a new reserve currency. You read in the newspapers these wonderful stories about “paper gold.” Nobody knows what paper gold is, you know. There are paper cigarettes, but paper gold is something which the government promises.³ It is necessary to abandon all ideas of an artificial currency and all those silly ideas about paper gold, gold paper. However, the name is not really important. The fact is that it is useless and hopeless for one country to try and keep a rate of interest lower than the international situation permits.

In the nineteenth century the slogan of those excellent British economists who were titans at criticizing socialistic enthusiasts, was: “There is but one method of relieving the conditions of the future generations of the masses, and that is to accelerate the formation of capital as against the increase of population.” Since then, there has taken place a tremendous increase in population, for which the silly term “population explosion” was invented. However, we are not having a “capital explosion,” only an “explosion” of wishes and an “explosion” of futile attempts to substitute something else—fiat money or credit money—for money.

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¹‘These lectures were delivered by Mises in the 1960s. —BBG

²In 1969 the IMF created Special Drawing Rights, sometimes called “paper gold,” intended to supplement existing bank reserves. —BBG

³When a member of Mises’ audience once asked him what he thought of “paper gold,” he responded, “You should ask the alchemists.” —BBG