4. The Blocking of 5000 Francs Notes

(Letter to Mr. Courtin, editor-in-chief of Le Monde, January 31, 1948)

There is still in the minds of many people a vague idea that the suppression, at any moment, of a large number of bank notes can effectively influence the level of prices and the rate of foreign exchange. Just as inflation, they believe, undoubtedly makes prices rise, so deflation, meaning the reduction of the number of bank notes, must lower them. This reasoning seems to possess irrefutable logic. Nonetheless, it has been contradicted by the facts every time that the experiment has been attempted, and among these experiments I include the Belgian experiment, of which more later.

There is no example of a direct deflation of paper money which made its value rise. This is true of England after the Napoleonic wars, of the United States after the Civil War, of France in 1871, of the countries of South America, whose experiences of this type are so numerous and so instructive, and, closer to us, it is true of Czechoslovakia as well as of England, of France, and of Germany immediately after the last war. In all these cases, the efforts to curtail the quantity of money used have been futile, the money removed from circulation having immediately found substitutes in credit, or when the curtailment has been effective the resistance of prices has soon made it necessary to cease the curtailment of money and restore means of payment to the public. The classical example is that of Czechoslovakia after 1918, where prices resisted firmly all the efforts of the courageous minister Raschin, and where the downward trend, moreover under disastrous conditions, did not commence until the rise in the rate of Czechoslovakian exchange occurred, under outside influences.

What is the basis of this phenomenon, which contradicts so persistently the ideas of the old economist Ricardo, ideas which are supported unknowingly by reformers who believe themselves well informed, and who would do better to look to an economist like the Frenchman Aftalion, or to an American like Irving Fisher, to modernize their conceptions?

There is an essential difference between inflation and deflation of money. When the state issues bank notes to pay for services, it is at one and the same time creating revenue and new means of payment.

When it destroys bank notes its action is felt by the treasuries: it suppresses means of payment but it leaves the revenues intact. But, it is the amount of revenue which influences prices.

In the present case and supposing that we suppress definitely three hundred billion bank notes, shall we at the same time lower the railroad fares, the price of coal, the price of gas, of electricity, workmen’s salaries and the price of the raw materials necessary to industry? If all these prices remain stable, do we believe that the prices of consumer goods will decline? Can we believe that the consumers and the treasuries of enterprises, deprived suddenly of three hundred billions, will not immediately find some form of credit to replace the missing means of payment rather than see their enterprises close and idleness everywhere? The modest consumers who had put aside a few five-thousand-franc notes toward large purchases of clothing or furniture, what will they do? They will postpone their purchases, which will not worry the sellers into reducing their prices, being sure that the buyers will return. On the other hand, the purchases will concentrate on the consumer goods, the demand for these being the same. Let us reflect a moment: what is a reduction of two hundred billions from a consumable income of four thousand billions? Hardly one-twentieth.

Experience shows that there is never a reduction in price (supposing, of course, that inflation has been stopped) except through an increase in the offer of merchandise. But, you will say: how do you account for the Belgian experience? Here I will refer the reader to the very convincing graphs published last Friday in Une Semaine dans le Monde, and to the article which accompanies them. What do these graphs show? During all of 1945, after the partial blocking of cash and deposits, retail prices continued to rise, and very rapidly. During the same year, the means of payment, so suddenly reduced immediately after the Liberation, were restored with astonishing speed and had attained in the course of a year a level scarcely inferior to that at the start. The reduction in prices—and it was very slight—made itself felt only at the end of the year, under the twofold influence of a rapidly increasing stock of merchandise and, particularly, of a really stable exchange rate resulting from important foreign claims accumulated by Belgium during the war and a financial policy entirely committed to budget equilibrium.

There is more. When the Belgian “amputation” (reduction in means of payment) took place, the inflation provoked by the invader had not exercised its full action on prices. It is this leeway which permitted the Belgian operation.

Everyone knows that the French situation is exactly the opposite. The increase in prices actually precedes inflation instead of following it.

The idea that it suffices to curtail the quantity of money in use to lower prices should be abandoned once and for all. Things are somewhat more complicated than that. England, where this idea took form, has never applied it for its own account. Lord Keynes, whose competence is now cited by so many people, has always combatted it.

Since I have just mentioned the name of Lord Keynes, let me mention a little-known fact. Two years ago, during the course of a debate with an American economist,¹ a debate which appeared in papers in the United States, Lord Keynes said substantially to his opponent: “My dearest wish, at the point where things are now, is to see the Bank of England return to the convertibility of its paper in gold.” This is exactly what the present governmental policy aims at. Starting with balancing the budget, it aims at stabilizing the franc through freedom in the gold and currency market. This method comes closer to the concepts considered today as most modern than the obsolete methods which pretend that by a purely mechanical process they can control phenomena whose evolution depends above all upon men and their spontaneous behavior.

¹ Mr. Philip Cortney: The exact words used by Lord Keynes in his letter dated June 26, 1945, are the following: “And I can end up by most fully endorsing the last sentence of your preface—that ‘in order of urgency the main objective to be attained is the free convertibility of the pound sterling.’ ” To Rist the word “convertibility” had no meaning if it didn’t mean convertibility into gold. I happen to agree with him.