XXXI. Currency and Credit Manipulation (continued)

0:005. Credit Expansion It has been pointed out that it would be an error to look upon credit expansion exclusively as a mode of government interference with the market. The fiduciary media did not come into existence as instruments of government policies deliberately aiming at high prices and high nominal wage rates, at lowering the market rate of interest and at debt abatement. They evolved out of the regular business of banking. When the bankers, whose receipts for call money deposited were dealt with by the public as money substitutes, began to lend a part of the funds deposited with them, they had nothing else in view than their own business.

0:47They considered it harmless not to keep the whole equivalent of the receipts issued as a cash reserve in their vaults. They were confident that they would always be in a position to comply with their obligations and, without delay, redeem the notes issued, even if they were to lend a part of the deposits. Bank notes became fiduciary media within the operation of the unhampered market economy. The begetter of credit expansion was the banker, not the authority. But today credit expansion is an exclusive prerogative of government. As far as private banks and bankers are instrumental in issuing fiduciary media, their role is merely ancillary and concerns only technicalities.

1:36The governments alone direct the course of affairs. They have attained full supremacy in all matters concerning the size of circulation credit. While the size of the credit expansion that private banks and bankers are able to engineer on an unhampered market is strictly limited, the governments aim at the greatest possible amount of credit expansion. Credit expansion is the government's foremost tool in their struggle against the market economy. In their hands, it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.

2:30The inescapable consequences of credit expansion are shown by the theory of the trade cycle. Even those economists who still refuse to acknowledge the correctness of the monetary or circulation and Credit Theory of the Cyclical Fluctuations of Business have never dared to question the conclusiveness and irrefutability of what this theory asserts with regard to the necessary effects of credit expansion. These economists, too, must admit, and do admit, that the upswing is invariably conditioned by Credit Expansion, that it could not come into being and continue without credit expansion, and that it turns into depression when the further progress of credit expansion stops.

3:20Their explanation of the trade cycle, in fact, boils down to the assertion that what first generates the upswing is not credit expansion, but other factors. The credit expansion, which, even in their opinion, is an indispensable requisite of the general boom, is, they say, not the outcome of a policy deliberately aiming at low interest rates and at encouraging additional investment for which the capital goods needed are lacking. It is something which, without active interference on the part of the authorities, in a miraculous way always appears whenever these other factors begin their operation. It is obvious that these economists contradict themselves in opposing plans to eliminate the fluctuations of business by abstention from credit expansion.

4:14The naive supporters of the inflationist view of history are consistent when they infer It is clear from their, of course, utterly fallacious and contradictory tenets that credit expansion is the economic panacea. But those who do not deny that credit expansion is an indispensable condition of the boom disagree with their own doctrine in fighting the proposals to curb credit expansion. Both the spokesmen of the governments and the powerful pressure groups and the champions Those of the dogmatic unorthodoxy that dominates the university departments of economics agree that one should try to avert the recurrence of depressions, and that the realization of this end requires the prevention of booms.

5:04They cannot advance tenable arguments against the proposals to abstain from policies encouraging credit expansion. But they stubbornly refuse to listen to any such idea. They passionately disparage the plans to prevent credit expansion as devices which would perpetuate depressions. This attitude clearly demonstrates the correctness of the statement that the trade cycle is the product of policies intentionally aimed at lowering the rate of interest and engendering artificial booms. It is a fact that today measures aimed at lowering the rate of interest are generally be considered highly desirable, and that credit expansion is viewed as the efficacious means for the attainment of this end.

5:54It is this prepossession that impels all governments to fight the gold standard. Expansionism is the great slogan of our day. All political parties and all pressure groups are firmly committed to an easy money policy. If a bank does not expand circulation credit by issuing additional fiduciary media, either in the form of banknotes or in the form of deposit currency, it cannot generate a boom even if it lowers the amount of interest charged below the rate of the unhampered market. It merely makes a gift to the debtors. The inference to be drawn from the monetary cycle theory by those who want to prevent The Recurrence of Booms and of the Subsequent Depressions is not that the banks should not lower the rate of interest, but that they should abstain from credit expansion.

6:56The objective of credit expansion is to favor the interests of some groups of the population at the expense of others. This is, of course, the best that interventionism can attain when it does not hurt the interests of All Groups. But while making the whole community poorer, it may still enrich some strata. Which groups belong to the latter class depends on the special data of each case. The idea which generated what is called qualitative credit control is to channel the additional credit in such a way as to concentrate the alleged blessings of credit expansion upon in certain groups, and to withhold them from other groups.

7:43The credits should not go to the stock exchange, it is argued, and should not make stock prices soar. They should rather benefit the legitimate productive activity of the processing industries, of mining, of legitimate commerce, and, first of all, of farming. Other advocates of qualitative credit control want to prevent the additional credits from are being used for investment in fixed capital and thus immobilized. They are to be used instead for the production of liquid goods. According to these plans, the authorities give the banks concrete directions concerning the types of loans they should grant or are forbidden to grant.

8:28However, all such schemes are vain. Expansion in lending is no substitute for checks placed on credit expansion, the only means that could really prevent a rise in stock exchange quotations and an expansion of investment in fixed capital. The mode in which the additional amount of credit finds its way into the loan market is only of secondary importance. What matters is that there is an inflow of newly created credit. If the banks grant more credits to the farmers, the farmers are in a position to repay loans received from other sources and to pay cash for their purchases.

9:14If they grant more credits to business as circulating capital, they free funds which were previously tied up for this use. In any case, they create an abundance of disposable money for which its owners try to find the most profitable investment. Very promptly, these funds find outlets in the stock exchange or in fixed investment. The notion that it is possible to pursue a credit expansion without making stock prices rise and fixed investment expand is absurd. The typical course of events under credit expansion was, until a few years ago, determined by two facts. that it was credit expansion under the gold standard and that it was not the outcome of concerted action on the part of the various national governments and the central banks whose conduct these governments directed.

10:11The first of these facts meant that governments were not prepared to abandon the convertibility of their country's banknotes according to the rigidly fixed parity. The second fact resulted in a lack of quantitative uniformity in the size of credit expansion. Some countries got ahead of other countries and their banks were faced with the danger of a serious external drain upon their reserves in gold and foreign exchange. In order to preserve their own solvency, these banks were forced to take recourse to drastic credit restriction. Thus they created the panic and inaugurated the depression on the domestic market. The panic very soon spread to other countries.

11:00Businessmen in these other countries became frightened and increased their borrowing in order to strengthen their liquid funds for all possible events. It was precisely this increased demand for new credits which impelled the monetary authorities The policy of devaluation has to some extent altered this typical sequence of events. Menaced by an external drain, the monetary authorities do not resort to credit restriction and to raising the rate of interest charged by the central banking system.

11:50They devalue. Yet devaluation does not solve the problem. If the government does not care how far foreign exchange rates may rise, it can, for some time, continue to cling to credit expansion. But one day the crack-up boom will annihilate its monetary system. On the other hand, if the authority wants to avoid the necessity of devaluing again and again at an accelerated pace, it must arrange its domestic credit policy in such a way as not to outrun in credit expansion the other countries against which it wants to keep its domestic currency at par. Many economists take it for granted that the attempts of the authorities to expand credit will always bring about the same almost regular alternation between periods of booming trade and of subsequent depression.

12:49They assume that the effects of credit expansion will, in the future, not differ from those that have been observed since the end of the 18th century in Great Britain, and since the middle of the 19th century in Western and Central Europe and in North America. But we may wonder whether conditions have not changed. The teachings of the monetary theory of the trade cycle are today so well known, even outside of the circle of economists, that the naive optimism which inspired the entrepreneurs in the boom periods of the past has given way to a certain skepticism. It may be that businessmen will in the future react to credit expansion in a manner other The Chimera of Contra-Cyclical Policies An essential element of the unorthodox doctrines advanced both by all socialists and by all interventionists is that the recurrence of depressions is a phenomenon inherent in the very operation of the market economy.

14:17But while the socialists contend that only the substitution of socialism for capitalism can eradicate the evil, the interventionists ascribe to the government the power to correct the operation of the market economy in such a way as to bring about what they call economic stability. These interventionists would be right if their anti-depression plans were to aim at a radical abandonment of credit expansion policies. However, they reject this idea in advance. What they want is to expand credit more and more, and to prevent depressions by the adoption of Special Contra-Cyclical Measures. In the context of these plans, the government appears as a deity that stands and works outside the orbit of human affairs, that is independent of the actions of its subjects, and has the power to interfere with these actions from without.

15:18It has at its disposal means and funds that are not provided by the people, and can be are only freely used for whatever purposes the rulers are prepared to employ them for. What is needed to make the most beneficent use of this power is merely to follow the advice given by the experts. The most advertised among these suggested remedies is contra-cyclical timing of public works and expenditure on public enterprises. The idea is not so new as its champions would have us believe. When depression came in the past, public opinion always asked the government to embark upon public works in order to create jobs and to stop the drop in prices.

16:05But the problem is how to finance these public works. If the government taxes the citizens or borrows from them, it does not add anything to what the Keynesians call the aggregate amount of spending. restricts the private citizen's power to consume or to invest to the same extent that it increases its own. If, however, the government resorts to the cherished inflationary methods of financing, it makes things worse, not better. It may thus delay for a short time the outbreak of the slump, but when the unavoidable payoff does come, the crisis is the heavier, the longer the government has postponed it.

16:51The interventionist experts are at a loss to grasp the real problems involved. As they see it, the main thing is to plan public capital expenditure well in advance and to accumulate a shelf of fully worked out capital projects which can be put into operation at short notice. This, they say, is the right policy, and one which we recommend all countries should adopt. However, the problem is not to elaborate projects, but to provide the material means for their execution. The interventionists believe that this could be easily achieved by holding back government expenditure in the boom and increasing it when the depression comes.

17:38Now, restriction of government expenditure may certainly be a good thing, but it does not provide the funds a government needs for a later expansion of its expenditure. An individual may conduct his affairs in this way, he may accumulate savings when his income is high and spend them later when his income drops. But it is different with a nation or all nations together. The Treasury may hoard a considerable part of the lavish revenue from taxes, which flows into the public exchequer as a result of the boom. As far and as long as it withholds these funds from circulation, its policy is really deflationary and contracyclical, and may, to this extent, weaken the boom created by credit expansion.

18:30But when these funds are spent again, they alter the money relation and create a cash-induced tendency toward a drop in the monetary unit's purchasing power. By no means can these funds provide the capital goods required for the execution of the shelved public works. The fundamental error of the interventionists consists in the fact that they ignore the shortage of capital goods. In their eyes, the depression is merely caused by a mysterious lack of the people's propensity both to consume and to invest. While the only real problem is to produce more and to consume less in order to increase the stock of capital goods available, the interventionists want to increase both consumption and investment.

19:24They want the government to embark upon projects which are unprofitable precisely because the factors of production needed for their execution must be withdrawn from other lines of employment in which they would fulfill once the satisfaction of which the consumers consider more urgent. They do not realize that such public works must considerably intensify the real evil, The Shortage of Capital Goods One could, of course, think of another mode for the employment of the savings the government makes in the boom period. The Treasury could invest its surplus in buying large stocks of all those materials which it will, later, when the Depression comes, need for the execution of the public works planned, and of the consumers' goods which those occupied in these public works will ask for.

20:20But if the authorities were to act in this way, they would considerably intensify the boom, accelerate the outbreak of the crisis, and make its consequences more serious. In dealing with the contra-cyclical policies, the interventionists always refer to the alleged success of these policies in Sweden. It is true that public capital expenditure in Sweden was actually doubled between 1932 and 1939, but this was not the cause but an effect of Sweden's prosperity in the 30s. This prosperity was entirely due to the rearmament of Germany. The Nazi policy increased the German demand for Swedish products on the one hand and restricted and, on the other hand, German competition on the world market for those products which Sweden could supply.

21:18Thus, Swedish exports increased from 1932 to 1938 in thousands of tons, iron ore from from 2219 to 12,485, pig iron from 31,047 to 92,980, ferro alloys from 15,453 to 28,605, Other kinds of iron and steel from 134,237 to 256,146, machinery from 46,230 to 70,605.

22:03The number of unemployed applying for relief was 114,000 in 1932 and 165,000 in 1933. It dropped as soon as German rearmament came into full swing to 115,000 in 1934 to 62,000 in 1935 and was 16,000 in 1938. The author of this miracle was not Keynes, but Hitler. All this talk about contra-cyclical government activities aims at one goal only, namely to to divert the public's attention from cognizance of the real cause of the cyclical fluctuations of business.

22:52All governments are firmly committed to the policy of low interest rates, credit expansion and inflation. When the unavoidable aftermath of these short-term policies appears, they know only of one remedy to go on in inflationary ventures. 6. Foreign Exchange Control and Bilateral Exchange Agreements If a government fixes the parity of its domestic credit or fiat money against gold or foreign exchange at a higher point than the market, that is, if it fixes maximum prices for gold and foreign exchange below the potential market price, the effects appear which Gresham's as law describes. A state of affairs results which, very inadequately, is called a scarcity of foreign exchange. It is the characteristic mark of an economic good that the supply available is not so plentiful as to make any intended utilization of it possible. An object that is not in short supply is not an economic good. No prices are asked for it or paid for for it.

24:10As money must necessarily be an economic good, the notion of a money that would not be scarce is absurd. What those governments who complain about a scarcity of foreign exchange have in mind is however something different. It is the unavoidable outcome of their policy of price fixing. It means that at the price arbitrarily fixed by the government, demand exceeds supply. If the government, having by means of inflation, reduced the purchasing power of the domestic monetary unit against gold, foreign exchange, and commodities and services, abstains from any attempt at controlling foreign exchange rates, there cannot be any question of a scarcity in the sense in which the government uses this term. He who is ready to pay the market price would be in a position to buy as much foreign exchange as he wants. But the government is resolved not to tolerate any rise in foreign exchange rates in terms of the inflated domestic currency. Relying upon its magistrates and constables, it prohibits any dealings in foreign

25:25Foreign Exchange on terms different from the ordained maximum price. As the government and its satellites see it, the rise in foreign exchange rates was caused by an unfavorable balance of payments and by the purchases of speculators. In order to remove the evil, the government resorts to measures restricting the demand for foreign exchange. Only those people should henceforth have the right to buy foreign exchange who need it for transactions of which the government approves. Commodities, the importation of which is superfluous in the opinion of the government, should no longer be imported. Payment of interest and principle on debts due to foreigners is prohibited.

26:14Citizens must no longer travel abroad. The government does not realize that such measures can never improve the balance of payments, if imports drop, exports drop concomitantly. The citizens who are prevented from buying foreign goods, from paying back foreign debts and from traveling abroad, will not keep the amount of domestic money thus left to them in their cash holdings. They will increase their buying, either of consumers or of producers' goods, and thus bring about a further tendency for domestic prices to rise. But the more prices rise, the more will exports be checked. Now the government goes a step further.

27:00It nationalizes foreign exchange transactions. Every citizen who acquires, through exporting, for example, an amount of foreign exchange, is bound to sell it at the official rate to the Office of Foreign Exchange Control. If this provision, which is tantamount to an export duty, were to be effectively enforced, export trade would shrink greatly or cease altogether. The government certainly does not like this result, but neither does it want to admit that its interference has utterly failed to achieve the ends sought, and has produced a State of Affairs which is, from the government's own point of view, much worse even than the previous State of Affairs.

27:48So the government resorts to a makeshift. It subsidizes the export trade to such an extent that the losses which its policy inflicts upon the exporters are compensated. On the other hand, the Government Bureau of Foreign Exchange Control, stubbornly clinging to the fiction that foreign exchange rates have not really risen, and that the official rate is an effective rate, sells foreign exchange to importers at this official rate. If this policy were to be really followed, it would be equivalent to paying bonuses to the merchants concerned. They would reap windfall profits in selling the imported commodity on the domestic market. Thus the authority resorts to further makeshifts. It either raises import duties or levies special taxes on the importers or burdens their purchases of foreign exchange in some other way. Then of course foreign exchange control works. But it works only because it virtually acknowledges What is the market rate of foreign exchange?

29:01The exporter gets for his proceeds in foreign exchange the official rate plus the subsidy, which together equal the market rate. The importer pays for foreign exchange the official rate plus a special premium, tax or duty, which together equal the market rate. The only people who are too dull to grasp what is really going on and let themselves be fooled by the bureaucratic terminology are the authors of books and articles on new methods of monetary management and on new monetary experience. The monopolization of buying and selling of foreign exchange by the government vests the control of foreign trade in the authorities.

29:50It does not affect the determination of foreign exchange rates. It does not matter whether or not the government makes it illegal for the press to publish the real and effective rates of foreign exchange. As far as foreign trade is still carried on, only these real and effective rates are in force. In order to conceal better the true state of affairs, governments are intent upon eliminating all reference to the real foreign exchange rate. Foreign trade, they think, should no longer be transacted by the intermediary of money. It should be barter. They enter into barter and clearing agreements with foreign governments.

30:36Each of the two contracting countries should sell to the other country a quantity of goods and services and receive in exchange a quantity of other goods and services. In the text of these treaties, any reference to the real market rates of foreign exchange is carefully avoided. However, both parties calculate their sales and their purchases in terms of the world market prices expressed in gold. These clearing and barter agreements substitute bilateral trade between two countries for the triangular or multilateral trade of the liberal age. But they in no way affect the fact that a country's national currency has lost a part of its purchasing power against gold, foreign exchange and commodities.

31:30As a policy of foreign trade nationalization, foreign exchange control is a step on the way toward a substitution of socialism for the market economy. From any other point of view, it is abortive. That can certainly neither in the short run nor in the long run affect the determination of the rate of foreign exchange. Remarks about the Nazi barter agreements The barter and clearing agreements which the Nazi government of the Reich concluded with various foreign countries have been misinterpreted by the vast literature on the subject. As these misinterpretations are the basis of many current errors concerning monetary problems, it seems expedient to devote a few remarks to them.

32:22The considerations which motivated foreign governments to enter into such agreements with the Reich were not uniform. Neither were the political and economic consequences of these agreements homogeneous. We may deal with the problems involved by discussing, first, the case of the agreement with Switzerland and then those with the countries of the European Southeast. The Swiss banks had, before Hitler seized power, lent comparatively enormous sums to German business. Moreover, one of Switzerland's main industries, tourism, depended to a great extent on German patrons. The German foreign exchange control laws gave the German authorities the power to prohibit all payments to Swiss banks, and to prevent Germans from visiting the country.

33:15The clearing agreement was the only means for the Swiss to salvage at least a part of their German assets, and to induce the Reich to permit a limited number of Germans to spend a holiday in the Swiss hotels. The case of the Balkan agreements is even more interesting, as their meaning was still more distorted by misinterpretation. Let us look at an example. The Reich and one of the southeastern countries of Europe, we may call it Balkania, concluded an agreement concerning the mutual exchange of commodities which could be bought or sold on the world market for $20 million. Balkania had to give a world market value of $10 million in food and raw materials.

34:04Germany had to give a world market value of $10 million in manufactured goods. The peculiar feature of the bargain was that these commodities bought and sold were in the terms of the contract not valued according to their world market price, but at a higher rate, let us say 10% above the prices of the world market. For the goods Germany had to buy, Balkania was charged 11 million instead of 10. But, on the other hand, Balkania was credited for the goods it sold with 11 million instead of 10. This overvaluation was totally, or at least to a great extent, concealed in the rate of exchange between the Reichsmark and the Balkan, the monetary unit of Balkania's Let us assume that the dollar was actually worth 10 Balkans on the world market.

35:09By virtue of the barter agreement, Balkania sold to Germany food and raw materials for which English businessmen offered 100 million Balkans for 110 million, and bought manufactured Goods, which she could buy from English or American exporters for 100 million Balkans for 110 million. In order to understand the meaning of this strange procedure, we have to realize that the loss and the gain from these overvaluations compensated each other only for the whole nations, but not for the individual citizens. For Socialist Germany, where under Hitler all business was nationalized, this made no difference at all.

35:57But in Balkania, domestic production and domestic trade were still based on private ownership. Only the foreign trade of Balkania was controlled by the government. There it was of great consequence that those burdened by the overvaluation of the imported Goods and those favored by the overvaluation of the exported goods were not the same people. The terms of the Barter Agreement resulted therefore in a shift of income from some groups of citizens, of course the black sheep of the government, to other groups of citizens, of course the government's pet children. The government of Balkania distributed the boon of the transaction in this way.

36:431. Higher prices paid to the producers of the exported food and raw materials, 5 million. 2. Gains, legal and illegal, of the government agency entrusted with the execution of the Barter Agreement and of the friends of the government managing it, 1 million. 3. Gains retained by the Treasury, 4 million. The losses of the transaction, on the other hand, were distributed in this way. 1. Higher prices of imported commodities paid by those who were favored by the higher prices of the exported goods. 1 million. 2. Higher prices of imported goods paid by other citizens.

37:315 million. 3. Fair Prices of Imported Goods Paid by the Government, for example for arms, railroad equipment, etc., 4 million. It is obvious that the friends of the government and the peasants producing food and raw materials realized gains of 5 million, whereas the non-agricultural sections of the population were burdened with 5 million additional expenditure. Such an effect was in line with Balkania's whole economic policy. Like many other contemporary governments, the rulers of Balkania made every effort to favor the agricultural section of the population at the expense of the non-agricultural section.

38:21The political consequences of these agreements were twofold. As government became dependent on the Reich, but its power at home increased. The government now disposed of a fund which could be used for the benefit of its friends, who were on the payroll of the company or government agency entrusted with the execution of the Barter Agreement. Moreover, the government had the power to discriminate against those groups of the peasantry who did not support the government or who were members of a linguistic or religious minority. The products which had to be exported to Germany were purchased only from the sympathetic producers. The non-sympathizers were barred from the enjoyment of the benefits of the treaty.

39:11They had to sell their entire crop at the lower prices corresponding to the world market prices. In Yugoslavia, for instance, the Catholic Croat peasants complained that the government purchased only from Serbs. It is impossible to discover whether this complaint was really well founded. In any case, the Croats did not blame the Nazis, they blamed the Yugoslavian government. The Barter Agreements gave Germany a kind of monopoly of the trade with the countries from the Nazi point of view, this practice meant a skillful use of the domestic economic antagonisms within these countries for the achievement of their own political ends to the governments of the Balkan states, these barter agreements offered an opportunity of initiating a policy favoring the farming class at the expense of the non-agricultural class.

40:14Classes. What the industrial countries of Western and Central Europe achieved by tariffs and other measures discriminating against the products of foreign agriculture, and what the United States achieved by some of the agricultural measures of the New Deal, was in Romania, Hungary, Bulgaria and Yugoslavia achieved by the Barter Treaties with Germany. Faced with the problem of this German economic offensive in the Balkans, Great Britain was helpless. It had to withdraw from markets where it could buy only at prices higher than those in other countries. Consequently, the governments of the Balkan countries concerned declared that there were no pounds available for the payment of imports from Great Britain and refused to grant import licenses.

41:07Commerce between Great Britain and these countries was severely restricted. The same was no less true with regard to all other countries of Western Europe and of America. Such was the true nature of these much talked about clearing agreements, which were hailed by many authors as the dawn of a new age of monetary management.