VIII. The Aims and Method Cyclical Policy

VIII.
THE AIMS AND METHOD OF CYCLICAL POLICY

1. REVISED CURRENCY SCHOOL THEORY

Without doubt, expanding the sphere of scientific investigation from the narrow problem of the crisis into the broader problem of the cycle represents progress.⁵² However, it was certainly not equally advantageous for political policies. Their scope was broadened. They began to aspire to more than was feasible.

The economy could be organized so as to eliminate cyclical changes only if (1) there were something more than muddled thinking behind the concept that changes in the value of the monetary unit can be measured, and (2) it were possible to determine in advance the extent of the effect which accompanies a definite change in the quantity of money and fiduciary media. As these conditions do not prevail, the goals of cyclical policy must be more limited. However, even if only such severe shocks as those experienced in 1857, 1873, 1900/01 and 1907, could be avoided in the future, a great deal would have been accomplished.

The most important prerequisite of any cyclical policy, no matter how modest its goal may be, is to renounce every attempt to reduce the interest rate, by means of banking policy, below the rate which develops on the market. That means a return to the theory of the Currency School, which sought to suppress all future expansion of circulation credit and thus all further creation of fiduciary media. However, this does not mean a return to the old Currency School program, the application of which was limited to banknotes. Rather it means the introduction of a new program based on the old Currency School theory, but expanded in the light of the present state of knowledge to include fiduciary media issued in the form of bank deposits.

The banks would be obliged at all times to maintain metallic backing for all notes—except for the sum of those outstanding which are not now covered by metal—equal to the total sum of the notes issued and bank deposits opened. That would mean a complete reorganization of central bank legislation. The banks of issue would have to return to the principles of Peel's Bank Act, but with the provisions expanded to cover also bank balances subject to check. The same stipulations with respect to reserves must also be applied to the large national deposit institutions, especially the postal savings.⁵³ Of course, for these secondary banks of issue, the central bank reserves for their notes and deposits would be the equivalent of gold reserves. In those countries where checking accounts at private commercial banks play an important role in trade—notably the United States and England—the same obligation must be exacted from those banks also.

By this act alone, cyclical policy would be directed in earnest toward the elimination of crises.

2. “PRICE LEVEL” STABILIZATION

Under present circumstances, it is out of the question, in the foreseeable future, to establish complete “free banking” and place all banking transactions, including the granting of credit, under ordinary commercial law. Those who speak and write today on behalf of “stabilization,” “maintenance of purchasing power” and “elimination of the trade cycle,” can certainly not call this more limited approach “extreme.” On the contrary! They will reject this suggestion as not going far enough. They are demanding much more. In their view, the “price level” should be maintained by countering rising prices with a restriction in the circulation of fiduciary media and, similarly, countering falling prices by the expansion of fiduciary media.

The arguments that may be advanced in favor of this modest program have already been set forth above in the first part of this work. In our judgment, the arguments which militate against all monetary manipulation are so great that placing decisions as to the formation of purchasing power in the hands of banking officials, parliaments and governments, thus making it subject to shifting political influences, must be avoided. The methods available for measuring changes in purchasing power are necessarily defective. The effect of the various maneuvers, intended to influence purchasing power, cannot be quantitatively established—neither in advance nor even after they have taken place. Thus proposals which amount only to making approximate adjustments in purchasing power must be considered completely impractical.

Nothing more will be said here concerning the fundamental absurdity of the concept of “stable purchasing power” in a changing economy. This has already been discussed at some length. For practical economic policy, the only problem is what inflationist or restrictionist measures to consider for the partial adjustment of severe price declines or increases. Such measures, carried out in stages, step by step, through piecemeal international agreements, would benefit either creditors or debtors. However, one question remains: Whether, in view of the conflicts among interests, agreements on this issue could be reached among nations.

The viewpoints of creditors and debtors will no doubt differ widely, and these conflicts of interest will complicate still more the manipulation of money internationally, than on the national level.

3. INTERNATIONAL COMPLICATIONS

It is also possible to consider monetary manipulation as an aspect of national economic policy, and take steps to regulate the value of money independently, without reference to the international situation. According to Keynes,⁵⁴ if there is a choice between stabilization of prices and stabilization of the foreign exchange rate, the decision should be in favor of price stabilization and against stabilization of the rate of exchange. However, a nation which chose to proceed in this way would create international complications because of the repercussions its policy would have on the content of contractual obligations.

For example, if the United States were to raise the purchasing power of the dollar over that of its present gold parity, the interests of foreigners who owed dollars would be very definitely affected as a result. Then again, if debtor nations were to try to depress the purchasing power of their monetary unit, the interests of creditors would be impaired. Irrespective of this, every change in value of a monetary unit would unleash influences on foreign trade. A rise in its value would foster increased imports, while a fall in its value would be recognized as the power to increase exports.

In recent generations, consideration of these factors has led to pressure for a single monetary standard based on gold. If this situation is ignored, then it will certainly not be possible to fashion monetary value so that it will generally be considered satisfactory. In view of the ideas prevailing today with respect to trade policy, especially in connection with foreign relations, a rising value for money is not considered desirable, because of its power to promote imports and to hamper exports.

Attempts to introduce a national policy, so as to influence prices independently of what is happening abroad, while still clinging to the gold standard and the corresponding rates of exchange, would be completely unworkable. There is no need to say any more about this.

4. THE FUTURE

The obstacles, which militate against a policy aimed at the complete elimination of cyclical changes, are truly considerable. For that reason, it is not very likely that such new approaches to monetary and banking policy, that limit the creation of fiduciary media, will be followed. It will probably not be resolved to prohibit entirely the expansion of fiduciary media. Nor is it likely that expansion will be limited to only the quantities sufficient to counteract a definite and pronounced trend toward generally declining prices. Perplexed as to how to evaluate the serious political and economic doubts which are raised in opposition to every kind of manipulation of the value of money, the people will probably forgo decisive action and leave it to the central bank managers to proceed, case by case, at their own discretion. Just as in the past, cyclical policy of the near future will be surrendered into the hands of the men who control the conduct of the great central banks and those who influence their ideas, i.e., the moulders of public opinion.

Nevertheless, the cyclical policy of the future will differ appreciably from its predecessor. It will be knowingly based on the Circulation Credit Theory of the Trade Cycle. The hopeless attempt to reduce the loan rate indefinitely by continuously expanding circulation credit will not be revived in the future. It may be that the quantity of fiduciary media will be intentionally expanded or contracted in order to influence purchasing power. However, the people will no longer be under the illusion that technical banking procedures can make credit cheaper and thus create prosperity without its having repercussions.

The only way to do away with, or even to alleviate, the periodic return of the trade cycle—with its denouement, the crisis—is to reject the fallacy that prosperity can be produced by using banking procedures to make credit cheap.