5. HOW FREE-MONEY WILL BE JUDGED

N. The Theorist on Economic Crises

Free-Money has injured me quite as much as my colleague, the writer on the theory of interest; it has reduced my whole collection of theories to waste paper.

It seemed so plausible that a period of growth should be succeeded by a period of decay. It is so in nature, and it must be so in economic life, since man and everything he creates is part of nature. The ant-hill and the economic system of the bees are products of nature, so the economic system of men and nations must be the same. Man grows and passes away; why, then, should not economic fife, after a period of growth, end in dissolution ? Ruin overtook the Roman Empire, therefore ruin must overtake the economic life of all other nations periodically every few years in the shape of a great crisis. Just as summer is succeeded by winter, so a boom must be succeeded by a slump.

Was not that a theory worthy of a poet's pen? How simple it was, with its aid, to explain the intricate problem of unemployment! I had also ready to hand a soothing theory guaranteed not to disturb middle-class complacency. A lullaby, not a theory, was what was asked for, and in this respect the current explanation of economic crises was most suitable. In consequence of "speculative purchases" prices had risen and there was "feverish activity" in every field. Overtime and night-shifts were required to meet the increasing demand; wages soared. Of course this "hot-house growth" was an unhealthy manifestation which was bound to end in a sudden collapse. And the collapse occurred. Naturally demand fell short of such an enormous output of every kind; and demand failing, prices fell. Everything without exception, the products of industry, agriculture, mining, forestry, declined in price and the whole structure of speculation came down with a crash. The avaricious workers had absorbed with their overtime the whole "Wage-Fund" and the "Wage-Fund" being exhausted, there was not enough employment to go round. There were mountains of bread and clothes, yet the workers went cold and hungry.

Or take the classical Malthusian theory - how convincing it sounded and how widely it was accepted ! It sternly rebuked the dissolute masses: "The only use you could make of prosperity was to get married; you increased your miserable race beyond the limit of decency. At every turn our eyes are offended by swaddling clothes and cradles. The streets swarm; the schools are like rabbit-warrens. So now your own children have grown up to crowd you out of your occupations and to reduce your wages. Lowered wages mean falling prices; falling prices make business a losing venture and nip the spirit of enterprise in the bud. Propagation is the forbidden fruit, it is tainted with original sin, but is doubly sinful for the proletariat. Abstain then, leave breeding to the heathen, send your daughters to the nunneries, and we shall no longer have more workers than are necessary to deal with the available work. With wages rising, prices will also rise and stimulate enterprise. Moderation in all things, my friends, in the production of goods as well as in the production of children, otherwise we shall have overproduction both of goods and of consumers."

Or again there was a new theory, one of the best in my collection. Owing to accumulation of riches in comparatively few hands and disproportion between the purchasing power and the producing power of the masses, consumption falls short of production. Hence a glut of unsaleable goods in the market, a fall of prices, unemployment, depression and crisis. The rich are unable to consume up to their incomes, and the workers have no incomes to consume. Were incomes properly distributed, consumption would keep pace with production and crises would be averted.

How plausible this sounded ! And it is the sound that matters, for this theory was meant for the proletariat, and it is useless to appeal to the intelligence of a crowd of people nurtured on adulterated food and beer, crushed with cares and incapable of standing a hearty shock.

For I had a theory for every grade of society and every taste. If, occasionally, I met with serious objections I had recourse to my reserve theory which connected crises with the currency system. Usually the word currency sufficed to silence the objectors. "That is enough", they cried, "We know what Disraeli says, that next to love, the currency problem is the chief cause of lunacy, and we have no wish to risk a dangerous overburdening of our brains for the sake of a theory of economic crises !" Yet this was comparatively the simplest and soundest of all my theories. Commodities, I argued, are almost exclusively disposed of by way of commerce. that is, their exchange is effected through the agency of merchants. The merchant, however, does not buy commodities unless he expects to sell them at a profit. The prospective selling price must be higher than the purchase price, the price asked by the worker or manufacturer. So if prices tend to fall, the merchant is unable to estimate what price he ought to pay, while the manufacturer cannot, short of incurring an actual loss, reduce his offer below his own cost price. With the consumer the case is different. He buys, paying the price asked. He rejoices when prices fall and is chagrined when they rise, his only limit for the price paid being his own income. The merchant, on the contrary, must realise a price that will exceed a certain figure, namely the purchase price. He does not know whether he can obtain such a price. His selling price is uncertain, whereas the purchase price, once the bargain is struck, is a definite quantity.

When prices in general are stable or, still more, if they are rising, all is well, the sale will, in all probability, cover and exceed the outlay, so the merchant is safe in signing his order. But when prices fall, and keep on falling, 1, 2, 5, 10, 20, or 30%, as has often happened, the merchant has no foothold, so the only reasonable thin he can do, if he is a prudent man, is to wait. For the merchant cannot calculate his selling price on the basis of his outlay; he has to make an estimate of the price he hopes to realise. And if, within the period between purchase and re-sale, prices fall, he is forced to reduce his selling price and incur a loss. So the safest thing to do in times of falling prices is to postpone orders. For the motive power in the commercial turnover of goods is not the need of commodities but the hope of profit.

This postponement of the merchant's usual orders meant a stoppage of the manufacturer's sales. But the manufacturer is, as a rule, dependent on the regular disposal of his output, since he cannot store bulky or perishable goods. The stoppage of sales compelled him, therefore, to dismiss his workers.

Employment and wages failing, the workers, in their turn, were unable to buy, which brought prices still lower. Thus the initial decline of prices had created a vicious circle.

The moral of all this was that we must prevent prices from falling, that we must manufacture more money. In this way there will always be sufficient money to buy commodities, and merchants, being aware of the large cash reserves of banks and private individuals, will never be alarmed by the prospect of a shortage of money and slump of prices.

That meant a bimetallic standard or paper-money.

At bottom none of these theories satisfied me. The first, which looks upon the crisis as a kind of natural phenomenon, is too crude to need refutation. The second theory, which makes speculation responsible for the crisis, does not examine whether the surplus of money in the hands of Private individuals and professional speculators, without which speculation would be impossible, was not the real cause of speculation and consequently of the crisis itself. What is the use of setting up a central Bank of Issue and granting it a monopoly of the issue of banknotes for the purpose of "adapting the monetary circulation to the needs of the market", if notwithstanding the bank and its monopoly "speculation" can decide to force up prices whenever it pleases ? And because this theory overlooks that aspect of the question, it falls into the error of expressing pious wishes instead of indicating the necessary reforms. "Do, pray, abstain from speculation", is all it has to recommend as a protection against crises.

This theory does not, moreover, consider the real motive of the feverish activity, overtime and night-shifts". For without this speeding up of labour, all speculation would be doomed to failure. What is the use of a manufacturer proposing overtime to his workers if they reply that their present working hours suffice to meet their wants ? So if, at present, the workers are willing to join in "the feverish activity", it is simply because they have urgent wants which they expect to satisfy with the wages earned by overtime. But if demand is as urgent as supply, how can a crisis occur ? The speculation that induces money reserves to seek a market accounts only for the general rise of prices, but does not explain the failure of consumption to keep pace with production, or the fact that sales usually fall off with dramatic suddenness.

This failure to explain why consumption and production do not, as a rule, balance, is the weak point common to all these theories; but this question clamours most loudly for an answer in the case of the third theory, the theory of over-population. Overproduction resulting from over-population is here advanced as the cause of the crisis, which amounts to saying that the excessively large loaves are due to the excessive hunger ! The absurdity of such an argument becomes apparent if we keep in mind that commodities are produced for exchange, and that the hungry workers are both willing and able to give other products in exchange for those they need. If it were merely a question of over-production of some special kind of goods, say coffins, no explanation would be necessary; but there is too much of everything, for example both of agricultural and industrial products.

The theory that attributes the crisis to deficient consumption resulting from an unequal distribution of income is quite as unsatisfactory, for it fails to explain why sales go sky-high at one moment and then drop to earth the next; why a constant and latent cause (in our case the unequal distribution of incomes) should have an acute and sudden effect (boom and slump). Had faulty distribution of incomes been the cause, the crisis must necessarily have manifested itself as an uninterrupted, latent condition, a constant, unchanging surplus of labour; that is, the direct opposite of what was observed to happen.

But even the assumption that the incomes of the wealthy classes generally exceeded their personal wants was erroneous, as was proved by the debts of the land-owners great and small, and their clamour for protection by the State. Wants have no limit; they are infinite. The wants of the weavers in the Eulengebirge were, surely, not satisfied with the potato parings that fell to their lot, and the ducal coronets which the American millionaires bought for their daughters were not sufficient to appease their craving for dignity.

They reached out for an imperial crown, piling million on million, toiling day and night, reducing perhaps their own, and certainly their workers' standard of living to obtain it. And had they obtained it, a priest would have appeared and told them that earthly crowns are perishable that they must still toil and save, to bequeath billions to the Church and assure themselves a throne in the Kingdom of Heaven. Between potato parings and the church treasury there extends an ocean of wants large enough to engulf the maximum that men can produce. Neither is any man so rich that he is not bent on growing still richer; on the contrary, the greed of gain develops with successful gaining. The mighty fortunes of our epoch could never have been formed if after reaching the first Million their possessors had said: "We have acquired enough, let others now have an innings." No rich man ever allowed his surplus to lie idle as long as there was a prospect of a profitable investment. Interest, no doubt, was the essential condition for the lending of the capitalist's money, but in this respect the richest in the land acted no differently from the meanest saver of pence. No interest - no money, was the watchword all down the line. All of them made the lending of money dependent on interest, and even had we levelled all incomes it would not have altered the fact that the money-saver, the man who produced and sold more goods than he consumed, would not have put his money surplus into circulation until he was assured his interest. Thus the activity of the savers necessarily brought about an excess of commodities, stagnation of the markets and unemployment as soon as commerce and industry ceased to yield interest. The cause of the crisis lay in the fact that capitalists refused to invest their money unless they obtained interest, and that when the supply of houses, industrial plant and other instruments of production passed a certain limit, the rate of interest fell below the minimum yield necessary to pay the interest on the money invested in them. (Competition among house-owners in respect of tenants has the same effect as competition among the owners of industrial enterprises in respect of workers: it reduces the rate of interest. In the one case it diminishes rent, in the other it raises wages). As soon as this point was reached employers were no longer able to pay the interest demanded of them, and capitalists had no motive to lend their money gratis.

They preferred to wait for the crisis which could be counted on to "ease" the situation and to restore the normal rate of interest. They found it advantageous to renounce all interest for a short time in order to make sure of a higher rate, rather than immobilise their money in a long-term investment at a low rate. A certain minimum rate could always be extorted merely by waiting.

So the disproportion between the income and the consumption of the wealthy classes and between the purchasing power and the producing power of the workers cannot be regarded as the true cause of industrial crises.

The last theory, which connected the crisis with the currency, came nearest the truth.

That as long as prices tended downwards and goods could be sold only at a loss, no one thought of creating new enterprises or enlarging existing ones; that no merchant bought goods which he would have been forced to sell below the purchasing price; and that in these circumstances a crisis became inevitable, is obviously true. But this theory answered the question with new questions. It was right in stating that a crisis is equivalent to a general fall of prices, but it failed to provide a satisfactory answer to the question how the fall of prices occurred. It did indeed trace the fall of prices to a shortage of money, and hence proposed as remedy an increased manufacture of money (bimetallic standard, paper-money); but the proof was lacking that with or after the increase of the stock of money the supply of this money would adapt itself to the supply of goods, and more especially that money would be supplied to the market when the rate of interest began to decline. And that, after all, is the issue.

This point was not altogether overlooked; it was proposed to dissociate the currency from any kind of metal by abolition of the right of free coinage of silver and gold, so that the manufacture of money (not the supply of money) might be regulated; more money being manufactured when prices fell and less when prices rose. It was supposed that by this simple method the supply of money could always be adapted to the demand.

This proposal was never put into practice, which was lucky, for it would have proved a failure. Its authors mistook a stock of money for a supply of money, believing as they did, that because a large stock of potatoes means an equally large supply of potatoes, it must be the same in the case of money. But that is by no means true. The supply of potatoes or any other commodity corresponds exactly to the stock, since storage involves heavy expense. Had the traditional form of money resembled the general run of commodities, had it not been possible to hoard metal money without expense, the supply of money might reasonably have been estimated by the stock. But that, as we know, was not the case. The supply of money depended absolutely on the will of its owners. And not one penny was put in circulation commercially or financially as long as no interest could be obtained. No interest - no money; even though the stock of money were increased a hundred-fold.

Now suppose that such a reform in the system of issuing paper-money had achieved its purpose, namely the prevention of trade depression and acute crises. The country adopting the reform would then have speedily become so well stocked with houses, industrial plant and so forth that such things would have failed to yield the customary interest. Whereupon the old round would have started again; the money savers and capitalists would have opposed a reduction of the rate of interest, and employers of labour would have been unable to pay the old rate. Thousands of years of experience have taught the owners of money that their money will fetch 3 - 4 or 5%, according to the investment, and that to obtain this rate of interest they need only wait. So they would have waited.

But while the owners of money were waiting, demand for goods would have failed, and prices fallen. This in its turn would have alarmed commerce which, uncertain of the future, would have held back orders.

And thus we should have been once more face to face with slump, unemployment and crisis.

It was indeed proposed that in such cases the State should enable the employers of labour to carry on by supplying them with money at a lower rate or, if need be, free of interest. In this manner the State would have replaced the money withdrawn from circulation by the savers and capitalists. But what would this have led to ? on the one hand, the capitalists' useless masses of paper-money, on the other hand, in the national treasuries, corresponding masses of bonds and bills of exchange-long-term bills, moreover, and bonds such as employers require, not subject to withdrawal at short notice.

The masses of paper-money hoarded by private individuals (all private fortunes would finally have assumed that form) might any day have been set in motion by some trivial event, and this money, being only redeemable in the market in exchange for goods, would suddenly have become an enormous mass of demand which the State would have been powerless to control by means of the bonds and long-term bills. in this manner prices would have soared sky-high.

It was fortunate that we escaped this peril by introducing Free-Money, for the disastrous failure of the partial reform would of course have been used as an argument against the theory of paper-money, and we should have relapsed, perhaps for centuries, into the barbarism of metal money.

Free-Money makes the supply of money independent of all conditions; the exact quantity of money that has been put in circulation by the State is supplied to the market. What had hitherto been taken for granted, namely, that the supply of money, like the supply of potatoes, must always be equal to the stock, has for the first time become a reality. The supply of money no longer runs an independent course; it has ceased to be an arbitrary act; it is not influenced by human volition. The quantity theory now holds good, even in the simple form sometimes termed "crude".

Under such circumstances, how can a crisis occur ? Even if the rate of interest decreases, even if it falls below zero, money will nevertheless be supplied; and should prices tend to fall, the State will raise them again, simply by increasing the stock of money. The supply of money will then in all conceivable circumstances balance the supply of goods.

Now if it is Free-Money which prevents crises, we have to look for the cause of the crisis at the point where the traditional form of money differed from Free-Money. And the difference lies in the motives controlling the supply of money now and formerly.

Interest was formerly the essential and obvious condition of the circulation of money; whereas money is now supplied without interest.

Formerly, when a general fall of prices set in (already an indication that the supply of money was insufficient) money was withdrawn from the market (because with prices falling nobody buys or can buy goods commercially, without incurring the risk of losing on the outlay), and in this way a general fall of prices frequently developed into a frantic universal scramble for ready money, which inevitably precipitated prices to the lowest depths. Whereas at present money is supplied in all conceivable circumstances.

And with a general rise of prices, the index of an excessive supply of money, all private reserves of money sought a market, because everyone was anxious to participate in the generally expected further rise with as large as possible a stock of goods or of industrial shares. This made the expected rise inevitable, forcing up prices to the very highest level attainable by the supply of all private reserves of money. Whereas at present prices cannot rise at all, because there are no longer any private reserves of money.

The amount of money supplied to the market, the answer to the question whether a capitalist should or should not buy commodities. used to be determined by guess-work, public opinion, rumour, very often merely by the frown or smile of a sovereign. If the digestion of the "leading" stock jobbers was sound, and fine weather coincided with some favourable piece of intelligence, the "tone" of the market changed, and the sellers of yesterday became the buyers of today. The supply of money was a straw blown by the wind. And consider the haphazard fashion in which money was produced! If the diggers found gold-good; if they did not-we had to manage without. All through the Middle Ages down to the discovery of America commerce had to be conducted with the stock of gold and silver inherited from the Romans, because all the mines then known were exhausted. Trade and traffic were restricted to a minimum, because the scarcity of the medium of exchange did not permit the division of labour. Since that time much gold and silver has been discovered; but how irregular were these discoveries! There were "finds" in the fullest sense of the term.

Added to these fluctuations in the discovery of gold were the fluctuations in the currency policies of the various countries which sometimes introduced the gold standard by means of loans of foreign gold (Italy, Russia, Japan), thus withdrawing immense quantities of gold from the markets, and sometimes reverted to a paper standard and so thrust their gold back on the foreign markets.

The supply of money was thus the shuttlecock of the most varied and conflicting circumstances. That was the difference between the former monetary system and Free-Money; that was the cause of economic crises.