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• Foreword
• On the Manipulation of Money and Credit Three Treatises On Trade-cycle Theory
• Stabilization of the Monetary Unit— From the Viewpoint of Theory
• Introduction *
• I: The Outcome of Inflation
• II: The Emancipation of Monetary Value From the Influence of Government
• III: The Return to Gold
• IV: The Money Relation
• V: Comments On the “balance of Payments” Doctrine
• VI: The Inflationist Argument
• VII: The New Monetary System
• VIII: The Ideological Meaning of Reform
• Appendix: Balance of Payments and Foreign Exchange Rates *
• Monetary Stabilization and Cyclical Policy
• Preface *
• Part I: Stabilization of the Purchasing Power of the Monetary Unit
• I: The Problem
• II: The Gold Standard
• III: The “manipulation” of the Gold Standard
• IV: “measuring” Changes In the Purchasing Power of the Monetary Unit
• V: Fisher’s Stabilization Plan
• VI: Goods-induced and Cash-induced Changes In the Purchasing Power of the Monetary Unit
• VII: The Goal of Monetary Policy
• Part II: Cyclical Policy to Eliminate Economic Fluctuations
• I: Stabilization of the Purchasing Power of the Monetary Unit and Elimination of the Trade Cycle
• II: Circulation Credit Theory
• III: The Reappearance of Cycles
• IV: The Crisis Policy of the Currency School
• V: Modern Cyclical Policy
• VI: Control of the Money Market
• VII: Business Forecasting For Cyclical Policy and the Businessman
• VIII: The Aims and Method of Cyclical Policy
• The Causes of the Economic Crisis an Address
• I: The Nature and Role of the Market
• II: Cyclical Changes In Business Conditions
• III: The Present Crisis
• A.: Unemployment
• B.: Price Declines and Price Supports
• C.: Tax Policy
• D.: Gold Production
• IV: Is There a Way Out?
• The Current Status of Business Cycle Research and Its Prospects For the Immediate Future
• 1.: The Acceptance of the Circulation Credit Theory of Business Cycles *
• 2.: The Popularity of Low Interest Rates
• 3.: The Popularity of Labor Union Policy
• 4.: The Effect of Lower Than Unhampered Market Interest Rates
• 5.: The Questionable Fear of Declining Prices
• The Trade Cycle and Credit Expansion: the Economic Consequences of Cheap Money
• 1.: Introductory Remarks *
• 2.: The Unpopularity of Interest
• 3.: The Two Classes of Credit
• 4.: The Function of Prices, Wage Rates and Interest Rates
• 5.: The Effects of Politically Lowered Interest Rates
• 6.: The Inevitable Ending

VI

Control of the Money Market

1.

International Competition or Cooperation

There are many indications that public opinion has recognized the significance of the role banks play in initiating the cycle by their expansion of circulation credit. If this view should actually prevail, then the previous popularity of efforts aimed at artificially reducing the interest rate on loans would disappear. Banks that wanted to expand their issue of fiduciary media would no longer be able to count on public approval or government support. They would become more careful and more temperate. That would smooth out the waves of the cycle and reduce the severity of the sudden shift from rise to fall.

However, there are some indications which seem to contradict this view of public opinion. Most important among these are the attempts or, more precisely, the reasoning which underlies the attempts to bring about international cooperation among the banks of issue.

In speculative periods of the past, the very fact that the banks of the various countries did not work together systematically and according to agreement constituted a most effective brake. With closely-knit international economic relations, the expansion of circulation credit could only become universal if it were an international phenomenon. Accordingly, lacking any international agreement, individual banks, fearing a large outflow of capital, took care in setting their interest rates not to lag far below the rates of the banks of other countries. Thus, in response to interest rate arbitrage and any deterioration in the balance of trade brought about by higher prices, an exodus of loan money to other countries would, for one thing, have impaired the ratio of the bank’s cover as a result of foreign claims on their gold and foreign exchange which such conditions impose on the bank of issue. The bank, obliged to consider its solvency, would then be forced to restrict credit. In addition, this impairment of the ever-shifting balance of payments would create a shortage of funds on the money market which the banks would be powerless to combat. The closer the economic connections among peoples become, the less possible it is to have a national boom. The business climate becomes an international phenomenon.

However, in many countries, especially in the German Reich, the view has frequently been expressed by friends of “cheap money” that it is only the gold standard that forces the bank of issue to consider interest rates abroad in determining its own interest policy. According to this view, if the bank were free of this shackle, it could then better satisfy the demands of the domestic money market to the advantage of the national economy. With this view in mind, there were in Germany advocates of bimetallism, as well as of a gold premium policy.1 In Austria, there was resistance to formalizing legally the de facto practice of redeeming its notes.

It is easy to see the fallacy in this doctrine that only the tie of the monetary unit to gold keeps the banks from reducing interest rates at will. Even if all ties with the gold standard were broken, this would not have given the banks the power to lower with impunity the interest rate below the height of the “natural” interest rate. To be sure, the paper standard would have permitted them to continue the expansion of circulation credit without hesitation, because a bank of issue, relieved of the obligation of redeeming its notes, need have no fear with respect to its solvency. Still, the increase in notes would have led first to price increases and consequently to a deterioration in the rate of exchange. Secondly, the crisis would have come—later, to be sure, but all the more severely.

If the banks of issue were to consider seriously making agreements with respect to discount policy, this would eliminate one effective check. By acting in unison, the banks could extend more circulation credit than they do now, without any fear that the consequences would lead to a situation which produces an external drain of funds from the money market. To be sure, if this concern with the situation abroad is eliminated, the banks are still not always in a position to reduce the money rate of interest below its “natural” rate in the long run. However, the difference between the two interest rates can be maintained longer, so that the inevitable result—malinvestment of capital—appears on a larger scale. This must then intensify the unavoidable crisis and deepen the depression.

So far, it is true, the banks of issue have made no significant agreements on cyclical policy. Nevertheless, efforts aimed at such agreements are certainly being proposed on every side.

2.

“Boom” Promotion Problems

Another dangerous sign is that the slogan concerning the need to “control the money market,” through the banks of issue, still retains its prestige.

Given the situation, especially as it has developed in Europe, only the central banks are entitled to issue notes. Under that system, attempts to expand circulation credit universally can only originate with the central bank of issue. Every venture on the part of private banks, against the wish or the plan of the central bank, is doomed from the very beginning. Even banking techniques learned from the Anglo-Saxons are of no service to private banks, since the opportunity for granting credit by opening bank deposits is insignificant in countries where the use of checks (except for central bank clearings and the circulation of postal checks) is confined to a narrow circle in the business world. However, if the central bank of issue embarks upon a policy of credit expansion and thus begins to force down the rate of interest, it may be advantageous for the largest private banks to follow suit and expand the volume of circulation credit they grant too. Such a procedure has still a further advantage for them. It involves them in no risk. If confidence is shaken during the crisis, they can survive the critical stage with the aid of the bank of issue.

However, the bank of issue’s credit expansion policy certainly offers a large number of banks a profitable field for speculation—arbitrage in the loan rates of interest. They seek to profit from the shifting ratio between domestic and foreign interest rates by investing domestically obtained funds in short-term funds abroad. In this process, they are acting in opposition to the discount policy of the bank of issue and hurting the alleged interests of those groups which hope to benefit from the artificial reduction of the interest rate and from the boom it produces. The ideology, which sees salvation in every effort to lower the interest rate and regards expansion of circulation credit as the best method of attaining this goal, is consistent with the policy of branding the actions of the interest rate arbitrageur as scandalous and disgraceful, even as a betrayal of the interests of his own people to the advantage of foreigners. The policy of granting the banks of issue every possible assistance in the fight against these speculators is also consistent with this ideology. Both government and bank of issue seek to intimidate the malefactors with threats, to dissuade them from their plan. In the liberal countries of western Europe, at least in the past, little could be accomplished by such methods. In the interventionist countries of middle and eastern Europe, attempts of this kind have met with greater success.

It is easy to see what lies behind this effort of the bank of issue to “control” the money market. The bank wants to prevent its credit expansion policy, aimed at reducing the interest rate, from being impeded by consideration of relatively restrictive policies followed abroad. It seeks to promote a domestic boom without interference from international reactions.

3.

Drive for Tighter Controls

According to the prevailing ideology, however, there are still other occasions when the banks of issue should have stronger control over the money market. If the interest rate arbitrage, resulting from the expansion of circulation credit, has led, for the time being, only to a withdrawal of funds from the reserves of the issuing bank, and that bank, disconcerted by the deterioration of the security behind its notes, has proceeded to raise its discount rate, there may still be, under certain conditions, no cause for the loan rate to rise on the open money market. As yet no funds have been withdrawn from the domestic market. The gold exports came from the bank’s reserves, and the increase in the discount rate has not led to a reduction in the credits granted by the bank. It takes time for loan funds to become scarce as a result of the fact that some commercial paper, which would otherwise have been offered to the bank for discount, is disposed of on the open market. The issuing bank, however, does not want to wait so long for its maneuver to be effective. Alarmed at the state of its gold and foreign exchange assets, it wants prompt relief. To accomplish this, it must try to make money scarce on the market. It generally tries to bring this about by appearing itself as a borrower on the market.

Another case, when control of the money market is contested, concerns the utilization of funds made available to the market by the generous discount policy. The dominant ideology favors “cheap money.” It also favors high commodity prices, but not always high stock market prices. The moderated interest rate is intended to stimulate production and not to cause a stock market boom. However, stock prices increase first of all. At the outset, commodity prices are not caught up in the boom. There are stock exchange booms and stock exchange profits. Yet, the “producer” is dissatisfied. He envies the “speculator” his “easy profit.” Those in power are not willing to accept this situation. They believe that production is being deprived of money which is flowing into the stock market. Besides, it is precisely in the stock market boom that the serious threat of a crisis lies hidden.

Therefore, the aim is to withdraw money from stock exchange loans in order to inject it into the “economy.” Trying to do this simply by raising the interest rate offers no special attraction. Such a rise in the interest rate is certainly unavoidable in the end. It is only a question of whether it comes sooner or later. Whenever the interest rate rises sufficiently, it brings an end to the business boom. Therefore, other measures are tried to transfer funds from the stock market into production without changing the cheap rate for loans. The bank of issue exerts pressure on borrowers to influence the use made of the sums loaned out. Or else it proceeds directly to set different terms for credit depending on its use.

Thus we can see what it means if the central bank of issue aims at domination of the money market. Either the expansion of circulation credit is freed from the limitations which would eventually restrict it. Or the boom is shifted by certain measures along a course different from the one it would otherwise have followed. Thus, the pressure for “control of the money market” specifically envisions the encouragement of the boom—the boom which must end in a crisis. If a cyclical policy is to be followed to eliminate crises, this desire, the desire to control and dominate the money market, must be abandoned.

If it were seriously desired to counteract price increases resulting from an increase in the quantity of money—due to an increase in the mining of gold, for example—by restricting circulation credit, the central banks of issue would borrow more on the market. Paying off these obligations later could hardly be described as “controlling the money market.” For the bank of issue, the restriction of circulation credit means the renunciation of profits. It may even mean losses.

Moreover, such a policy can be successful only if there is agreement among the banks of issue. If restriction were practiced by the central bank of one country only, it would result in relatively high costs of borrowing money within that country. The chief consequence of this would then be that gold would flow in from abroad. Insofar as this is the goal sought by the cooperation of the banks, it certainly cannot be considered a dangerous step in the attempt toward a policy of evening out the waves of the business cycle.

[1. ][See above p. 40, n. 3.—Ed.]