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CHAPTER 2: The Problem of Legal Resumption of Specie Payments in Austria-Hungary 1 - Ludwig von Mises, Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War 
Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War, edited and with an Introduction by Richard M. Ebeling (Indianapolis: Liberty Fund, 2012).
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The Problem of Legal Resumption of Specie Payments in Austria-Hungary1
Process of Currency Regulation Since 1892
The currency reform that began in Austria-Hungary in 1892, and for whose introduction great material sacrifices were required by the two halves of the empire, still awaits formal conclusion through the legal resumption of specie payments. At the present time, the lawful money of the monarchy remains a paper currency. The Austro-Hungarian Bank is still relieved of the obligation to redeem its notes in specie, a legal status that remains indefinitely in force.
Admittedly, the experts believe that Austria-Hungary would be quite capable of completing the transition to a gold currency, and that the Austro-Hungarian Bank would be able to comply with all of the obligations that would arise from the legal resumption of specie payments.
Nevertheless, the desire to complete this great reform is small in both Austria and Hungary (as can be seen in the most recently concluded Bank inquiry), and there is no lack of voices that speak out against the legal resumption of specie payments. The present monetary regime, which might be described as a paper currency with gold reserves for foreign exchange transactions, or as a Bank-supported paper currency, would have its “temporary” character transformed into the permanent monetary system of the monarchy. The establishment of this fundamentally different monetary system is claimed to have its rationale in the monetary systems existing in other European countries. The arguments for this system are important enough that they deserve a detailed analysis.
Up until the second half of the 1880s, manufacturers in Austria-Hungary had adjusted themselves to a paper currency, following the ending of a silver-backed currency for private transactions. The value of the Austrian currency was accepted to be in continuous decline in relation to the currencies of other countries on a gold standard. The price of 100 florins in gold (250 francs) in 1872 was, on average, 110.37 Austrian paper florins; beginning that year (with a small interruption), it continued to go up to 125.23 Austrian paper florins in 1887. Both agricultural and industrial producers benefited from this deterioration in the exchange rate. The increase in the foreign exchange rate at the Viennese bourse functioned like a protective tariff on the import of foreign manufactured items and served as an export premium for domestic products sold abroad; it also benefited borrowers at the expense of creditors. Under these circumstances, plans for monetary reform could not depend on much support from either the industrial or agricultural sectors.
The situation reversed itself beginning in 1888, and the value of the Austrian currency began to increase (the price for 100 florins in gold amounted to an average of only 115.48 Austrian paper florins in 1890). Suddenly the manufacturers and exporters who were harmed by the higher valuation of the currency understandably became supporters of the monetary reform that they had fought for years. In general, the belief was widely held that the increase in the exchange rate that began in 1888 was most likely neither a coincidental nor temporary event; instead, it could be traced back to deeper economic causes. There was considerable agreement that the fall in the agio would not stop of its own accord; indeed, it would continue at an increasing rate in the years ahead if a change in the currency was not introduced in a timely manner.
This view was completely justified. The general economic and political situation produced a continuous improvement in the monarchy’s balance of payments, and as a result the foreign demand for Austrian exchange was increasing and the Austrian demand for foreign exchange was decreasing. At the time, there was absolutely no indication that this relationship would change in the years ahead.
The adoption of gold as a basis for the Austro-Hungarian monetary system appeared to be the most suitable way to prevent any further increase in the exchange rate, even though up to that time gold had never been used in the Austrian monetary system. To completely stop any further declines in the foreign exchange rate on the Viennese bourse, the answer was to legally bring the paper florin into a fixed relationship with gold and to obligate the Austro-Hungarian Bank to exchange all amounts of gold offered for banknotes at that rate. This was the approach taken by the legislature. Beginning on August 11, 1892, the effective date of the new exchange rate law, the value of one Austrian florin (2 crowns expressed in the new denomination) essentially could not increase above the value of 2 francs, 10 centimes or 1 mark, 70.1 pfennig.
It was, however, just as important to limit any fluctuation in the value of the Austrian currency at the lower range of the exchange rate. Even if the Christian Social Party (which at that time was rather small and not strong enough to push through all of their demands) had vigorously resisted every step taken to prevent an inflationary bias, the two governments and the majorities of both parliaments were in agreement: the fixing of the international value of the Austro-Hungarian exchange rate was necessary to completely eliminate the speculative activities that had come about as a result of the continuing fluctuations in the exchange rate. The most effective method for achieving this goal would be an immediate transition to a gold standard. Moreover, another positive factor behind the currency reform was the opportunity to improve the international creditworthiness of both halves of the monarchy; Western foreign countries had complete confidence only in nations that were on a gold standard.
There was no clear provision in the Monetary Reform Act of August 2, 1892, detailing the transition to a gold-backed currency. Such a provision would have had little meaning, since the transition to a gold-backed currency required extensive and costly preparations, and could be completed only at a later date. The task had to be approached, therefore, with the greatest caution in order to prevent a disaster similar to the one that occurred a little earlier in Italy, which had delayed the establishment of a fixed exchange rate. Thus the final transition to a gold currency was, in fact, put off; however, continuous efforts were being applied in preparation for it.
Initially, the state notes were taken out of circulation at a fixed rate of exchange. This happened in the following manner: gold proceeds from a large government bond issue were transferred to the Austro-Hungarian Bank, so the Bank could redeem the notes on behalf of the state. However, the redemption of the state notes did not initially take place in exchange for gold; they were redeemed through the issuing of banknotes, of silver florins that up until then had been held as reserves in the vaults of the Bank, and of five-crown and one-crown coins. Even today, the silver florins are face-value coins, just like the earlier German Taler; in contrast, the five-crown and one-crown coins are token coins, and no one is obligated in private transactions to accept in payment more than 250 crowns of the first type or 50 crowns of the second type. Provisionally, the gold remained in the Bank as backing for the notes, with the proviso, however, that at a later point in time the gold would enter into circulation in place of a large portion of the banknotes.
Banknotes took the place of the irredeemable state notes at a fixed rate of exchange. From then and up to the present the Bank’s notes are irredeemable at a fixed rate of exchange. The great progress lay in the fact, however, that under the provisions of the statutes of the Bank, the banknotes were backed by gold and were negotiable, while the state notes had no backing. In addition, it should be mentioned that the gold reserves of the Bank were considerably increased through purchases from private importers as well. The reserves amounted to 1,099.3 million crowns on December 31, 1907, and were at that time exceeded in size only by the gold reserves held by the Bank of France and by the Russian State Bank.2
The only type of currency that currently stands in the way of the introduction of the pure, gold-backed currency, as it would be represented in Bamberger’s ideal,3 is the silver florin, whose minting had been reserved for the government after 1879 and which has been discontinued since 1892. As has already been mentioned, the silver florin is still a legal, face-value coin; however, it is no longer of great importance. At the end of 1904, the monarchy’s entire inventory amounted to 336 million crowns in silver florins, according to estimates by the Austrian Finance Ministry. Due to the agreed-upon minting of an additional 64 million crowns in five-crown coins, which already had been partially implemented, the amount has decreased to 272 million crowns. The increasing demand for the monarchy’s token coins should be able to absorb this remaining amount in at least two decades, even at a modest increase in the token coins. Any threat to the gold-backed currency is thus not to be feared from this corner.
Incidentally, the silver florin has been slowly withdrawn from circulation since the beginning of 1908, and they are being accumulated in the Bank’s vaults. At the end of October 1908, with the minting of the new five-crown coins currently under way, the entire sum of silver florins may have amounted to slightly more than 300 million crowns, of which 285 million were held by the Bank, with the remaining 15 million being in circulation.4
During the summer and autumn of 1892, the foreign exchange rate corresponded fairly closely to the underlying parity of the currency’s exchange rate (100 Austrian florins = 170.1215 marks); indeed, it even dropped substantially below this rate for intermittent periods. Toward the end of the year it began to increase, and this unfavorable relationship continued for the next two years. An agio emerged in relation to the ratio established in the law of August 2, 1892, that temporarily even reached 6.5 percent.
The reason behind this unexpected drop in the value of the Austrian currency, whose continuing increase in value had been viewed as something to be prevented, was due to, as Kalkmann has conclusively shown,5 the simultaneous financial squeeze on the international monetary market. In 1892, when the rate of interest was low for the English, Dutch, and Germans, they had loaned money to the Austrians and bought Austrian notes. As a result of the Australian crisis in May 1893,6 the interest rate rose in London and then in Berlin and Amsterdam as well; the English, Dutch, and German investors now sought to pull their monies out of Austria as quickly as possible. They sent to Vienna the Austrian notes that they had in their possession and demanded payment. Since this could almost only take place through remittance of gold, the price of gold rose immediately and significantly on the Viennese bourse in line with the increase in the London private discount rate. The high discount rate on the foreign stock markets depressed the prices of Austrian and Hungarian investments even more, and caused a large reverse flow of funds that at the same time contributed to the decline of the exchange rate.
The devaluation of the Austrian currency in 1893 was only one link in a long chain of events that occurred as part of the effects on Europe from the Australian and American crises. The government, however, was not guilt-free, insofar as it entered the Western currency markets and aggravated the strain on them at the most unfavorable moment imaginable; that is to say, by issuing 100 million florins in gold bonds and by withdrawing gold assets from abroad.
The government of the Dual Monarchy would have had to undertake two measures in order to prevent the increasing agio. The first measure would have been the release of gold or gold exchange at the parity ratio fixed by the law of 1892. However, the Ministry of Finance was against this, being afraid that this would result in the loss of the gold reserves after those reserves had only recently been regained through great sacrifice. Furthermore, the outcome would have been in doubt. In spring 1893, the Austrian Credit-Anstalt for Commerce and Industry repeatedly made large amounts of foreign exchange available to the market, but without any noticeable effect. The attempted lending of foreign exchange by the Austro-Hungarian Bank had just as little effect.
A satisfactory outcome could have resulted only if the Bank had followed an energetic interest rate policy. However, that would have been impossible because the two governments, influenced more by political considerations than by economic ones, attempted to keep the rate of interest low, and by lending large amounts of money, they tried to create an artificial quantity of credit on the markets. On August 2, 1893, the Bank of England increased its discount rate from 2.5 percent to 3 percent; on August 9, from 3 percent to 4 percent; and on August 23, from 4 percent to 5 percent. While doing so, it announced that additional increases in the discount rate would be forthcoming, and soon rumors circulated that it would not balk at increasing its official discount rate to 10 percent, if the outflows of gold did not end soon. The German Reichsbank had already increased its official discount rate to 5 percent on August 11, and it was officially announced in Berlin that the Reichsbank planned to align its discount rate in accordance with London in order to protect its gold reserves. The Austro-Hungarian Bank, however, persisted with its discount rate at 4 percent, even though the agio on the Austrian currency was constantly increasing and already equaled 5 percent by mid-August; as late as September 27, the Hungarian finance minister, Weckerle, spoke out in parliament against any increase in the discount rate. Only on October 5, when the decline in the currency’s value was already very noticeable on Western markets, did the Bank increase the discount rate to 5 percent.
The definite improvement in international currency markets allowed even the Austrian foreign exchange rate to soon rise again. On November 9, 1893, the London foreign exchange rate achieved its highest level on the Viennese bourse, reaching 127.65. This rate marked a devaluation of 6.3 percent compared with the new parity of 120.087. Over the course of November, the agio fell extremely fast. After the London foreign exchange rate had fallen again to almost 125.00 on December 19, and then temporarily increased to 126.00 on February 1, 1894, it fell slowly but fairly constantly throughout 1894 and 1895. On October 17, 1895, for the first time again, the foreign exchange rate stood at parity.
From that point onward, the foreign exchange rates followed a less extreme trend. Since 1896, they have diverged no further from the parity ratio than would be the case following the legal resumption of specie payments. The small deviations from parity that could arise would be within the two gold points, that is, considering the costs of transporting gold coins, the wear and tear on the weight of coins circulating within the country’s borders, the costs of minting, and the loss of interest income during their minting and transportation.
From these numbers, it can be seen without a doubt that, since 1896, the Austrian currency has been able to match any of the European gold currencies in terms of the stability of its value.
As a result of the apparently successful achievement of a stable intercurrency exchange rate, which was the intended purpose of the currency reform, the two governments brought forward a bill before both parliaments in spring 1903 that had as its purpose the legal resumption of specie payments as the “crown” (as it was called) to the efforts for monetary reform. Because of the major political crisis that soon broke out, the bill never came up for parliamentary consideration, let alone for final passage. In the meantime, the proposals brought forward by the previous liberal government had become totally meaningless in the face of the complete change in the Hungarian government, and as a result, Austrian Minister Beck formally withdrew the bill on July 7, 1906.
Throughout this time, public opinion in Austria had remained negative toward the proposal. Of considerable importance were the opinions of the Industrial Council and the statements made by the Chambers of Commerce and Industry in Vienna and Brünn.8 These views were summarized and detailed in a series of newspaper articles. At the present time, it can be said with good reason that opposition to the legal resumption of specie payments and the reasons for taking this position are shared by all of the major Austrian political parties.9 Even the government appears to have aligned itself with this view, having abandoned its previous position and claiming to have found a theoretical support for this view in Knapp’s Staatlicher Theorie des Geldes [The State Theory of Money].10
The legal resumption of specie payments is said to be too risky, in view of the uncertainty of future events on the international currency market and the unsettled political situation at home. Its only purpose, it is claimed, is to assure the stability of the foreign exchange rate, which has already been achieved without legalized specie redemption due to the Austro-Hungarian Bank’s foreign exchange policy. The legal introduction of specie payments would require the Bank to resort to more frequent and larger increases in the discount rate in order to protect its gold reserves. This would drive up the cost of borrowing, which would in turn put obstacles in the way of manufacturing. The relatively low discount rate in Austria was made possible only by the fact that the Bank was not obligated to redeem its notes. Even in times of great tension on the international currency markets, the Bank could keep the interest rate appropriately low, because it did not have to fear that its gold reserves would be withdrawn for the purpose of being sent abroad when the price of gold made it seem right to do so.
A critical examination of these views must attempt, above all, to determine the fundamentals of the Bank’s foreign exchange policy.
The Position of the Austro-Hungarian Bank on the Currency and Foreign Exchange Markets
The foundation of the currency reform activities of the Austro-Hungarian Bank is based on the near total concentration of the gold reserves of the monarchy within the Bank, along with foreign gold reserves in possession of the Bank.
The gold reserves of the Austro-Hungarian Bank amounted to:
In comparison with these gold reserves, which as was mentioned are exceeded in amount in Europe only by those held by the Bank of France and the Russian Central Bank, the amount of gold still freely in circulation does not add up to very much.
The designers of the reform of 1892, which was in most respects modeled after the German monetary system, planned for a fairly wide circulation of gold inside the domestic economy. According to their plan, small transactions would be handled by silver, nickel, and bronze token coins, and medium-size transactions by face-value gold coins, while banknotes would be used only for large transactions, insofar as these could not be replaced through improved uses of checks, bank transfers, and the clearing mechanism. Accordingly, in Article 82 of the Bank Statutes, which were changed by an imperial decree on September 21, 1899, a provision was added that banknotes were not to be allowed in amounts smaller than 50 crowns. The issuing of twenty-crown notes would be permitted only until the time of the legal resumption of specie payments. On the other hand, the issuance of ten-crown notes to a maximum amount of 160 million crowns was also planned for the period following the introduction of specie payments. These latter notes could not be seen, however, as banknotes in the usual sense; it would be more correct to designate them as gold certificates because they had to be fully backed at all times by gold.11
The time was seemingly drawing near in 1901 when the Bank would be prepared to resume legal redemption in gold, since it was already doing so, on demand, though not as yet so obligated. In anticipation of this, the Bank began to issue ten- and twenty-crown gold coins at the end of August 1901, since at the time of legal resumption all smaller notes up to 20 crowns were supposed to be removed from circulation. It was thought that the twenty-crown notes could more easily be taken out of circulation if this was done at the same time that they were replaced with gold coins. In addition, as the population became accustomed to the use of gold coins, it would be easier to determine what the actual demand for them would be throughout the empire. Another way of determining the demand for them would be by simply determining the amount of twenty-crown notes in circulation. Concerns were expressed, however, about the amounts that might be needed to meet the demands in the rural areas due to a fear that the population there might hoard the gold coins. As was soon demonstrated, concerns of this type were completely unfounded.
To the great surprise of the government and the Bank, the public’s opinion about the gold coins turned out to be quite negative. It had been expected that the population would greet the appearance of a gold currency with jubilation and see in it a demonstration of the success of the currency reform. Instead, the people who had grown to adulthood under the reign of paper money found the use of gold coins to be uncomfortable. The five-crown coins, silver florins, and one-crown coins, which had been placed in circulation after 1892, could be kept in circulation only because the one- and five-florin state notes had been withdrawn at the same time. Everyone who received the gold coins in payment attempted to exchange them for notes as quickly as they could, so the gold soon flowed back into the Bank.12
Additionally, a smaller amount of 10 million crowns was placed in circulation by the Hungarian government by the end of March 1903.
At the beginning of 1908, therefore, there was at most 234.8 million crowns in circulation (ignoring the insignificant amounts placed in circulation by the Hungarian government, and about which no particulars are available). Considering the stability of the foreign exchange rate, it may be assumed that the coins in circulation did not flow out of the country in any considerable amount. On the other hand, it is certain that a large portion of the coins remained in the coffers of the government and in the vaults of the large banking institutions, and so on.
The actual amount in circulation, therefore, is thus found to be considerably lower than the maximum cited above. Even this smaller amount of gold was kept in circulation by artificial methods, with the exchequer trying to make its payments in small amounts of gold, often against the desire of the recipients. It is worth noting that, as was stressed in the 1903 report on guidelines for implementing specie payments, “recently the circulation of twenty-crown coins has been decidedly in decline, while the circulation of ten-crown coins has shown a fairly sustained increase. This leads to the conclusion that in view of the undeniable public distaste for using gold coins, the issuing of ten-crown notes that was set at 160 million crowns by an imperial decree on September 21, 1899, has turned out to be too low given the demand for notes of this denomination.”14 Bilinski came to the same conclusion when he referred, in particular, to the use of ten-crown coins in industrial areas.15
In the 1903 draft proposing the legal resumption of specie payments, the government completely dropped the position it had maintained up to that point concerning the denomination of notes and withdrew its opposition to the issuance of smaller notes. Paragraph 2 of the draft gave the Bank the right to issue ten- and twenty-crown banknotes, even after the legal resumption of specie payments; however, this was done with different regulations concerning the backing of these notes. These notes were to be completely backed by precious metals up to an amount of 400 million crowns; for any quantity in circulation that exceeded this amount, the same regulations would apply as those for other notes issued by the Bank that were backed by gold.
Thus, in a very short time, the government’s view on the question of the size of the denomination of notes and, therefore, on the question of how much gold would actually be in circulation had undergone a surprising change. It would be incorrect to assert that this reversal primarily was due to the experience of what happened after the gold coins had been placed in circulation. Similar experiences are to be found in other countries, without this leading to a change in government policy. Most recently in Russia, though gold coins were initially rejected, they were still forced on commercial transactions.16
Over the years, the Austrian government has not objected to imposing great inconveniences on the market if it was seen as furthering an important, or allegedly important, public interest. The relatively minor inconvenience that the citizenry experienced due to their unfamiliarity with gold coins would have been easy for them to get over. It is probably more accurate to say that the Finance Ministry had, in the meantime, discovered the great economic impact that is inherent in the concentration of the national gold reserves in the central bank. The reports about the reasons behind reform policy decisions offer many clues in this direction; on the other hand, the practices of the Bank and the exchequer to constantly try to put gold into circulation appear oddly in contrast with that.
The monarchy’s gold reserves for foreign exchange were not concentrated to the same degree as the gold reserves in the Bank’s possession; the monarchy still had control of large amounts in foreign exchange and other assets held in foreign accounts.
After the Austro-Hungarian Bank had acquired large amounts in foreign exchange, the Statute of 1862 (Plener’s Bank Act) formally granted it a qualification in paragraph 20: “for the maintenance of a corresponding ratio between its holdings of the precious metals (coined and uncoined gold and silver) and the banknotes in circulation, it may buy or sell foreign exchange at locations abroad.” However, only the edict circulated by the Ministry of Finance on October 30, 1868, in fulfillment of the law of June 30, 1868, gave the Bank permission to include negotiable foreign exchange as backing for the Bank’s notes. In the crisis during summer 1870, the Bank provisionally was granted the authority to include in its portfolio foreign exchange along with the precious metal as backing for notes in circulation.
In Article 111 of the 1887 Bank Statute, the Bank was, in general, permitted “for as long as the fixed exchange of state notes is not abolished in both parts of the Dual Monarchy, to include as part of their specie reserves any foreign exchange (up to a maximum amount of 30 million florins) that are held in locations abroad, and which are legally payable in a currency backed by the precious metals.” The purpose of this regulation was to transform a part of the Bank’s holdings of precious metals into interest-earning assets, and, thus, increase the stock dividends of the Bank and the portion of the Bank’s profits that went to the state.17
Under Article 111 of the Bank Statute of September 21, 1899 (which is still in effect) the Bank is permitted, for as long as its obligation to redeem its notes in legal hard currency is suspended, to include as part of its specie reserves any foreign exchange and foreign notes (up to a maximum amount of 60 million crowns) that are held in locations abroad, and which are legally payable in a currency backed by precious metals equivalent to gold.
The Bank is further allowed under Article 56k of the statute to buy and sell, in addition to foreign exchange at locations abroad, the acquisition of which had already been previously permitted, the following: checks at locations abroad; foreign notes and additional foreign exchange not denominated in crowns that may be bought domestically; also to issue checks and money orders at locations abroad; to undertake debt collections abroad and to make payments on foreign accounts; and to maintain sufficient funds abroad for the conduct of these activities. In addition, the Bank was authorized by Article 65, No. 4, to provide at locations abroad foreign exchange having a maturity of a maximum of six months (exactly analogous to foreign exchange held domestically), insofar as it—except for the maturity date—matches requirements for foreign exchange available for discount. The legal status of including negotiable and foreign banknotes redeemable in gold was included under Article 84. All of these provisions are separate from the suspension of specie payments; and paragraph 3 of the 1903 draft would have permitted the inclusion of foreign exchange (up to a maximum of 60 million crowns) as part of the Bank’s precious metal reserves after the legal resumption of specie payments.
Even though the Bank was allowed to acquire foreign exchange in this manner, long before the initiation of the currency reform, it made little use of it.
Up to 1887, the Bank was limited to the amount of 200 million florin notes that it could put into circulation under Plener’s Bank Act, which was modeled after Peel’s Bank Act.18 This limit on the Bank’s ability to issue notes not backed by the precious metals required the Bank to reduce its foreign exchange holdings because the growth in domestic market transactions resulted in an increasing demand for notes. Thus, due to the actual and anticipated domestic demand for notes, which had to be backed by gold, the Bank’s foreign exchange holdings were repeatedly, and almost completely, liquidated, particularly after 1882.19 At the end of 1882, for example, foreign exchange holdings amounted to only 95,981 florins.
On average, the foreign exchange holdings of the Bank at the end of each year amounted to:20
Prior to 1892, the Bank’s foreign exchange holdings did not have an important role in matters relating to monetary policy. After the end to the unrestricted minting of silver coins in 1879, the Austrian currency became a floating currency, with its value linked neither to the price of a precious metal nor to a foreign currency. Neither gold nor foreign exchange redeemable in gold could be obtained from the Austro-Hungarian Bank. The Bank’s operations in relation to its foreign exchange portfolio were limited to the exchange of short-term paper for long-term paper. Attempts to influence the currency exchange rate by selling off foreign exchange at a particular price failed completely. Doubtless any similar attempt would have led to a similar failure; the relative insignificance of the foreign exchange holdings would have certainly frustrated all such attempts.
The currency reform of 1892 did not initially bring about a change in the Bank’s policies. It was only the unfavorable structure of the foreign exchange rates for the Austrian currency in 1893 and 1894 that resulted in both the Austrian and Hungarian governments approaching the Bank at the beginning of 1894, with the initiative originating with Ernst von Plener, who was then Austrian minister of finance. They declared that it was particularly important that, so as to assure that “the legitimate needs of business could regularly depend upon the Bank’s assistance, that the Bank assign the greatest possible expansion to their dealings of foreign exchange and currencies, and make whatever adjustments necessary so a portion of its reserves might be used for the execution of foreign currency transactions.”21
After it was repeated not much later, the Bank met this request in the most generous way. Beginning in 1896, the Bank began to focus its interest on the foreign exchange market to a much greater extent. Making use of the ordinances in the new Bank Statute, beginning in 1900 the Bank acquired other foreign assets in its revolving accounts in other countries, in addition to its holdings of foreign exchange.
On the basis of the public records, it is possible only to a limited extent to present a quantitative summary of the Bank’s dealings in foreign exchange. The Bank provides no data about its holdings of foreign exchange and other foreign financial assets separate from its precious metal reserves; these are often simply covered under the entry “other activities.” We, therefore, have to limit ourselves to quoting the few numbers that are spread out through a number of different publications. However, these numbers are sufficient to offer a picture of how significant a part these foreign exchange holdings played in the Bank’s business.22
The Bank’s holdings in foreign exchange and assets amounted to:23
The following data are available about the Bank’s dealings in gold and foreign exchange:
An idea about the size of these transactions can be gained from a memorandum issued by the Bank’s governor, Dr. von Bilinski. On one day, December 12, 1903, the volume of transactions undertaken by the foreign exchange department of the Bank amounted to a total of 71,901,000 crowns, in the amounts: 203,500 British pounds; 41,876,355 German marks; 18,527,333 French francs; and 196,000 Dutch florins.
The Bank’s profits from its dealings in foreign currencies and exchange are correspondingly understood to have constantly increased. They amounted to:
By an intensive cultivation of its transactions in foreign exchange, the Bank succeeded in gradually attaining the dominant position on the Vienna foreign exchange market. The trade in foreign currency and exchange conducted by the major banks in Vienna, which had been a rich source of income for them, fell into an inexorable decline. In 1895 the earnings of just the Credit Anstalt, the Bankverein, and the Länderbank together (the three largest banks) amounted to 2.67 million crowns, but in 1907 it came to no more than 1.39 million crowns.
Of particular importance for the development of the Bank’s foreign exchange dealings was the transfer of all the government’s gold supplies to the Bank. Up until 1901, the government had deposited its gold revenues, most of them from customs duties, with Viennese investment banks for a low rate of interest. In exchange, these Viennese investment banks were under the obligation to furnish the necessary sums for foreign payments at the same low terms to both the Austrian and Hungarian governments. These transactions were quite lucrative for the banks, but not for the treasury in general. The government’s foreign payments on particular dates for bond coupon redemption constantly exceeded its receipts in actual gold, and therefore it was forced to make considerable purchases of foreign exchange to cover these expenditures. For obvious reasons, the foreign exchange rate on exactly these days is quoted above parity, and for this reason the banks could count on a high price from the state’s coffers. This disadvantage carried even more weight because this offered the banks the possibility of thwarting the discount policy of the central bank. Those clauses in the Bank’s statutes that allowed it to have interest-earning deposits as well as to handle certain types of coinage and liquid assets (in notes or coin) in foreign currencies (Articles 75 and 111) provided the prerequisites for the central bank to take over the official administration of the government’s gold, which it did in 1901.26
In this way, the Austro-Hungarian Bank gradually gained a preeminent position on the foreign exchange and currency markets. The vast majority of the country’s gold reserves, as well as a large portion of the foreign currency and other short-term receivables that the monarchy had to have abroad, were now available to the Bank. The majority of all foreign payments took place through the Bank’s mediation. Through this method an enormous power was concentrated in the hands of the Bank, which it employed in the defense of its specie reserves for the good of the entire economy.
The De Facto Resumption of Specie Payments
The discussion concerning the economic impact of Austria-Hungary’s currency policy is, therefore, often directed along the wrong channels, so there is frequently a complete misunderstanding about the nature of the actual circumstances at the present time. From a formal, legal perspective that focuses on the literal letter of the law, it is constantly pointed out that specie payments are still suspended within the monarchy. And from a purely legal point of view, it cannot be disputed that the Austro-Hungarian Bank remains exempt from meeting any obligation of redeeming on demand its notes for legal coinage in the precious metals. But we consider this legal fact to be of secondary importance.
From the economic perspective, the suspension of specie payments has no importance, because for twelve years the Bank has made no use of this legal clause; not for a single day has it barricaded itself behind Article 111. The Bank has been prepared at all times to issue gold and gold-backed foreign exchange, checks, and so on to anyone who was in a position to transfer to the Bank the equivalent value in its notes or other Austrian payment instruments. Therefore, no further particular explanation is required for explaining the stability of the foreign exchange rates since 1896. De facto, if not legally, Austro-Hungary is currently a gold-standard country.27 For this reason, any increase in the price for foreign exchange on the Viennese bourse that would be above the upper gold point is already impossible, because the Bank constantly supplies foreign exchange at a lower rate.28
Looked at in this way, it is unimportant that the Austro-Hungarian Bank primarily, but not exclusively, issues foreign exchange and checks backed by gold, instead of actually exporting gold like other central banks. In no way does this indicate the Bank’s desire to step back from its voluntarily assumed obligation to make specie payments. In fact, the opposite is true, since the Bank issues foreign exchange below the gold point, making it more advantageous to receive and to provide these instruments instead of any actual gold.
The Bank also has not viewed its supply of gold as a noli me tangere [an untouchable item], but rather has willingly placed it at the service of the business world. The Bank has exported gold as often as this has been considered necessary to replenish any reduction in its reserves of foreign assets, and receives an equivalent value in foreign exchange or other assets at its various branches, which it can then control by the issuing of checks.
Equally irrelevant is the fact that, in general, it is not possible to know in Vienna at what price the Bank will be ready to supply foreign exchange. It is no different in Berlin and London; even there no one can know at what price foreign exchange will be demanded the next day, and the only constant is that the gold points form the limits for any fluctuations in the foreign exchange rates. Exactly the same is the case in Vienna: the lower boundary of the exchange rate is determined already by the legal obligation of the Bank to redeem every kilogram of gold offered to it at the rate of 3,280 crowns (less the minting fee of two crowns); the upper boundary may not be legally fixed, but for all practical purposes it has been set at a rate lower than the upper gold point, as shown by the fact that the Bank never refuses to supply gold or foreign exchange below that upper point.
Admittedly, one could argue that while the Bank does indeed at this time voluntarily supply foreign exchange below the gold point, it, however, does not have to do so and could refuse to at any time; or it could refuse to supply it at lower prices, or at least it could refuse to issue it to certain individuals such as well-known arbitrage dealers. Whoever makes this claim, however, would only demonstrate his limited knowledge of the politics and economics of the situation. Under the current rules, the Bank could not introduce a change of such importance as refusing or restricting the supplying of foreign exchange against the wishes of both governments. No minister would give his agreement to this step without a very pressing need. Nor could there be a shift away from the Bank’s current policy of exporting gold on demand, until all other means were found to be ineffective at stemming an outflow of gold.
The Bank would no more thoughtlessly resort to such a drastic measure as discontinuing gold payments than would any of the other countries that are legally required to make such specie payments. The impact on the market would be the same as the suspension of specie payments in any of the gold-standard countries. The immediate effect on the currency market from doing so, and, through this, its effect on annuities rates and other securities, would be devastating, to say nothing of the deeper, more long-term effects on the entire economy from a new agio emerging for a period of time.
Legally, it may very well be the case that specie payments are currently made voluntarily by the Bank only because they could be discontinued under tacit agreement with the government; whereas after legal resumption of specie payments, a law or at least an imperial emergency decree with the temporary force of law would be required for specie payments to be stopped. From an economic perspective, however, the voluntary nature of specie redemption does not really exist, because the historical precedent of making such payments leaves no choice other than requiring the legal introduction of specie payments.
The domestic and foreign stock exchanges, as well as the banking world in general, have been accustomed to the current situation for a long time; and understanding the nuanced reality of this aspect of public life in the country, these markets have assigned the same value to the currency of the Austro-Hungarian Monarchy as they do to other gold-standard countries.
In these circumstances, the legal resumption of specie payments, as both governments requested it in the spring of 1903, represents nothing more than a legal formality. It would mean only that the law recognized an already existing situation; the economic reality of specie payments that now already exists would be made into the permanent rule by a formal legal adoption of a gold standard. For quite some time now, specie payments have already been implemented for all practical purposes, with banknotes being fully redeemable.29
The secretary general of the Austro-Hungarian Bank, Hofrat von Pranger, therefore, justifiably asserted in a session of the General Council on April 2, 1903, shortly after the introduction of the guidelines, that as far as the Bank is concerned, questions connected with the introduction of specie payments had already been decided. Whether or not the Bank was legally obligated to redeem its notes for a precious metal was no longer a deciding factor in the Bank’s behavior as guardian of the currency. The Bank would take exactly the same measures in the defense of the currency after the legal resumption of specie payments as it took currently, if the necessity for a defense of the currency were to occur.30 The Bank does not currently refuse to pay gold upon demand for domestic use or for foreign transactions, and nothing will be changed by a legal provision. Austro-Hungary thus currently makes specie payments in practice, if not as a legal obligation.
It is therefore unnecessary to ask how it has been possible for the Austrian currency to have so stable a value since 1896, since this appears to be sufficiently explained by the policy of de facto specie payments. Instead, it should be asked, what has made it possible for the monarchy to resume specie payments and to maintain them up to the present day?
The answer is found in the extensive account given by the Austrian Finance Ministry about the monarchy’s balance of payments, which is the only one currently available in the entire statistical literature.31 It shows that the balance of payments was “positive” even when this was achieved only by a considerable export of investments. Therefore, the Austrian economy constantly had sufficient foreign exchange available in order to meticulously meet any foreign demands.
The generally favorable pattern of the balance of payments naturally does not exclude the fact that for longer or shorter periods of time there temporarily has been an unfavorable exchange rate. A particularly severe disruption of this type was caused by the widely discussed devaluation of the Austrian currency in 1893. The agio appeared for the last time toward the end of 1895: since 1896 it has been completely gone. Is this an indication, perhaps, that since 1896 there has not even been a temporary need to export gold to cover a momentary deficit in the balance of payments?
Most certainly not. Even after 1896, the monarchy’s balance of payments—and this occurs in all countries, even in the wealthier ones—has repeatedly shown a deficit. However, the Austro-Hungarian Bank had changed its policy method in the meantime: it had learned to conduct a discount policy and indeed to conduct it as vigorously as the circumstances required: that is, the Bank would increase its discount rate to bring about an improvement in the balance of payments. In addition, the Bank has every time supplied gold and foreign exchange for export whenever required. This was made possible due to the large precious metal reserves and the stockpile of gold-backed currency that the Bank had accumulated over time.32
The change in the Bank’s activities, which it completed during 1896 without any fanfare, remained unnoticed by the public for a long period of time. Only gradually have people begun to recognize its importance, and it has still not yet entered everyone’s awareness that with the actual resumption of specie payments, the great task of the currency reform has been fully successful with only its formal adoption still remaining to be completed.
The Alleged Advantages of Suspended Specie Payments for the Currency Market
The difference between legal and practical specie payments, which we have just developed, is not covered by the distinction between compulsory and de facto specie payments that is widely used in discussions about the Austrian currency. Compulsory specie payments, according to this distinction, mean the regulations governing the monetary system that would come into effect following, for example, the adoption and implementation of the specie payment guidelines of 1903; that is, a monetary constitution that legally obligates the Bank to redeem its notes for specie. In contrast, the present arrangement of de facto specie payments is one in which the Bank has the authority to redeem its notes, but is not under the obligation to do so.33
Indeed, the Bank does redeem them voluntarily, but the fact that this occurs only voluntarily, it is said, carries a weight of great importance. That is to say, this enables the Bank at any time to refuse to export gold and, in this manner, to protect its specie holdings and the currency during periods of rising interest rates on the international currency markets without having to implement a reciprocally spiraling hike in the discount rate. The expectation that the Bank may not pay in gold frightens away those who would desire to acquire foreign payment instruments merely to invest abroad at higher rates of interest; as a result, such individuals do not apply to the Bank for redemption, and thus the Bank does not have to actually refuse such demands for specie payment.
On the other hand, those with legitimate commercial claims for specie payments in order to import goods, as well as the demands by large bond debtors (countries, provinces, municipalities, private railways, mortgage banks, etc.) who need to redeem coupons that are reaching maturity can count on the Bank meeting their demands at any time. The entire economy, it is said, enjoys the advantages of a currency that is internationally stable in value at a low discount rate.
The Bank’s “active” foreign exchange policy consists in its refusal to provide to other banks the financial instruments that they may wish to export to invest abroad at more favorable interest rates than those available domestically. An increase in the foreign exchange rate above an acceptable level does not take place in spite of the Bank’s refusal to supply foreign exchange for short-term investment abroad. At a slightly higher foreign exchange rate the demand for foreign exchange stops of its own accord, because from these bankers’ point of view the low likelihood of being able to gain from the interest rate arbitrage does not justify the risk of a loss on the foreign exchange. Thus, under our current currency arrangement, the Bank does not face the problem of having to completely match the interest rate policies being followed in other countries, under the fear that other banks would drive up the exchange rate and withdraw gold in an attempt to capitalize on the interest rate differentials. It does not have to copy every increase in interest rates abroad with no concern for whether or not this would place an undue strain on the domestic credit market. It will be different after the introduction of legal specie payments. Then every banker will be in a position to present banknotes for redemption and claim as much gold from the central bank as he wants to send abroad in order to capitalize on the higher interests prevailing there. The Bank will see its foreign currency portfolio increase and its gold reserves decrease; and, since the Bank will have to offer a rate of interest sufficiently high to stop the flow of gold abroad, the higher rate of interest will at the same time raise the cost of borrowing for the entire domestic economy. Therefore, the benefit received by the entire domestic business community from a low rate of interest will have to be sacrificed for the private economic advantage of the financial sector.34
It is believed that the validity of this argument may be seen especially in the events on the currency markets during the tensions in 1906 and 1907. During this time, the Austro-Hungarian Bank in fact succeeded in defending its gold reserves with an interest rate that did not rise above 6 percent, while at the same time the bank rate in London
amounted to 7 percent and in Berlin to even 7.5 percent. If, like the other European central banks, the Austro-Hungarian Bank were solely dependent on its discount policy for a defense of the currency, it would definitely have had to take refuge in a higher interest rate in order to prevent an outflow of gold. And because Austro-Hungary is a debtor country, the interest rate would have to have been even higher here than abroad in order to get creditors to defer making their claims.
If we compare the discount rate of the Austro-Hungarian Bank with that of the German Reichsbank in 1898, the result is that the average rate in Berlin was higher than in Vienna; only in 1899 was the average rate the same for both banks, and throughout 1902, with some exceptions, the average rate in Vienna was not quite a quarter of a percent higher than in Berlin. In 1903, 1904, and 1907, the bank rate in Vienna was also lower on average than the rate in London; this difference amounted to a quarter of a percent in 1903 and was negligible in 1907. One must, however, keep in mind that the Bank of England discounted below its official interest rate, while the Austro-Hungarian Bank has not done this for many years. A comparison with the French situation, with respect to the particular position of the Parisian currency market, does not show anything of significance.
Of particular note is the great stability of the Austro-Hungarian Bank’s discount rate. It never climbed as high as that of the German and English central banks, and it also never fell as low. In the sixteen years from 1892 up to and including 1907, the Bank of England changed its discount rate seventy-four times; the German Reichsbank did so fifty-seven times; the Austro-Hungarian Bank, twenty-one times; and the Bank of France, ten times.
For the movements of international precious metals, however, it is the market discount rate, not the Bank’s discount rate, that is decisive. The leading position on the currency markets definitely centers on the private discount rate.
A comparison of the market discount rates immediately gives a different view than that given by the Bank’s discount rate. It is seen that the interest rate on the open market in Vienna consistently remained above that in Berlin; even 1900 and 1907 (crisis years in Germany) and 1903 were not exceptions to this. In general, the Viennese private discount rate was similarly above the London rate; only in 1902 and 1903 did the interest rate in London exceed that in Vienna. It is self-evident that Vienna also had a higher private discount rate than in Paris.
This structure of interest rates on the open market naturally does not exclude the fact that sometimes the rate in Vienna temporarily stood considerably below the rates in foreign countries. This was most clearly observed during the critical events in the last quarter of 1907.
It can be seen that sometimes even the private discount rate in Vienna sank below that in the Berlin and London markets, and that the Austro-Hungarian Bank’s discount rate was in general lower than that of the German Reichsbank, and even temporarily lower than that of the Bank of England.
The predominant explanation that the Bank could follow this interest rate policy due to the peculiarities of the Austrian currency system is totally unjustified.
Above all, it is not the case that the Austro-Hungarian Bank “simply refused to export foreign exchange and gold, when it considered this as only serving the purpose of facilitating foreign investments.”35
The Bank’s conduct was a far cry from this explanation. Whenever it seemed advisable under the circumstances, the Bank sent gold abroad. If the domestic currency requirements were temporarily low and the Bank’s gold holdings relatively high, the Bank would trade a portion of its gold reserves for interest-earning foreign exchange, rather than have the gold reserves remain in its vaults earning no interest. During extremely stressful times on the international currency markets, such gold exports by the Bank take on increased importance, because they help alleviate the situation on the international currency markets and therefore directly bring about an improvement on the domestic currency market.
This naturally assumes that domestic claims made on the Bank are sufficiently low that the gold does not have to be held, even under the most stringent observation of the regulations relating to gold reserves. Even putting aside the specific regulations concerning gold backing for the ten-crown notes and a portion of the banknotes that replaced the state notes, up to now the total notes in circulation have been far below the Bank’s authorized maximum limit of two and a half times the precious metal reserves (holdings in gold in domestic and foreign coins as well as bars, silver florins, token coins, and foreign exchange up to a maximum of 60 million crowns), even during times of heaviest demand, and are predicted to remain even lower in the years to come.
The only concern is if the Bank, due to gold exported abroad, runs the risk of exceeding its tax-free limit of 400 million crown notes in circulation. Every increase in notes above this limit imposes a 5 percent tax on the Bank; if the interest rate earned by the Bank does not exceed 5 percent, it suffers a loss from issuing these notes. The income earned from gold exported to foreign markets can, under certain circumstances, completely cancel out these losses. The Bank’s concern over this statutory regulation disappears as soon as its discount rate rises to 5 percent or higher, which is usually the rule in times of great financial distress.
The correct policy for the Bank, then, in these circumstances, is to send gold abroad in trade for interest-earning foreign exchange. The general economic advantage joins the private economic gain of the bank stockholders and the state treasury, both of whom are keenly interested in the profitability of the Bank. Thus, the gold sent abroad helps to mitigate the rise in the price of gold on foreign exchange markets and at the same time reduces the demands made on the Bank by those at home who want to send gold abroad in order to profit from the higher interest rates. Because the difference between Viennese and foreign interest rates becomes smaller than it would have been without the Bank’s gold exports, the incentive to acquire foreign currency or to export gold is lessened. In essence, this is exactly the same policy repeatedly followed by the Bank of France. The assistance that the Bank of England received from its French sister institution during the Baring Crisis and in autumn 1907 had its basis primarily in the discount policy followed in Paris. France most effectively protected its liquid assets and its relatively low interest rate simply by making its gold available abroad. The gold holdings of the Bank of France are enormous, and the Bank is not obligated by any legal clauses to maintain a particular ratio of currency to gold backing. It can, therefore, easily do without a large amount of gold and, like the Austro-Hungarian Bank, come to the assistance of foreign markets at critical moments.
By exporting gold, however, the Austro-Hungarian Bank increases its holdings of foreign exchange and other foreign assets. It is thus in a position to sell foreign exchange to those capitalists who want to send gold abroad, and can sell it at a price which always lies below the upper gold point. In this case, therefore, it never comes to an actual export of gold through private hands. The entire transaction peters out through foreign exchange passing into private hands out of the Bank’s portfolio. The effect on the domestic currency market, however, is the same as an actual export of gold. Notes flow back into the Bank and the market rate rises.
Foreign central bank disclosures about the transfer of the precious metals indicate the international gold transactions that have already occurred. The situation is not as simple in reference to the Austro-Hungarian Bank. In general, the Bank’s foreign exchange activities can be documented only through movements in “other assets” on the Bank’s balance sheet. If the accrual of “other assets” corresponds to a decrease in gold reserves, then it can be construed from this that the Bank exported gold and acquired foreign receivables in exchange for it. A decrease of “other assets” can indicate any number of activities. If it corresponds to an increase in the “foreign exchange reserves,” that is, those foreign exchange assets that are calculated as part of the gold reserves, then this can be considered to be a purely accounting operation, under which long-term foreign exchange that has come to be qualified as part of the foreign exchange reserves has been added to the precious metals account. It is also conceivable that the Bank has applied foreign exchange to its asset accounts with its corresponding banks. If with a decrease of “other assets” there occurs no corresponding increase in its precious metal holdings or in its foreign exchange reserves, then one must conclude that there occurred a transfer of foreign exchange and checks to the private sector, which has to be considered as a decrease in the circulation of notes.
The Bank avoids the need for supplying gold for export; however, since the voluntary introduction of specie payments that took place in 1896, it has never refused to supply foreign exchange below the upper gold point. It is possible, therefore, that requests for the surrender of actual gold never reach the Bank because, in these circumstances, it is cheaper to export foreign exchange than it is to export actual gold. For the Bank alone, with its large, non-interest-bearing reserve of gold, the export of gold is lucrative at any time, because it thereby exchanges uninvested capital for interest-bearing capital; for other capitalists, only an increase in the foreign exchange rate above the upper gold point creates an incentive for an actual export of gold. As soon as the Bank observes the emergence of a speculative demand for foreign exchange, it immediately increases the discount rate in order to defend its foreign exchange holdings and, therefore, its gold reserves. The Austrian situation differs from the mechanism of the international movement of precious metals as illustrated by Goschen36 only in that the export of gold and the trade in foreign exchange are concentrated in the hands of the Bank.37
As long as the Bank monopolizes the gold trade and the foreign exchange rate does not reach the upper gold point, the Bank has a preeminent though not a dominating position on the foreign exchange market. The Bank encounters competition from other banks, and therefore has to direct its foreign exchange sales according to market prices. The foreign exchange rates on the Viennese bourse are subject to the same determining forces as the Berlin or London markets. The rates cannot fall below the lower gold point, because otherwise it would be more lucrative to acquire gold and deposit it in the Bank; and it cannot rise above the upper gold point, because the Bank then seeks to counteract the dwindling supply of foreign exchange by the timely export of gold. This is the core of the Bank’s foreign exchange policy: always to hold in readiness a sufficient reserve of foreign exchange, even if actual gold would have to be exported for this purpose.
Thus, it would be a complete misconception of the Bank’s actual activities to assert that it refused to release foreign exchange when it concerned speculative demands for arbitrage rather than the satisfying of “legitimate” needs of business. It should be incidentally noted that it would be extremely difficult to make such a clear distinction between legitimate and illegitimate demands for foreign exchange, which would be necessary for such a different handling of the two. There are certain types of demands for means of payment in global commerce that could become exceedingly disruptive for the foreign exchange rate, but which nevertheless cannot be considered to be illegitimate: for example, the demand for foreign exchange to make payments for investments purchased abroad (even possibly speculative ones) that are flowing back to the domestic market. These backflows, however, appear regularly as soon as a persistent scarcity of money exists abroad.
The rates for Austrian as well as Hungarian bonds may remain relatively higher on the domestic market, due to the strong demand of domestic private banks, savings banks, and primarily the postal savings bank to meet their capital requirements by switching into fixed-interest-earning assets, when dividends on stocks are low or nonexistent.
A drop in the rate of Austro-Hungarian investments in the foreign markets does not generally generate a subsequent and corresponding drop on the Viennese and Budapest markets, therefore, because the domestic credit institutions purchased these assets and then sought to sell them to the broader public. Any difficulties created for the (doubtless speculative) acquisition of those financial instruments flowing back to the domestic market would shake the trust in the stability of their rate of return and increase the cost of credit far more strongly and more persistently than would ever be caused by temporary increases in the discount rate.
It should, incidentally, not be denied that the Austrian Ministry of Finance possesses an entire series of powerful instruments that it could use to prevent the large financial institutions from speculatively acquiring foreign currencies. We completely disregard the fact that at every Austrian credit-issuing institution a functionary of the Finance Ministry is appointed as presiding commissioner, to whom the task falls of overseeing that institution’s financial conduct; and that at two major Viennese banks the director (governor) was appointed by the crown.
However, it is far more important that over the last twenty-five years legislation has been passed that, more or less, has brought every type of economic activity under the unrestricted discretion of state oversight. This is not the place to provide more details about this oversight, or to demonstrate how Austria has turned away from political-economic individualism faster and more effectively than have other European countries. For anyone desiring to place obstacles in the way of a bank or an industrial enterprise in which a bank is interested, there is no more suitable method than this state oversight, including its desire to export gold. We do not want to claim that any such actions against the exportation of gold have ever occurred. On the contrary, as we will demonstrate later, we think that the banks themselves have never demonstrated the intention of sending gold abroad as a monetary investment, because there have existed within the borders of the monarchy opportunities for more profitable uses of their capital. Thus, there has not been the need for initiating threats or making appeals to their patriotism.
However, in the exceptional case that an Austrian bank still had the intention of loaning a large sum abroad—perhaps in order to come to the assistance of one of its own foreign subsidiary institutions or of a closely associated enterprise—the Austro-Hungarian Bank still has an effective weapon on hand in order to prevent this type of undesired gold export. The Bank is the ultimate source for monetary instruments within the country, and all other banks are obligated to maintain good relations with it, because they have to retain the possibility of re-discounting their portfolios with the central bank. Under these circumstances, a nod by the central bank is sufficient to bring an end to any demand for foreign exchange. The source for the closing off of this demand is neither the legal suspension of specie payments nor any related circumstance; rather it lies in the fear of possible countermeasures on the part of the central bank. The Bank’s position of power on the currency market would not be in the least weakened by the legal resumption of specie payments. It is generally known that the German Reichsbank, which is obligated by law to make specie payments, successfully uses similar methods to prevent the export of gold.
At the moment that the Bank actually absolutely refused to supply foreign exchange, or supplied it only below the upper gold point, whether for everyone or only for gold exporters, or indeed at the moment the possibility even existed that the Bank would plan or seriously consider doing it, the foreign exchange rate would skyrocket. The agio would experience a substantial height, because the demand for foreign exchange would rise to a significant magnitude given the available supply. The domestic currency market would be gripped by panic; foreigners who have deposited their monies in Austria and Hungary would forcefully attempt to withdraw them; on the foreign stock markets, a massive offering of Austrian and Hungarian investments would emerge at falling prices; and the monarchy would face the choice of either quietly observing the fall in the rates on investment or would have to at least temporarily buy them up and pay for the securities that were flowing back into the country. In addition, there would then arise a domestic demand for gold-backed currency on the part of those who wanted to cover, on a timely basis, foreign payments that were coming due at a later date.
A refusal by the Bank to supply gold would have the same effect, then, as a serious economic crisis or an impending political and military disaster. The effect on the bourse would be the same as the suspension of specie payments in a country legally obligated to pay them.
It should also be emphasized, again, that the Bank does not even remotely consider refusing to supply foreign exchange and checks abroad, and it is determined even in serious times of crisis to continue actual specie payments for as long as it is absolutely possible; this is no different from the central banks of England and France, and the German Reichsbank. In this endeavor, the Bank can count on the vigorous support of the state and the approval of the entire business community. How firmly the market trusted the Bank’s willingness and ability to pay specie was seen in the difficult days of November 1907; during that time and in spite of many difficulties the thought that the Bank would discontinue the delivery of foreign exchange was not considered even for an instant.
The often-heard claim that the Bank maintains the stability of the foreign exchange rate through the abolition of speculation should also receive a few words. The Bank, it is said, appears on the foreign exchange market as a supremely powerful counterforce that has paralyzed speculators who have an interest in frequent and severe price fluctuations. We are confronted here with that widespread and amateur view that tries to connect all adverse and apparently inexplicable market events back to speculative activity. On the one hand, reference is made to the well-known legal and criminal prohibitions against arbitrage. On the other hand, it is asserted that the Bank does not completely suppress foreign exchange speculation, but instead limits it to a narrow band between the two gold points. However, the Bank accomplishes this by no means other than by actual specie payments, identical, for example, to the actions of the Bank of England. If the initial assertion is accepted, then it also would be necessary to say that the Bank of England prevents an increase in the foreign exchange rates on the London market by consciously engaging in counterspeculation by, at any time, supplying gold at a fixed price.
Thus, it cannot be claimed that the relative low Viennese currency rate is connected to the fact that the Bank is not obligated to make specie payments. The Bank does not make use of its right to refuse redemption on demand, and could not do so without the greatest damage to the stability of the foreign exchange rate. The entire doctrine of the alleged advantages from merely de facto specie payments that are not obligatory under the law to secure a lower level of interest rates, is nothing more than a repetition of the old theory of “isolated” countries that lack currencies backed by precious metals, a theory that has been repeatedly disproved, most recently by Kalkmann.38
During the era of paper money the assertion was made that the international money market could not influence the Austrian currency, because its value was independent of foreign currencies, and therefore the monarchy could not be negatively affected by any outflow of specie. The conclusion was made that it was not necessary for the Austro-Hungarian Bank to align its discount rate to those set by Western European central banks. Since the country already had to bear all the disadvantages of a paper currency, it could at least benefit from the one advantage of its monetary isolation: the ability to adjust the interest rate to reflect the country’s domestic needs and conditions, with only the most cursory consideration to external circumstances.
Wilhelm von Lucam, the long-serving secretary general of the Austro-Hungarian Bank,39 had already fought this error for a generation and argued the following proposition: the Bank can do nothing with its discount policy that would be forbidden to a bank making specie payments, and is not prevented from doing anything that is obligatory to such a bank.40 He did not succeed in convincing his opponents. Similarly unsuccessful were the events of 1879-87 and 1893-94, during which the lack of an active discount policy led to a marked increase in the agio.
We have demonstrated that even today, the low bank discount rate in Vienna cannot be explained in this way. We must attempt to find another explanation for the evident fact that the Austro-Hungarian Bank actually makes specie payments and can maintain an interest rate lower than the central bank of the much richer German Empire.
The Discount Rate in Austro-Hungary in Relation to Foreign Discount Rates
Any theory that sees in the legal suspension of specie payments an explanation for the advantageous level of the discount rate in Austria-Hungary starts with the assumption that the interest rate in a debtor country like the Austro-Hungarian Monarchy necessarily must be higher than in creditor countries like England, Germany, France, and Holland. An incentive for foreigners to acquire Austro-Hungarian investments has to be created, and the most reliable way of doing so is by offering a higher rate of interest.
The validity of this statement for the capital market, that is, the market for long-term investments, cannot be doubted. Austria-Hungary, in fact, is in debt to foreign countries to a very large extent. According to reports issued by the Austrian Ministry of Finance about the monarchy’s balance of payments, foreign holdings of Austrian, Hungarian, and Bosnian securities at the end of 1903 amounted to 9,809 million crowns, compared with Austrian holdings of foreign securities of only 600-700 million crowns. The interest rate for long-term investments is also considerably higher in the monarchy than it is abroad. This is generally so well known that a closer statistical proof seems unnecessary. We will therefore content ourselves with a comparison of the market prices of German imperial bonds with Austrian crown bonds.
A comparison of the bond prices of different countries is reliable up to a certain point. The legal formalities under which public bonds are issued internationally and their technical financial structure have become more uniform in various countries over the last several decades, so the cost of credit offers a benchmark for the differences in their marketability. This is not true of observed differences in central bank discount rates. It has been pointed out that individual central banks have not imposed similar standards for determining the quality of the bills of exchange to be discounted, neither concerning the term of the bond nor regarding the type of their accrual and the number of necessary signatures. Attention has also occasionally turned to the central banks’ private rate and the treatment given to those applying for discount based on momentary fluctuations on the market. Even when only looking at the observable and legal bases under which credit is extended, the instances already cited ought to be sufficient to demonstrate that the importance of the central bank rate is different in each country.
Of much greater importance, however, is the Banks’ policy for determining the actual amount of credit extended. Whether a bank extends a loan to a certain person and in what amount is mostly delegated to the complete and free discretion of its functionaries. Sometimes a line is indirectly drawn by the decision of a bank’s governing body that it is obligated to select its officers from certain circles; however, even this limitation is basically irrelevant. More often the benchmark for creditworthiness is determined by the general guidelines of that bank, and the particular principles for making such decisions that have developed over time at each individual institution and from which great care is taken not to depart. Yet under these general principles the officials in charge have a completely free hand. Thus, even at the various branches of the same bank, the same practice will not be completely followed, let alone at the central banks of different countries. In these circumstances, any conclusions would be incorrect that are based on a comparison of the absolute levels of central bank discount rates. Only from their trends, either rising or falling, can conclusions be drawn about changes that are occurring on the currency markets.
The same is true for the private discount rate. Its importance also differs from country to country, and even from place to place within the same country. In addition, it is also subject to temporal and also secular and periodic changes. Even in the same location, the individual financiers in the brokering of private bills cultivate their own particular views about what constitutes first-class bills and refuse to accept other investments into their portfolios that they consider questionable. The number of firms whose credit is universally recognized as “excellent” is infinitesimally small. The decisive factor in determining the membership in this small circle is based on established business practices and the judgments of the participants in the credit transactions. Following these top, private discounts, there is also at some stock exchanges another level of “second-class” bills, which are locally awarded the characteristics of trustworthiness and reliability in private brokering. In addition, there are also investments that are indeed traded at the private discount rate; however, they are not considered fungible, and at the close of the business day on the stock exchange a specification of its status is required. All of these delineations are fluid and often are only discernible with difficulty owing to the intermingling of the normal brokering of bills with private brokering of bills at the bourse.41 Only the choicest, first-class bills of exchange can be spoken of in terms of absolute liquidity in international transactions, and only the signatures of a few large banks and large bankers—“international houses” in the literal sense—are considered to be in this category. The majority of the other, private discounts are dependent upon local circumstances linked to their particular market, so that even within the same country differences in the private discount rate can appear; and in periods of crisis, when the needs for currency are more pressing and general confidence has been shaken, considerable differences can appear in these rates without actually bringing about currency flows.42 More understandable are similar events in relation to the stock markets of different countries. It would therefore be premature for one to assume from the mere existence of differences in the private discount rates between two countries that compensating flows of the precious metal are called for, or that the absence of such flows suggests obstacles have been placed in the way of the mobility of gold.
The private discount rates on individual bourses differ in their importance because they generally have completely different institutional arrangements. An equilibrium in the flow of currencies can be established not only through a formal equality between the discount rates; there can also be an inequality between discount rates on different bourses that corresponds to an internal balancing within a bourse in which capitalists are too timid to deposit money abroad because of their limited knowledge about foreign markets or other various legal and political circumstances; only an especially strong incentive for undertaking foreign investments may overcome this.
In this way, different discount rates existing at the same moment in different countries can be explained regardless of differences, also at the same time, in the foreign exchange rate between areas having the same precious metal as their currency. This is because the harmonization of currency markets is not shown by a tendency for equalization between central bank discount rates or between private sector discount rates within the same country. Instead, harmonization is seen when there emerges an international abundance or scarcity of money, and movements in the discount rates move along parallel curves in the various currency markets. Gold flows do not result in creating a mathematical equilibrium between discount rates; rather they result in the establishment of a certain equilibrium relationship between interest rates in the individual countries; in their absolute level, however, the discount rates are influenced far more by national determinants than by international ones.
It is clear that the discount rate within the monarchy is dependent upon events on the international currency market. The private discount rate in Vienna rises and falls in parallel to the markets in Berlin and London; and whenever exceptions appear, these can always be traced back to particular events on the national currency market, regardless of whether there is an especially large excess supply of or demand for currency. The types of domestic events that can counteract international tendencies occur just as frequently on the currency markets of the Western countries.
It would be misleading in such a discussion to ignore the monarchy’s large foreign indebtedness. These debts are owed on the capital markets, and not on the currency markets where foreign-owned assets in Austria occasionally confront the much smaller counterclaims of Austrian-owned assets abroad. This strongly contrasts with the situation in Imperial Germany, where German-owned foreign investments are estimated to be 16 billion marks; yet Germany is continually borrowing large amounts from abroad on the currency market.
Foreign countries can acquire bonds in Vienna by returning Austrian and Hungarian investments they hold; but due to the high ratings of these securities, such operations are not easily accomplished. The lack of short-term debt abroad strengthens the position of the Austrian currency market to an extraordinary degree during times when discount rates are high. Foreign countries are not able to withdraw assets from the monarchy at these times, because they do not have debts at their disposal that are coming due; instead, they have to shift to borrowing on the Austrian money market. In Austria, such foreign applications for loans have to compete with the opportunity offered to Austrian capitalists for lending their money in Hungary instead. The official Bank rate provides only a very unsatisfactory indication about the interest rate prevailing in Hungary, parts of Galicia, and in Bukovina. The Austro-Hungarian Bank is considered of limited use for lines of credit in these areas. The need for credit by producers and traders in these parts of the empire are primarily provided by private banks, provincial banks (called “Sparkassen” in Hungary), and trade associations, whose intermediation enormously increases the cost of credit. Only indirectly does the central bank influence the terms for credit through these other institutions.
In Hungary, mortgage rates of 6 to 8 percent are not unusual, and for personal or corporate debt it can be as high as 10 to 12 percent. Those provincial financiers are in a position, even at the high interest rates they pay, to assure themselves of 2 percent or more above the Bank rate. Austrian lenders enjoy a monopoly over these financial assets, because they are the only ones in a position to judge the creditworthiness of these individuals and institutions. Their incentive to loan funds abroad is always very low, because they can enjoy a rate of interest in their Hungarian transactions that widely exceeds the highest rate they can earn at any time on the international currency market.
If foreign claims on the currency market of the monarchy are thus relatively low, then so too are the domestic claims. No complaint is repeated more often in the Austro-Hungarian Bank’s annual reports than the lament that a more intensive use of the Bank’s capital is not possible. If the smooth development of the German economy suffers from the fact that the demand for new capital exceeds available savings, the opposite is true for Austria, though less so in Hungary. Investment activity is low and the unfortunate political situation has paralyzed the enterprising spirit in Austria. The previous Austrian minister of commerce correctly pointed out that in Austria monetary liquidity is not a sign of economic prosperity, but instead a sign of stagnation and the languishing of entrepreneurial activity.
Even if it were assumed that legal resumption of specie payments would change this unfavorable economic situation and bring about a rise in the rate of interest, there still would be no reason to resist its implementation. The goal of a sound economic policy is not maintenance of a low market rate regardless of the circumstances. Rather, its goal is to unleash the use of the country’s productive resources. Between the two evils of an economic depression or high interest rates, the latter is certainly the lesser of the two evils.
The Costs of the Foreign Exchange Policy
Professor Georg Freidrich Knapp is the author of the pathbreaking work Staatliche Theorie des Geldes [The State Theory of Money]. He has received credit for being the first to attempt a unified, comprehensive view of modern currency policy. He is also generally known for diametrically opposing the Austro-Hungarian Bank’s foreign exchange policy of coordinating its discount policy with that of other central banks. Both are acts of exodromic management.43 Exodromic interventions are necessary in order to establish intercurrency exchange rate stability, Knapp argues, because the exchange rate does not, as commonly believed, automatically adjust even when there are full-fledged specie payments. Every exodromic action requires sacrifices, Knapp says. Those businessmen who discount bonds and who receive loans at the Bank on the basis of collateral make these sacrifices in the form of reduced profits as the price for the Bank’s following its discount policy.
The Bank also makes sacrifices due to its foreign exchange policy, Knapp states. However, at the end of the day the Bank does not really make this sacrifice, because it expects to be compensated for it by the state. The Bank employs a portion of its capital to purchase a large quantity of bills of exchange on the English market and continually replenishes it as soon as any particular bills reach maturity. It occasionally purchases these bills with the intent of making a profit whenever the exchange rate should prove favorable; but more often than not, the Bank acquires the bills at unfavorable rates regardless of what they may cost. In addition, the Bank releases these bills at parity as soon as the exchange rate becomes unfavorable. In this way, the Bank indeed suffers losses, except in the unusual case when the bills that it is holding were purchased at a favorable time in terms of their price. The parity rate is reestablished through these interventions, which otherwise would be left to the anarchic forces resulting from the blind gambles of individual interests; thus an important goal of public policy is achieved that is well worth the sacrifice, Knapp concludes. And the Bank can expect that the state will compensate it for the losses that it may suffer from this process.44
It is not our purpose here to examine to what extent Professor Knapp’s theory is correct concerning the pantopolic character of the intercurrency exchange rate.45 It can only be judged and accepted in the context of the logical structure of his overall theory of money. However, a debate cannot be avoided over his view of the foreign exchange policy followed by the Austro-Hungarian Bank. Above all, it must be stated that the Bank’s foreign exchange policy required no sacrifices on its part; on the contrary, as was previously mentioned, it led to considerable profits. The investment of a portion of the Bank’s assets in foreign exchange and in interest-bearing gold investments abroad yields significant profits; even the quite negligible fluctuations in the exchange rate that are kept within narrow bounds through the Bank’s actions favorably influence its income. The Bank does not buy foreign exchange when it is up in price, but rather when it is down, and then releases that foreign exchange at rising prices for a profit.
It is also incorrect to say that the Bank releases bills and checks abroad at parity; more often it demands the price corresponding to the prevailing market rate. In order to prevent an increase in the exchange rate above the theoretical upper gold point, the Bank always acts to prevent its holdings of foreign exchange on the market from running out. In no way does it achieve this by presenting itself as a buyer on the market; indeed, there would be no more blundering method than that. The appearance of a new buyer on the market can only function to drive the prices even higher. As we have shown, when the price of exchange is moving in an unfavorable direction, the Bank more often seeks to increase its assets through gold exports. It increases the available supply of foreign exchange and creates the possibility for satisfying all subsequent claims that may be presented to the Bank.46
Because the demand for foreign exchange normally occurs most intensely on particular days and during particular months of the year, the Bank’s purchases of foreign exchange when its price is low and its sales of foreign exchange when its price is high serve to reduce the fluctuations in the price for foreign exchange. Thus, the divergence of the price for foreign exchange from parity seems less apparent in Austria than in London and Berlin. Looking over longer periods, however, the average height of the prices for foreign exchange is dependent upon supply and demand over the entire period under consideration and not upon these short-term influences.47
The supposed opposition between discount and foreign exchange policies should be considered just as incorrect. The Austro-Hungarian Bank is not relieved of the need to counteract temporarily unfavorable patterns in the balance of international payments by implementing interest rate increases, as well as through an intelligent use of its large foreign exchange holdings. In the case of defending the currency, the foreign exchange reserve is really best suited for increasing the precious metal holdings (indeed, it is the cheapest and easiest way). If the Bank wanted to yield up its entire inventory of foreign exchange holdings to foreign demands and use the resulting revenues to increase its gold reserves, the Bank could render the same services to the economy in the future as surely as it does less conveniently and more expensively at present. This is because the Austro-Hungarian Bank’s management of reserves is no different from the specie payment system used in England and Germany, only more refined and flexible. It is a specie payment system resulting from the centralization (one is tempted to say, the nationalization) of gold exports.
An otherwise sharp-eyed judge of foreign exchange policy emphasized that the Bank undertakes operations that appear to contradict all the rules of arbitrage with regard to approaching payment dates. For example, it acquires German bills at a 4 percent Reichsbank discount, even though its own discount rate is higher; or it sends gold abroad, even though the foreign exchange rate is still quite far from the gold exporting point.48 Upon closer examination, however, these operations lose their unusual appearance and can be easily explained. That is to say, the Bank’s assets in the form of foreign bills represent an advantageous capital appropriation whenever its own discount rate is higher than foreign rates. In the Bank’s portfolio, an entirely different importance is accorded to foreign bills in comparison to domestic bills. From the perspective of Bank policy as well as partly from a legal standpoint, foreign bills primarily serve as reserves just like the precious metal holdings which they partly replace. In comparison with the non-interest-bearing precious metal holdings any interest income, however small it may be, appears in a favorable light. Critics of the Bank’s foreign exchange policy start with the assumption that the monies invested in foreign assets are drawn away from funds otherwise available for domestic discounting of bills. If the critics were correct, then the Bank’s foreign exchange policy would have exactly the opposite effect ascribed to it (which would be incorrect, as we have demonstrated). It would drive up the domestic discount rate instead of pushing it down.
In truth, however, the monies employed in foreign exchange dealings are withdrawn from the stockpile of the precious metal and not from the Bank’s domestic bond portfolio. Undoubtedly, it is within the Bank’s power to apply these monies to the domestic currency market as well; this would have to be accompanied by a reduction in the coverage of notes and giro assets49 with the reserve of precious metals and foreign gold-backed assets. The Bank’s liquidity might be negatively affected and would be dangerous for maintaining the equilibrium in the balance of payments. Moreover, the resulting reduction in interest rates would promote the development of unhealthy speculation. These are reasons enough for viewing an expansion of domestic discount activities at the cost of the precious metal reserves to be highly undesirable.
That the export of gold is always lucrative for the Bank, even when the foreign exchange rate has not yet reached the gold export point, emerges from the most recent literature as well as from earlier statements.
It is inappropriate to speak, therefore, about costs that are imposed by the Bank’s foreign exchange policy, or about sacrifices caused from that policy in the name of maintaining the currency. The Bank’s policy is to the greatest advantage of the entire economy; that the policy yields tidy profits, as well, for the Bank’s shareholders and the two governments that receive a high proportion of the proceeds cannot be denied. It has been repeatedly explained by the Bank’s leading personages that the Bank ultimately has profits in mind in its currency and foreign exchange dealings. It is only necessary to look at the numbers in the Bank’s business reports to see that the proceeds have been increasing, year by year, from this branch of its business.
The Form of the Bank Constitution
All fears expressed about the legal resumption of specie payments are unfounded. The legal resumption of specie payments will not require the slightest change in the current policies of the Bank. That which the Bank currently does voluntarily will be obligatory in the future, but there is no reason to believe that legal specie payments will cause any more difficulties than de facto redemption does now. However, should maintaining the gold-backed currency ever become impossible for the Austro-Hungarian economy in a time of crisis, the Bank’s legal obligation to redeem notes will prove neither an aid nor an obstacle. In any case, it is an illusion to think that halting foreign exchange transactions by the Bank, that is, halting de facto specie payments to maintain the currency’s exchange rate, would generate results any less serious than would be the halting of legal specie payments.
It must, in any case, be admitted that the existing rules under which the Bank currently operates might be impaired by the implementation of a law requiring specie payments. An entire series of changes in the present statutes of the Bank can be recommended to facilitate a continuation of the Bank’s current policy.
In this regard, an initial increase in the amount of foreign exchange that can make up a part of the precious metal reserve could be proposed. It would be advantageous to replace the rule that fixes the quantity of foreign exchange that can constitute a part of the Bank’s specie reserves with a variable amount, perhaps along the lines of saying that the Bank is granted the authority to invest a certain proportion of its precious metal holdings, for example, up to 10 to 15 percent, in foreign exchange. By this method, the costs of increasing the precious metal holdings would be at least partially reduced.
An increase in the amount of tax-free notes that may be issued by the Bank, which has been limited to 400 million crowns for more than two decades, could also be considered. A reduction in the 5 percent tax on banknotes issued in excess of those 400 million crowns could be especially advantageous under some circumstances. In order to remove every difficulty in the way of the Bank’s investing gold abroad, the banknote tax could be fixed at a level of half of a percent below the existing bank discount rate. The government’s revenue shortfall from reducing the tax on the banknotes that would occur from time to time when the interest rate was lower than 5.5 percent need not be worried about; it could be recouped by the higher income earned by the state due to the Bank’s increased revenues. The Bank would have a free hand to exchange gold for foreign exchange without fearing that it would suffer losses due to more frequent transgression of the tax-free limit on the issue of notes, which might then result in the Bank having to raise the discount rate. On the other hand, at interest rates of 6 percent and above, an increase in the revenue from the tax on banknotes would occur, which certainly no one would oppose. Any conflict between public and private interests that might exist, because the higher discount rate might be perceived as an undue pressure on the entire economy from which the central bank gained an advantage, would thus be essentially eased.50
It already appears to be a forgone conclusion that the smaller note denominations of 10 and 20 crowns will have to be retained, that the stamping of silver token coins will have to be augmented due to increasing demand, and that the silver florin, which will eventually be replaced by a two-crown piece, will be removed from circulation. Then the Bank and the exchequer can stop imposing gold coins on commerce, which has accepted them only grudgingly.
As it is assumed that the public’s habit of preferring paper to gold will not change in the foreseeable future, it may well be that in the future only banknotes and token coins will circulate domestically, while the essential role of note coverage and guardianship of commercial payments would devolve upon gold. It cannot be ignored that such a “constitution” for management of the currency would be in significant ways very far from the ideal of a gold-backed currency, which was envisioned by the champions of gold monometallism in the second half of the nineteenth century. It would not be correct, however, to describe such a monetary system as a paper currency with gold reserves for foreign commercial transactions. Even under such a system, gold would remain the standard of value in Austria-Hungary, while notes redeemable in gold would circulate at all times.
The single advantage of “saturating” domestic commerce with gold is the creation of a reserve upon which one can draw at times of war. A war chest can also be constructed in other, more efficient ways by increasing the country’s primary central reserve. This would not be allowed to lie fallow; rather, in the form of assets held in foreign exchange and investments abroad, it would be generating income. The Bank could take over its management.
Based on these assumptions, nothing speaks against the resumption of legal specie payments, while, on the other hand, much speaks for it. It would above all strengthen the international credit of the monarchy, which is urgently needed given the monarchy’s enormous foreign debts. The transition to a legally binding gold currency would offer the nation’s creditors no more of a guarantee for compliance with payment obligations than is already assumed under the current system of de facto specie payments. However, the great moral consequence of implementing this measure is not to be doubted. It would quite conspicuously bring to the consciousness of a wider domestic and foreign audience the reality of the currency reform’s success.
The Bank Feud Between Austria and Hungary over the Legal Resumption of Specie Payments
The problem of the legal resumption of specie payments raises a particular complication due to its relationship to Hungary’s efforts to dissolve the bank association between the two halves of the Dual Monarchy.
Since the conclusion of the Déak Compromise in 1867,51 Hungarian politics have ceaselessly endeavored to loosen the common bonds that connect that country to Austria. The achievement of economic autonomy from Austria has appeared as an especially important goal for Hungarian policy as a preliminary step leading to political independence. The national rebirth of the non-Magyar peoples of Hungary—Germans, Serbo-Croatians, Romanians, Ruthenians, and Slovaks—will, however, pull the rug out from under these endeavors and contribute to the strengthening of the national ideal of a Greater Austria.52 At the moment, however, Hungarian policy is still determined by the views of the Magyar nobility, and the power of the government rests in the hands of the intransigent Independence Party.
For this party, however, the Bank question has great political significance. Over the course of not quite three years of rule, the Independence Party has had to abandon one point after another in its program. If it were to concede on the Bank question as well, it must justifiably fear that in a short period of time a more radical group will displace it. Thus, political motives primarily influence the party’s opinion concerning the Bank question.
The Austro-Hungarian Bank appears advantageous for Hungary only when viewed from a purely economic standpoint. It generously makes available to the Hungarian economy the rich funds of the Austrian money market. Hungary’s portion of the Bank’s discount portfolio is much greater than Austria’s. Calculating to which part of the Dual Monarchy go bond payments, Hungary’s portion amounts to 60 to 65 percent, while Austria’s hovers between 35 and 40 percent. And this does not exhaust the advantages for Hungary. The negotiability of Hungarian bonds in Austria enables their issuance to Austrian capitalists and private banks, because it can always count on the central bank rediscounting them in emergencies. The competition for Austrian capital on the Hungarian currency market doubtless depressed the interest rate in Hungary, which still remained abnormally high.
Hungary is a country with an unfavorable balance of payments. According to Fellner, who certainly had no intention of painting a bleak picture, the annual deficit of the Hungarian balance of payments to all foreign creditors amounted to 176 million crowns. However, it should be noted that out of the total assets of 277 million, not less than 145 million, or far more than half, rest upon cash remittances from emigrants that are subject to fluctuations based on the circumstances in the countries to which Hungarians have immigrated. In addition, on the asset side are the notable postings of an export surplus of 96 million and transactions for finished products of 24 million crowns. On the debit side, there appear interest, dividend, and bond transactions worth 352 million crowns.53 Much more hazardous for Hungary is its exceedingly high rate of debt to Austria. The unity of the currency market has reached the point where the Austrians have deposited incredibly large amounts in short-term investments in Hungary. As long as the Dual Monarchy lasts, these obligations pose no threat to the Hungarian currency. This would be different following a political separation. Hungary would be able to prevent the withdrawal of these monies only through large sacrifices in the form of higher interest rates.
On the other hand, Austria has little to fear from dissolution of the Austro-Hungarian Bank. Austria has, in contrast to Hungary and other foreign countries, a favorable balance of payments even without including investment exports. Assuming that Austria wanted to withdraw monies with short maturities that are deposited in the land of St. Stephen’s crown,54 it would create a currency surplus on its own money market, which should in part enable industry to find new markets to replace the ones lost in Hungary. Only a devaluation of the Hungarian currency, which could easily occur as a result of dissolution of the Austro-Hungarian Bank, would be hazardous for Austria. Initially this would be because of Austria’s large holdings in Hungarian investments; later, for as long as the customs union persists, that is, until 1917, the agio resulting from a Hungarian currency devaluation would reduce the competition of Austrian producers facing the Hungarians. However, there can be no doubt that the banking and currency policies implemented by an independent Hungary would attempt everything possible to prevent a devaluation of its monies.55
Nevertheless, at the conclusion of the last compromise in the fall of 1907, Austria knowingly inserted a series of stipulations to be prepared in case of a possible appearance of a gold premium in Hungary. A special ordinance in the final protocol of the compromise, which has the power of law, determines that if the bank and currency union is terminated the method for calculating all payments should be in gold. This would not only apply for reciprocal state financial benefits, that is, the benefits from country to country, but also for all other benefits to the nation, in regard to which there exists a contractual obligation between the two countries. This also applies to benefits concerning all parties in the country insofar as they are subject to contractual obligations. This pertains not only to sales taxes, in particular the beer, brandy, sugar, and mineral oil taxes, but also freight payments by the railways, because parity in the railway tariffs was agreed upon in the compromise.56
Terms accepted in the initial protocol (dubbed in honor of their initiator the “Benedikt formula”) relating to the Bank go even further in their regulations, which, while not having the force of law, possess, however, the character of a binding contract. Accordingly, the two governments are obligated to reach agreements, prior to the reorganization of an autonomous Hungarian note-issuing bank, to assure the execution of the ordinances under the treaty concerning the regulation of trade and commercial relations between the two nations. In particular, the agreements prevent any impediments or interference with the goal of free trade between the two nations that might arise from any eventual differences in the value of separate Austrian and Hungarian currencies.57
It appears ever more likely that Hungary would be prepared to give in on the Bank question for setting the conditions under which the Austro-Hungarian Bank will be legally obligated to pay in specie. Hungary’s interest in the “crowning” of the currency reform is a purely political one. If the Bank’s privilege has to be renewed once more, the monetary constitution should contain this type of redemption rule, so that the construction of an autonomous bank will at least be possible later. For that reason above all else, Hungary wants to be financially independent from Vienna, to at least partially pay off its debts to Austria, and to receive new support in Western Europe for this. The possibility, in the first instance, of having investments in Hungarian crowns in France remains very limited, however, as long as a gold-backed currency does not exist in Hungary.
As was shown, Austria has at the moment no reason to refrain from giving legal sanction to the current currency situation; from the standpoint of enhancing Austria’s international credit standing, there is much that speaks for it. Even the financial emancipation of Hungary cannot appear undesirable. Austria’s large holdings of Hungarian bonds make it much too dependent on the changing fate of the Hungarian economy; the sale of a part of these investments, which at present is difficult to accomplish, could only improve Austria’s position. Currently, Austria possesses, not including domestic bonds, a barely appreciable amount in investments that have an international market: in times of war, this could hinder fund raising far more than is desirable. After creating a large market for Hungarian bonds in Paris, those Hungarian investments remaining in Austrian possession would become a valuable asset. The Hungarian market would receive a further powerful boost, in that the domestic demand for investments would turn more than previously toward bonds on the international market.
Austria’s opposition to the legal resumption of specie payments rests solely on fears concerning what its impact will be on the structure of the discount rates. We believe we have demonstrated the erroneous nature of these fears. To fight against an institution that would be beneficial for Austria merely on the basis of a traditional mistrust that says that anything that Hungary actively desires must be disadvantageous for Austria is not an intelligent policy. Just because Hungary could also profit from the change, and even if the general bitterness of the Austrians toward the dodges of the Magyar politicians is justified, it is wrong-headed on that basis to oppose legal specie resumption.58
Neither in Austria nor in Hungary can substantive arguments be made for the continuation of the current currency situation of de facto specie payments. Nothing speaks against the legal requirement that would be the fait accompli of the transition to the gold-backed currency.
[1. ]The present work was completed at the beginning of December 1908. [This article originally appeared in German in the Jahrbuch für Gesetzgebung, Verwaltung und Volkswirtschaft (Schmollers Jahrbuch), vol. 33, no. 3 (1909).—Ed.].
[2. ]About the course and the motives of the entire reform, see Spitzmüller, “Die österreichisch-ungarische Währungsreform,” Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 11, pp. 337ff., 496ff.; Mises, “The Political-Economic Motives of the Austrian Currency Reform,” Chapter 1 in this volume; Knapp, Staatliche Theorie des Geldes (Leipzig, 1905), pp. 377ff.
[3. ][See Chapter 1, “The Political-Economic Motives of the Austrian Currency Reform,” footnote 51.—Ed.]
[4. ]See Der österreichische Volkswirt, Oct. 31, 1908.
[5. ]See Kalkmann, Die Entwertung der österreichischen Valuta und ihre Ursachen (Freiburg i.B., 1899), pp. 1ff.; “Die Diskont- und Devisenpolitik der österreichisch-ungarischen Bank (1892-1902),” Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung 12, pp. 463ff.
[6. ][A speculative bubble in the Australian property market in the 1880s finally started to burst when the Federal Bank of Australia “failed” in January 1893. In May of that year, eleven commercial banks suspended trading, leading to a severe financial crisis.—Ed.]
[8. ]See Verhandlungen und Beschlüsse des Industrierates, issue 9, “Die Aufnahme der Barzahlungen” (Vienna, 1905), pp. 1ff.; Sitzungsberichte der Handels- und Gewerbekammer für das Erzherzogtum Österreich unter den Enns, 1903 (Sitzung vom 12. Mai 1903 und Beilage Nr. 6); Verhandlungen der Handels- und Gewerbekammer in Brünn (Beilage Nr. 2 zum Protokoll der Sitzung vom 9. November 1903).
[9. ]See Neue Freie Presse, July 18, 1907 (report about the explanations offered by the representatives of the German National Party, the Christian Social Party, and the Polish Club Party in the budget committee of the House of Representatives); about the position of the Social Democrats, see Arbeiter-Zeitung, October 23, 1907.
[10. ][Georg Friedrich Knapp (1842-1926) made his reputation as a statistician specializing in mortality problems. He also wrote on the history of German agriculture in the eastern territories. He was considered a leading member of a group known as the “Socialists of the Chair,” who advocated state socialism under imperial paternalism in Germany before the First World War. In 1905, Knapp published The State Theory of Money, in which he argued that the selection, use, and value of money were matters of government regulation, independent of the market. For a summary and an insightful critical analysis of Knapp’s argument, see Edwin Cannan’s review of The State Theory of Money in Economica (June 1925), pp. 212-16.—Ed.]
[11. ]See Die neuen Valuta- und Bankgesetze, edition and notes by Calligaris (Vienna, 1901), pp. 121ff., 324ff., 347f.
[12. ]See Jahresbericht der Wiener Börsenkammer für 1901 (Vienna, 1902), pp. 78f.
[14. ]See Beilagen 1718 zu den stenographischen Protokollen des Abgeordnetenhauses, 17th session, 1903, p. 4.
[15. ]See Bilinski, “On International Payments,” lecture in the special session of the 4th Polish judicial and political economics conference in Krakow on October 2, 1906, translated from the Polish, p. 6. (This important essay, which is not available in print, was made available to me by the secretary general of the Austro-Hungarian Bank in the most considerate manner.)
[16. ]See Claus, Das russische Bankwesen (Leipzig, 1908), pp. 41, 141.
[17. ]See Mecenseffy, Die Verwaltung der österreichisch-ungarischen Bank 1886-1895 (Vienna, 1896), p. 5.
[18. ][Peel’s Bank Act of July 1844 divided the Bank of England into two parts: a Note Issuing Department and a Banking Department. The Issuing Department was restricted in the quantity of banknotes it could issue on the basis of the government debt (a maximum of fourteen hundred pounds), and notes beyond this had to be fully covered on the basis of additional deposits of gold coin or gold or silver bullion.—Ed.]
[19. ]See Leonhardt, Die Verwaltung der österreichisch-ungarischen Bank 1878-1885 (Vienna, 1886), pp. 39, 74f.
[20. ]See Statistische Tabellen zur Währungsfrage der österreichisch-ungarischen Monarchie (Vienna, 1892), p. 128.
[21. ]See XV. regelmäßige Jahressitzung der Generalsammlung der österreichisch-ungarischen Bank am 25. Februar 1894 (Vienna, 1894), pp. xvii, xxi.
[22. ]See Zuckerkandl, op. cit., pp. 449ff.—Frankfurter Zeitung, May 17, 1908, names the different sources, in particular the financial journal Kompaß and the Tabellen zur Währungsstatistik published by the Royal and Imperial Finance Ministry.
[23. ]See Bilinski, op. cit., p. 7.
[26. ]See Bilinski, op. cit., pp. 8ff.; Zuckerkandl, op. cit., pp. 441ff.
[27. ]One actually has to designate the Austrian currency as a “limping” gold standard, because the silver florin is currently still the face-value coin. However, the Austro-Hungarian Bank never attempted to conduct a gold premium policy following the French, particularly since this amount will be reduced in the coming months by 28 million crowns by the further minting of five-crown coins.
[28. ]Because in the following pages, an “upper gold point” is repeatedly discussed, this requires a more detailed explication. As long as the Bank prevented the exporting of gold by issuing foreign exchange, the upper gold point had no practical meaning; this will not change even after the legal resumption of specie payments in gold, unless the Bank completely abandons the foreign exchange policy that it currently follows. Because a precise, theoretical determination of the upper gold point is difficult to establish, the Bank, which requires a guideline for issuing its foreign exchange, used as a rule of thumb to always issue foreign exchange at a price that was closer to parity, as this was defined by the variations in the exchange rates in Berlin and London. By following this rule, it developed that the fluctuations in the foreign exchange rates were milder in Vienna than in the countries with specie payments. See Landmann, “Die währungspolitischen Aufgaben der schweizerischen Nationalbank,” Schweizerische Blätter für Wirtschafts- und Sozialpolitik, vol. 15, pp. 307ff. A statistical review of the large amount of material available might provide interesting details; however, hardly anything would be changed as a result.
[29. ]See Neue Freie Presse, April 1, 1903.
[30. ]See Abendblatt der Neuen Freien Presse, April 2, 1903.
[31. ]See Tabellen zur Währungsstatistik, 2nd ed., pt. II, pp. 213ff.; Gruber, “Bericht betreffend eine Statistik der internationalen Zahlungbilanz,” Internationale statistische Institut X. Session (London, 1905); Fellner, Die Zahlungsbilanz Ungarns (Vienna, 1908), pp. 1ff.
[32. ]See Kalkmann, op. cit., pp. 42ff.; Herz, op. cit., pp. 493ff.
[33. ]The linguistic usage is quite fluid. Many understand the placement of gold coins in circulation beginning in 1901 to be part of the de facto system of specie payments. We hold ourselves to the designations applied in the best journalistic works about the Austrian currency.
[34. ]See “Barzahlungen und Währungspolitik,” Die Zeit, September 25, 1907; see, in addition, “Die Devisenpolitik der Bank,” Die Zeit, August 23, 1907; Riedl, “Fakultative oder obligatorische Barzahlung,” Neues Wiener Tageblatt, July 14, 1907; Müller, Die Frage der Barzahlungen im Lichte der Knappschen Geldtheorie (Vienna, 1908), pp. 41ff.; and finally, the texts cited on pages 37 and 38 in footnotes 7 and 8.
[35. ]See “Die Devisenpolitik der Bank.”
[36. ][Viscount Goschen, The Theory of the Foreign Exchange, 3rd ed. (London: Effingham Wilson, 1919). George Goschen, First Viscount Goschen (1831-1907), was a prominent British liberal who later switched to the Conservative Party. He served at various times as vice president of the Board of Trade, paymaster-general, president of the Poor Law Board, First Lord of the Admiralty, and as a director of the Bank of England. His book on the workings of the foreign exchange market is still considered a classic on the mechanisms of international exchange.—Ed.]
[37. ]See Bilinski, op. cit., p. 3.
[38. ]See Kalkmann, op. cit., p. 48.
[39. ][Wilhelm von Lucam (1820-1900) was the secretary general of the Austrian National Bank in the mid-1800s, at the time when the growth of joint-stock banks confronted the central bank with an increasingly difficult task: to secure sufficient liquidity and to prevent an inflationary expansion of the money supply with a limited range of policy instruments. The very close and personal contact between managers of the central bank and leading participants of the Viennese financial center made an informal agreement in critical situations easier. However, when disagreements among the managers of the central bank arose, it was occasionally necessary to push through resolutions that had not been agreed upon unanimously. The words of Wilhelm von Lucam exerted great influence in that small circle of businessmen who dominated the Viennese money and capital market.—Ed.]
[40. ]See Lucam, Die österreichische Nationalbank während der Dauer des dritten Privilegiums (Vienna, 1876), pp. 66ff.
[41. ]See Prion, Das deutsche Wechseldiskontgeschäft (Leipzig, 1907), pp. 62ff.
[42. ]See Weill, Die Solidarität der Geldmärkte (Frankfurt, 1903), pp. 26ff.
[43. ][“Exodromic” refers to policies meant to stabilize movements in exchange or exchange rates.—Ed.]
[44. ]See Knapp, Staatliche Theorie des Geldes, pp. 247ff.
[45. ][“Pantopolic” refers to all market activities relating to the balance of payments.—Ed.]
[46. ]See Müller, op. cit., pp. 14ff.
[47. ]See Heyn, “Kritische Erörterung des Projekts der Beseitigung des Goldagios in Spanien,” Jahrbücher für Nationalökonomie und Statistik, 3rd ser., vol. 25, pp. 756ff.
[48. ]See “Die Devisenpolitik der österreichisch-ungarischen Bank,” Frankfurter Zeitung, May 17, 1908.
[49. ][“Giro” refers to a form of bank transfer by a payer from his account to the person or business entity to which a sum of money is owed.—Ed.]
[50. ]See Schumacher, “Die deutsche Geldverfassung und ihre Reform,” Jahrbuch für Gesetzgebung, Verwaltung und Volkswirtschaft (Schmollers Jahrbuch) 32 (1908): 1344ff.
[51. ][The “Déak Compromise of 1867” refers to Ferenc Déak (1803-76), a leading Hungarian political figure of the nineteenth century, who proposed the establishment of a “Dual Monarchy” of Austria-Hungary to replace the former Austrian Empire. He argued, in opposition to those Hungarian nationalists who wanted to establish a completely independent Hungary, that the Magyar nation would financially and economically gain by maintaining a political union with Austria under the rule of the Habsburg Monarchy.—Ed.]
[52. ][The “national ideal of a Greater Austria” refers to what in the nineteenth and early twentieth centuries was sometimes called the “Austrian idea.” The vision was for a multinational empire under Habsburg rule in which each of the nine major linguistic and ethnic national groups who populated the Austro-Hungarian Empire would have equal rights, civil liberties, and local governing autonomy through which all of the member groups would gain by sharing a common political and economic “space” in Central Europe. Many Austrian classical liberals advocated it as the alternative to the growing nationalist antagonism and disunity within the Habsburg domain.—Ed.]
[53. ]According to Fellner, op. cit., pp. 151ff. For similarly unfavorable results arrived at by a different set of calculations, see Gärtner, “Der österreichisch-ungarische Ausgleich,” Archiv für Sozialwissenschaft und Sozialpolitik, vol. 25, pp. 391ff.
[54. ][The “land of St. Stephen’s crown” refers to the historical territory ruled according to “divine right” by the kings of Hungary. Tradition says that St. Stephen I held up the crown during his coronation in the year ad 1000 as an offering to the Virgin Mary to symbolize a “contract” between her and the holder of that royal office.—Ed.]
[55. ]See Spitzmüller, “Die staatsfinanzielle Vereinbarungen im österreichisch-ungarischen Ausgleich,” Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, vol. 17, p. 391.
[56. ]Ibid., pp. 392f.
[57. ]See Bunzel, “Die Bankformel,” Neue Freie Presse, November 28, 1907; November 27, 1907; December 19, 1907. The fact that the bank formula is not able to insure Austria completely from the results of a devaluation of the future autonomous currency is emphasized in particular by Reitler, “Die Bankfrage in Österreich-Hungarn,” Der Tag, October 15, 1908. See also “Die Bankfrage,” Das Vaterland, December 13, 1908.
[58. ]See the speech by the director of the Viennese Giro und Kassenvereins, Dr. Hammerschlag, in the meeting of the Viennese Chamber of Commerce on May 12, 1903 (minutes, ibid., p. 217).