Is Inflation Desirable?

A. F. W. PLUMPTRE February 1 1933

Is Inflation Desirable?

A. F. W. PLUMPTRE February 1 1933

ECONOMISTS agree . . .

That statement is so revolutionary and unorthodox that we must pause for explanation. Of course, all economists don’t agree on anything; but then, to quote Miss Agnes Macphail, M.P., “There are economists and economists." The majority of them do agree upon certain important matters. For instance, 1,000 American economists sent a written protest to the President of the United States when the Smoot-Hawley Tariff was before Congress two years ago. It is easy to believe that the interests which favored the tariff were exceedingly anxious to propagate the rumor that “economists disagree.” Indeed, the economists did disagree—almost unanimously ! And there is at least one newspaper in Canada which sedulously propagates the same rumor. Perhaps it has a guilty conscience.

Economists, as I mentioned above, agree. They may not agree with all the views expressed in this article, especially when we come to discuss the “nationalization” of credit and the banking system. But one of the points upon which their opinion is most solid is that a rise in prices throughout the world is at present not only desirable but urgently necessary. “But surely,” objects a member of the old school, “that is inflation!”

Is Inflation Desirable?

WHETHER it is true of a man, I don’t know; but I feel fairly confident that you can kill a policy by giving it a bad name. “Inflation” is certainly a bad name. It suggests an increasingly rapid expansion, with a pop at the end. It suggests something artificial, as opposed to “natural”—as if our whole life were not highly artificial and unnatural, or, as we like to call it, “civilized.” Worst of all, it suggests something unsound—“watered stock,” “bucket shops,” “over-optimism,” “inflated values” and all that.

Inflation being a bad name, some ingenious American decided to discover a better one. He produced the word “reflation,” to mean, vaguely, Governmental or other action destined to cause prices to stop their precipitous fall and, if possible, to rise a bit. Thus “reflation” is the term now used in genteel financial circles where the word “inflation” would cause a temporary cessation of cerebral functions.

But whatever we call it, there is little doubt that rising prices are urgently necessary if the endless procession of bankruptcies is to cease, if agriculturalists are to receive a reasonable return for their labors, and if industrialists are once more to find it profitable to increase their payrolls.

Could prices be raised by an expansion of the amount of money and credit in existence? Of course they could. If enough new money were put into people’s hands—anybody’s hands—they would eventually be tempted to spend some of it. And more purchasers mean higher prices. This is pure common sense.

The very fact that, all over the world, there are people willing to produce and at the same time willing to consume each other’s production, should be clear enough proof that, among other causes of the situation, is the insufficiency of money by means of which the necessary exchanges could be made. People are quite willing to talk of general overproduction—over-production of almost everything—as if it were the cause of the depression and therefore the only way out lay in steadily reducing the volume of production. They seldom appreciate that over-production means that goods have been produced in excess of what people, with their existing money incomes, are willing or able to purchase. They forget, further, that people’s money incomes are in part dependent upon the amount of money in existence. Thus we must agree with G. G. McGeer who, representing current “radical” opinion on monetary' matters, recently wrote in Maclean’s that there is “a plenty of everything but consumers' buying power.”

If an expansion of the amount of money is so desirable, why has it not been made? There are the following reasons:

Í. Financial leaders, parliaments and the public have not given much attention to the problem, believing for some reason that the volume of money would look after itself.

2. While the world’s currencies were almost all being kept convertible into gold, international co-operation was necessary. One country alone could not materially influence prices throughout the gold standard world. But the economists had no sooner impressed this upon the world than the gold standard broke down. The lesson was then out of date. But we still hear on all sides of the absolute necessity of international co-operation if anything'7* to be accomplished in the monetary field.

3. Misconceptions about the “soundness” of keeping the currency proportioned to gold reserves played an important part in restraining positive action in increasing the volume of money.

4. The usual channels through which money flowed into circulation became clogged. These channels were the loans and investments of bankers; and the deeper grew the depression the more hopeless it became to expect that bankers would or could increase their loans and investments. Indeed, the increasing insecurity and falling prices have led them to contract rather than expand their operations.

International co-operation is still the most desirable form in which monetary expansion might be introduced. For then those international difficulties which arise when movements of prices, wages, confidence and general economic conditions vary from country to country are partially avoided. But the hope of international action along these lines is exceedingly slim. Not only is there a very solid block of opinion in all countries which believes that a policy of monetary expansion is either impotent or harmful or even wicked, but there are countries, especially in Europe, where the prevailing opinion actually opposes rising prices. If the Imperial Conference could not reach agreement upon matters of immediate, practical monetary policy, the hope that any World Economic Conference could do so is almost infinitely remote.

Two Kinds of Expansion

FOR THESE REASONS, we in Canada are likely to be left pretty much to our own devices in solving our monetary problem. Incidentally, we have no official body such as a Central Bank in the country which might be responsible for solving that problem, so it is likely to be solved, if at all, in a pretty piecemeal manner.

There are many ways in which monetary expansion may take place in Canada. Some of these are much more effective and less harmful than others. One of the best is undoubtedly that which was used last November. The banks borrowed money from the Government under the Finance Act, the necessary Dominion notes being created for the purpose. The Government then borrowed the same amount from the banks and—this is the important pointput the money into circulation by spending it. By this means, money was created and put to work by joint agreement between the Government and the banks.

Another way in which monetary expansion might be achieved is by depressing the foreign exchange rate. If the value of the Canadian dollar declined in New York and London this would mean that our exports, for which payment is made in foreign currencies, would yield more Canadian dollars to Canadian exporters. That is, the prices of our exports would rise immediately, to the great relief of much of our farming and industrial population. The refiationary rise in prices which was sought would be under way immediately. The increased solvency and better prospects of such borrowers would almost certainly result in an expansion of the volume of money through the normal channels of bank loans and investments. That is to say, money would be sucked rather than pumped into circulation.

There is a variety of objections to this policy. It is likely to hurt importers. It is likely to hurt those who have debts to pay in the increasingly expensive foreign currencies. If carried too far. it might upset American confidence in Canadian securities; and if these were dumped upon the Canadian market the depression might take a turn for the worse rather than for the better. In spite of these arguments it is probably a preferable and less dangerous alternative to the monetary policy of the past—one of masterly inactivity under the banner of “Cannot and dare not.”

Nevertheless even that policy is preferable to some of the proposals which are being made from time to time. From among the variou; currency schemes that are being suggested, we may take three for discussion here:

  1. The Nationalization of Credit.
  2. The issue of non-interest-bearing Dominion notes to retire the Government debt, which at present consists of interestbearing Dominion bonds.
  3. The Nationalization of the Banking System.

As they are usually presented, these plans are closely interconnected.

Nationalization of Credit

THE nationalization of credit is often proposed as the best way in which an improved currency policy might be put into force. I have never yet heard a precise statement of what this process of nationalization involves, so it is a difficult proposal to discuss. It is clear, however, that Mr. McGeer. in the articles mentioned, desires nationalization. The object of the proposed change is to secure "the independent management of the issue of money and the circulation of credit.”

If the principles upon which money is issued are to be changed, it is desirable to know what the new principles are to be. It is not easy to be sure, from Mr. McGeer’s articles, what new principles he would substitute. The following paragraph may, however, give us a clue:

“We adopted usury, it is true, as an expediency for the purpose of increasing the circulation of the volume of money that existed, but we have maintained it as the monopolistic privilege of the few long after we learned that the credit of the National Government could successfully be used as a purchasing-power medium of exchange. Yes, long after we knew that governments did not need to borrow at interest that which they already possessed in abundance themselves.”

From this paragraph I deduce that Mr. McGeer would like to see the Dominion Government issuing notes and creating credit, i.e.. writing book-entry bank deposits to its own credit in the books of the Nationalized Banks. But we are left in the dark as to what precisely shall determine the amount of “money” so created. We are told that “governments need not borrow.” Presumably, therefore, everything which the Government ever spends beyond its current income, including all its capital expenditures, will come simply from newly created money.

Whether Mr. McGeer meant this or not, it is perhaps worth while to point out the danger of this policy.

During the years 1925-29 the capital expenditures in the budget of the Dominion Government amounted roughly to $100,000,000. This was financed by borrowing. If the proposed policy had been in force, this money would presumably have been “created.” Thus the total volume of Dominion notes outstanding might not have risen merely by the $2,000,000 which they actually did—i.e., from $208,000,000 to $210,000,000—but they might have risen by $100,000,000 more !

Now, the prevalent opinion is that the years 1925-29 were, on the whole, of a mildly “inflationary" character in Canada. That is to say, the volume of money expanded and a general average of all types of prices and incomes probably exhibited a rising tendency. But those who urge that governments need not borrow but need only create money to finance capital expenditures, would apparently have issued a vastly greater amount of money !

The truth is surely this: It is possible to conceive, at least vaguely, of an “ideal” amount of money existing at any time in Canada or any other country. The amount | of that ideal will, of course, depend upon whether the country is trying to maintain a ! stable level of prices, or to maintain stable | exchange rates with some other country, or j to follow some alternative policy.

The ideal amount of money will also depend ujxm the way in which people use I what money is already available. A hundred I dollars used once a month will finance the same amount of trade as $50 used twice a ! month. And the use of money may change j quite rapidly. For instance, in Canada during the past three years the total value of sales and purchases—of transactions requiring money payments—has decreased about twice as rapidly as the volume of money in existence. This shows that the people of Canada are using their money less freely, and the money is circulating less rapidly, than three years ago.

Mr. McGeer has seen clearly what all too few others have seen—first, that there is such an “ideal” amount of money; and. secondly, that whatever this ideal amount may be. it bears no definite relationship to the volume of gold which happens to lie in certain vaults.

He has also seen that we are unlikely to Î arrive at. the ideal, or anything very closely approaching it. if we strictly limit the issue jof notes to gold reserves. But he failed to [observe that, thanks to the Finance Act, there is in Canada no strict limitation. He also sees that the ideal amount of deposit creation is not likely to be achieved by the banking system as it now exists, with its present traditions and customs, and with no person or body of people officially responsible for determining or maintaining any monetary policy at all.

But at this point his anti-banker mania leads him astray; for he believes that the hankers have been utilizing this power of credit creation to serve their private ends, whereas the truth of the matter is that the bankers have been running their businesses I for the most part completely unaware of the j existence of the jxnver and often unaware that they were “creating credit” at all.

But if the amount of money in circulation j is not perfect at present, how much less j perfect would it probably be if money creation were handed over to a government that was enjoined to finance all its deficits and all its capital expenditures out of the creation of new money ! I can see no possible justification for the belief that an “ideal” amount of money would be created by a “nationalized control of credit” which would follow such a policy. It would inevitably result in inflation not of a desirable, hut of the most undesirable and violent character.

Further, any scientific scheme for the control of the volume of money in circulation must provide for contractions from time to time, as well as for expansions of that volume. If money is to be created and put into circulation through governmental expenditure, then, as Mr. McGeer points out, it must be retired for destruction through governmental taxation. But while one often hears it urged as a principle that governments should create money and spend it, one seldom hears profuse praise for the reverse side of the same medal—i.e., the principle of increased taxation and the destruction of the money thus collected. Such a proposal is not likely to be politically popular !

Danger of Created Money

VE MAY NOW pass on to discuss the proposal that the Government should create money, in the form of Dominion notes or credit, not only to finance current capital expenditures, but to retire the whole national debt and relieve the budget of its burden of bond interest.

The demand for such an issue of “government credit” usually arises from a total lack of appreciation of the difference between a i Dominion bond and a Dominion note. The j essential difference does not lie, as is often j supposed, in the mere fact that one bears interest and the other bears none. The ' essential difference is that the bond is not used and is not usable as “money.” It is ; because the note does not bear interest that i it can be used as money. It is often said, of I course, if a man owns a $1,000 bond, that I “he has $1,000.” But, in the technical ¡sense, he has not $1,000 in money any more than he could be said to have $1.000 in money if he happened to own a motor car "worth”—i.e., exchangeable for—$1,000.

If Canada suddenly redeemed her existing bond issues by printing Dominion notes or creating deposits, she would he replacing a lot of things which are exchangeable for money by a lot of other things which actually are money. Thus the amount of money in existence would be greatly increased and prices would be forced up by the pressure of purchasers; for every one who used to have a $1,000 interest-yielding bond would now have $1,000 of notes with which he would immediately buy either goods, such as a motor car, or another interest-bearing security.

It is not claimed here that increasing the issue of Dominion notes is undesirable. But it is claimed that to increase them in proportion to current government deficits and capital expenditures is a thoroughly unscientific and dangerous policy to advocate or to pursue, and also that to increase the Dominion note issue by retiring the National Debt would be to expand the amount of money in circulation in astronomical proportions. Such a proposal cannot be taken seriously.

Is Interest Justified?

THIS discussion of the difference between notes and bonds leads us naturally into the well-worn problem of whether the payment of interest in general is either just or expedient.

The payment of interest or, to use the more picturesque phrase preferred by Mr. McGeer, the practice of usury, is inherent in a social system which allows private property and the disposal by each person of his own income largely as he sees fit. If I own a house worth $5,000 I am free to lend it to some one else and charge him a “rent” for its use until he returns it to me. If I get $5,000 income, I am free to lend it or any part of it to some one else and charge him “interest” for its use until it is returned. So long as there are people who will pay “rent” or “interest” for the use of other people's goods or money which they want to borrow, just so long will these practices last. If an attack is made upon the immorality of interest, it is in the same breath an attack upon the system of private property as it exists. Both may be wicked; but both appear likely to remain in Canada for some time to come, and must be taken into consideration when discussing practical policies.

If interest must he paid at all, it must be paid by the Government as well as competing borrowers. Otherwise no one will lend to the Government. The rate at which the Government can borrow will depend at least in part upon the rate which private borrowers and also foreign governments can afford to pay.

Many people who attack interest payment as wicked and unjust are really confused in their minds. For they see that a certain group of people, namely those with large incomes, are the chief recipients of interest payments. Therefore they say “Abolish interest,” when they only mean “Abolish big incomes” and are not at all willing to abolish the rights of private property, including their own.

But the mere demonstration that interest is inseparable from private property does not necessarily justify the existence or the practices of the banking system.

The function of “banking,” so we have often been told, is to receive money on deposit and, after keeping a margin on hand, to lend the balance out in one form or another. Interest may be paid to attract deposits, and a higher rate will be charged to borrowers; the difference between the rates being the bankers' commission which covers the costs of maintaining the banking system as intermediary between lenders (depositors) and borrowers. This would clearly seem to he a useful function in society as it is at present organized; and so long as the holders of hank stock are not receiving exorbitant dividends and the directors of banks are not receiving exorbitant fees it would seem likely that the public is served at a charge that is not extortionate. It is along such lines as these that the place of the banking system in society is usually justified.

Should Banks be Nationalized?

THE demand that the Canadian 4 chartered banks should he nationalized may arise from two different sources. In the first place, there may be those who believe that the banks, as they are operated at present, do not supply the right volume of money to the country. In the second place, there may be those who believe that the banks do not distribute their loans in the manner most advantageous to the country. Let us first consider whether “nationalization” would be likely to secure a better distribution of credit.

Now it is clear that, if society were reorganized on some new basis in which each industry and each person did not have to face the alternative of either “making ends meet” or else going bankrupt, then the banks could, and no doubt would, make loans to people who were worthy but insolvent or likely to become so. But as things are, the banks must be careful to loan money only to those who are likely to pay it back. This would be just as true if the banking system were nationalized. For the policy of allowing a nationalized banking system to run deficits continuously, which would presumably be met by further “creations” of money and credit, would be just as dangerously inflationary as we have seen that a deficit-running, credit-creating government would be.

If this be true, in what way would a nationalized banking system differ from our present system? Would it pay smaller dividends, thus discriminating against those investors who happened to have bought bank shares rather than some other security? Would it radically change the distribution of its loans? Would the directors managers and branch managers who are jointly responsible for the present distribution of loans be discharged and “national” appointees take their place?

The question boils down to this: Some one has to be responsible for distributing the loans and investments of the banking system. Few people would claim that the Canadian bankers have made no mistakes, that they have not lent too much to one industry at one time and too little to another at some other time. Few people would claim that no illegitimate fortunes have been made by, or in collusion with, some Canadian bankers. But. on the whole, Canadian bankers appear to be efficient distributors of an existing volume of money. Certainly, when their record in this regard is compared with that of bankers in other countries, there is little cause to blush. And I cannot feel at all certain that a nationalized banking system would do their job more efficiently ; that more people would be satisfied, and that personal interests would interfere less.

The proponents of nationalization are, for the most part, desirous that the banks should come under national control in order to use the powers of finance to guide the development of Canadian economic activity. If this end is in view, it would probably be more effectively attained by a Board of National Investment, such as has been advocated for some years by the British Liberal party. The object of such a Board would be to supervise all new issues of securities in Canada. After all, the banks for the most part only supply working capital to going concerns. The new issue market is the main source of funds for expansion and development.

We may now turn to the other argument in favor of “nationalizing” the Canadian banks. To this argument, it seems to me, the banks are far more vulnerable than they are to criticisms of the way in which they distribute their loans.

Mr. McGeer has discovered the missing breastplate in the armor of the banks. Unfortunately for his own case, instead of loosing a swift arrow to the unprotected jxjint he launched an indiscriminate quiverful of attack and abuse, the greater part of which fell harmlessly away so that it was not plain that any wound had been inflicted.

The crucial point is that, as a system, the banks no longer merely passively receive deposits and distribute loans, but are the chief creators of loans and deposits. Each individual bank and branch may operate as a pool for deposits and a source for loans. But the system as a whole creates and destroys “credit,” i.e., deposits and loans. Therefore—and this is most important—all the defensive arguments which picture the banks merely as society-serving go-betweens between outside depositors and borrowers fall to the ground.

Banks Control Money

THERE can be no doubt that, as a system, the Canadian chartered banks control, in large measure, the volume of money available in Canada. There no doubt that the volume of money has an influence upon the level of prices and general prosperity of the country, although that influence is certainly far less direct and predictable than many monetary' enthusiasts claim. Nevertheless, the president of the Canadian Bankers' Association, in a prepared statement presented to the Canadian House of Commons Committee on Banking and Currency in 1928, made the following remarkable statement (the italics are mine):

"The banker is primarily and mainly concerned about the safety of his advances and the certainty that the advances will be returned within a reasonable time with adequate interest. He is not thinking about the volume of credit in the country nor the effect which the granting or withholding of credit in the particular instance will have upon the price level of commodities in the country.”

One might think that the president was advancing this as an argument in favor of the establishment of a central bank or other institution whose duty it would be to see that the right amount of credit was issued, whose eyes would not be so intent upon “the particular instance,” that the country’s situation as a whole would not be seen. Actually, however, he believed himself to be opposing the foundation of a central bank. Indeed, in his annual speech as general manager of one of the chartered banks, he said, only last November: “What good purpose a central bank could serve is something that I, for one, cannot see.”

If Canadian bankers persist in making such statements as these they are simply digging their own graves. No great public institution can stand up against concerted public opposition, least of all a banking system which is open to “runs on the banks” and withdrawals of deposits by a dissatisfied portion of the public. The public is beginning to be aware that the banks at present largely control the volume of money and credit. The public is also getting ideas, often exaggerated ones, about how that power might be used beneficently. If the bankers will not accept the resixmsibility of using that power, and at the same time insistently oppose the suggestion that a central bank should be founded to assume it. the banks will find themselves “nationalized”—and in the not too distant future.

We have seen that there are gcxxl reasons for not interfering in any radical manner with the banks in their traditional business of receiving deposits and making loans—at least while society is on its present economic basis. But how to justify the existence of the Canadian banking system as a credit-creating and credit-destroying agency, I don’t know. Perhaps it can be done. It certainly cannot be done merely by denying the fact that it has such powers. The days of such ostrich-banking are certainly numbered.

If I were a Canadian banker in this day and age, when every business and institution is being called upon to demonstrate that its existence and operations are in the interests of society, and when at the same time there is an increasing public belief that the volume of money and credit has a direct bearing upon economic conditions—as a banker under these circumstances I should go to Ottawa, clamoring that some benevolent government should take the responsibility of credit creation and destruction off my hands and invest it in some “national” institution such as a Central Bank or Board of Credit Control. Having achieved that, I should go back to St. James Street or King Street to carry' on my depositreceiving, loan-making business with a light heart and an easy conscience.

Editor's Note—This is the second article by Mr. Plumptre in a series discussing the gold standard, inflation and national credit. Previous articles by G. G. McGeer, presenting the other side of the case, appeared in the December 1, December 15 and January 1 issues of Maclean's.