Money

As soon as inflationary finance has led to the abandonment of the gold standard the monetary unit begins to depreciate. The depreciation is likely soon to be accelerated by speculation. Peo ple are unwilling to hold balances in a discredited unit. They pay away their money as fast as they can in exchange for "real values," for things, that is, of which the value does not depend upon the monetary unit. They buy commodities, or ordinary shares, or foreign currencies—anything which can rise in price as the value of money falls. When people pay away balances, they can only pay them to one another. The aggregate of balances cannot de crease. The unspent margin has been swollen by bank advances to the Government and cannot be decreased except by repayments. When people accelerate their payments the effect is to increase the consumers' outlay out of proportion to the unspent margin. And along with the consumers' outlay the consumers' income increases. The velocity of circulation is increased. The result is that the price level is raised more than in proportion to the unspent margin. A rapid rise of prices disorganizes markets. The prices of different products rise very unequally. People buy things for a temporary investment rather than for consumption. For such an object foreign currencies are a more convenient acquisition than any commodity, and it sometimes happens that there is a rush to the foreign exchange market which raises the rates of ex change, and therefore the prices of foreign trade products, out of all proportion to the prices of home trade products. The same discredit of the currency which leads people to pay away balances of cash, impels them to borrow from the banks. It is highly profit able to borrow for a short period and to use the proceeds to buy commodities or foreign exchange, if in the interval before repay ment the money value of the things bought has risen by an amount many times the charge for interest. The currency units in which the loan is repaid are worth much less than those in which it was originally received. If temporary borrowing is stimulated, that means that the banks create more credit and the unspent margin is further increased, and all the effects of inflation are accentuated. Moreover discredit of the currency makes long-term borrowing impossible. People will not put their savings in investments which depend for their value upon a depreciating unit. The Government, having started inflationary borrowing, finds that it cannot borrow in any other way. A vicious circle of inflation is set up, and it is only too likely to end in a complete breakdown of the currency system, the value of the unit in gold or in wealth dwindling to an infinitesimal fraction of its former parity.

Devaluation and Deflation.

When discredit has brought depreciation of the unit beyond a certain point, a restoration of the former gold value becomes impossible. The gold standard can only be restored by devaluation, the adoption of a new parity, not differing by much from the existing gold value of the currency in the market. Devaluation was common in the middle ages, when the imperfection or debasement of the coin had led to a depre ciation of the unit, and a restoration was deemed impracticable or undesirable. Nowadays it is sometimes denounced as being something like a fraud, which robs creditors of their due. This is a misapprehension of the real nature of a monetary standard. The equivalence of the monetary unit to a specified weight of gold , or silver is established by law and can be altered by law. Creditors have no vested right in the maintenance of the law unchanged. On the other hand when the depreciation is not so great as to make a return to the old parity with gold impracticable, there are real advantages in re-establishing it. The old parity commands con fidence in a way that no new parity could do.

The process by which a currency is raised in value, either to its former gold parity, or to a new parity above its existing value, is called deflation. Deflation requires a diminution of the consumers' income and the consumers' outlay, and is usually effected by means of a contraction of credit and similar measures. The shrinkage of demand and the fall of prices have a paralyzing effect on enter prise, causing trade depression, unemployment and bankruptcies. It is on account of these injurious consequences that the value of a currency unit can only be raised to a very limited extent. One of the features of the "trade cycle" (the periodic fluctuations of productive activity familiar to economists between 1815 and 1914) was a general worldwide rise of prices, followed by an equally general contraction of credit and fall of prices. The un employment and trade depression characteristic of the latter phase of the cycle were symptoms of deflation, though the pre ceding inflation, applying as it did to all gold standard countries, was not based on inconvertible paper money. (See also BANKING AND CREDIT; CURRENCY; QUANTITY THEORY OF MONEY; CHEQUE; BILL OF EXCHANGE; MONEY MARKET; BANK-RATE; INFLATION AND DEFLATION ; TRADE CYCLE; DOLLAR STABILI ZATION, etc.)