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required for the transaction of business,
and the bank was making no loans
except for proper and necessary busi-
ness purposes; hence, there was noth-
ing to do about it.

They did not realize that they had
lost their bearings; they were judging
the need for credit by the demands of
an abnormal situation. England was
off the gold basis, the paper currency
was inflated and depreciated, prices
were inflated and of course the demand
for crckiit was just as great as though
conditions had been normal. The
famous Bullion Report, by Lord Liver-
pool's committee, pointed out the
fallacy of judging the state of credit or
of currency merely by the amount re-
quired to carry on business at the
existing level of prices. That criterion
is unsafe unless the price level is
related to the gold standard, or some
other concrete standard. To allow
the volume of currency to be regulated
by the demand, while the demand in
turn is dependent upon values and the
values are dependent upon the volume,
is traveling in a circle.

Means of Reducing Inflation

Surely there can be no question that
the purchasing power of a currency
which has no definite relation to gold,
or to any concrete standard, is depen-


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The Annals of the Amebican Academy

dent upon the volume put into circu-
lation. Currency issues are usually
under the control of some authority
and regulated to supply a circulating
medium which will itself sustain a
fixed relation to the standard of value
and therefore a normally stable level
of prices, but where not regulated
according to this policy, but simply
paid out upon governmental expendi-
tures, the purchasing power inevitably
declines. Every additional issue di-
lutes and diminishes the value of all
that is outstanding. Once issued it
stays out until it is redeemed, not
necessarily in gold, but by cancellation
which involves a contraction of credit.
If the notes are issued by a central
bank it is in the process of granting
credit, and the notes may be retired
in payment of the credit. But this
means that the only way to reduce
inflation is by . producinj^ and saving
Healtk and applying it to the cancella-
tion of credit.

The economic oflFense in printing
money to carry on the expenses of a
government is in attempting to get
something for nothing. That cannot
be done in any economic sense; there
is always a settlement somewhere by
somebody. The people must pay in
somemannerforwhatever their govern-
ment expends. If it prints money
to meet its pasrments, they suffer in the
corresponding depreciation of all the
outstanding paper issues. If it creates
and uses purchasing power in any other
form of credit, the effect upon prices is
the same.

This effect upon prices or, in other
words, the resulting depreciation of
the purchasing power of credit, follows
from an attempt to use a large amount
of purchasing power without any

corresponding increase in the supply
of things to be purchased. The effect
of inflation upon prices is not a myste-
rious or occult phenomenon peculiar to
currenpy, but simply a phaae of the
familiar operations of the law of supply
and demand. In so far as an increased
supply of currency is called for by a
more general state of industrial activity
and a more complete industrial em-
ployment of the population, '"expan-
sion" is the proper term to describe it;
'^inflation" begins when the amount of{
credit in use is not required and offset
)y greater production and a corres|
;>onding increase in the amount
x>mmodities to be handled.

The War and Price Inflation
Wages and Prices

The original cause of the recent
rise of prices undoubtedly was the war.
It created a practically unlimited de-
mand for man-power, equipment and
supplies. The first effect was to take
up whatever slack there was in the
industries, and if the demand had gone
no further, the effect upon wages and
prices would have been but sUght.
But it could not be stopped at this
precise point. It soon assumed the
form of a competitive struggle for
labor and materials. The government
let the contracts for its cantonments,
which were located in aU parts of the
country, on a cost-plus basis, and the
contractors proceeded to offer wa^es
which would attract labor from other
employments. Then came the con-
tracts for munition works, gun works,
aeroplane factories, shipyards and
equipment of all kinds. And the
demand for labor in the ordinary
industries did not fall off. The enor-
mous expenditures of the government

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The Cause and Process of Inflation


poured more money into the regular
channels of trade ; the demaQd for goods
for private consumption increased, and
the makers of such goods struggled
vigorously to hold their employes
against all competitors, including the
war industries. In short, there was a
practically unUmited, competitive de-
mand> playing upon a strictly limited
supply of labor and materials, and a
great rise of wages and prices was the
natural result.

This is the basis for the contention
that the inflation of credit followed and
resulted from the rise of prices and did
not contribute to it, but the contention
goes too far. Those who hold that an
increased supply of credit will promote
higher prices are free to admit that it
is the use of the increased supply, and
not the mere fact that the supply is
available, which makes prices rise.
But they point out that if the increased
supply of credit was not available i t
^>rC cniild t\q\ be used , and that under the
war-time conditions, if freely available,
it was oertwi to be used and certain
to force up wages and prices. The
heedless attempt to drive the industrial
machine beyond its physical capac-
ity caused the inflation. Because of
enormous pressure for goods we turned
into the channels of industry and trade
twice as many dollars as had been in
use before, each representing nominally
the old purchasing power.

Bank Credit Expansion and Production

The available information indicates
that production in this country in-
creased but slightly after the United
States entered the war. It increased
in some lines by drawing labor from
others, but not much on the whole.
There was a great expansion of bank

credit, however, for the purpose of
financing the competitive struggle over
the limited supply, of labor and mate-
rials. This expansion furnished com-
petitors with the means to bid against
each other and thus contributed
directly to the rise of prices, while
contributing very little, if at all, to
production. We had a grand scramble
for labor and materials instead of
an organized scheme of utilizing our
industrial forces.

If a single family, living in a position
of partial economic independence, as on
a farm, should suddenly face reverses
or the necessity of making heavy non-
productive expenditures, it would know
immediately what it would have to do.
It would have to work harder, produce
more, live more economically, and have
a larger surplus with which to meet the
new demands upon it. The economic
law is the same for a nation as for a
family, but there is not the same ready
apprehension of the facts. Our peo-
ple did not understand that the out-
lays upon the war must be met by
increased production and greater econ-
omy. They thought that they could
go to the banks and borrow for the
government loans and even to pay their
taxes, and but for a few gasless Sundays
and some economy in the use of sugar,
flour and a few other commodities
which we were required to share with
our Allies, they expected to go on about
as usual. Indeed, in business circles it
was argued that business must go on
as usual in order that the war taxes
might be paid.

This is not written in criticism. We
were no diflFerent from other peoples
in this respect. There is no such popu-
lar knowledge of economic law as
would be required to suddenly reorgan-

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Thb Annals of the American Academic

ize a nation to meet the emergencjr of
war without inflation. That would
mean the most resolute and abstemious
voluntary self-denial on the part of
every person, in order that the indus-
trial resources of the country might be
turned over to governmental uses, or
there would have to be an arbitraiy
seizure of the industries and conmmn-
deering of the population. Inasmuch
as the public would not understand the
reasons for such a course, 'it may be
assumed that it could not be followed
without an amount of contention and
dissatisfaction that would have seri-
ously interfered with its effectiveness
and perhaps lessened the power of the
country in the war. In other words,
the conduct of a war without more or
less inflation is impossible.

Borrowing as a Cause of Inflation

This admission, however, is outside
of the argument that the free use of
bank credit, with the failure to co5rdi-
nate and control industry, and the
wholesale promotion of competition
over labor and materials, contributed
largely to the rise of wages and prices
and the cost of the war. This conten-
tion is not answered by simply saying
that the rise of wages and prices re-
quired the use of more credit. It is
necessary to go back of the rise of
wages and prices and take account of
the fact that, while every employer
was interested in increasing his own
output, he could only increase his
working force by hiring labor away
from his competitors, and that the
labor turnover had reached propor-
tions never before approached. In the
last analysis this was the situation
largely responsible for rising prices and
the demand for more credit. jThis bor-

"owing for the purx)ose of enlarging the|
mtput of an individual plant, but which I
iid not increase the total production,!
was pure inflation.

Now that we have this inflated state
of credit, how are we to get rid of it?
Upon the theory of those people who
hold that a supply of currenpy or bank
credit is analogous to a supply of
railway cars an increased supply of
currency, having no greater influence
in creating business than the latter, all
of this inflation will disappear as soon
as conditions in production work back
to normal, or when a period of dq>re3-
sion comes. But the analogy is un-
sound. There is a difference between
idle money or bank credit and idle
railway cars. The latter are instru-
ments of carriage, pure and simple, but
idle capital or credit can be made
effective in creating business. Th^
can be used in different ways and
shifted to different fields. Their own-
ers are never content to have them idle
for long.

This great body of outstanding bank
credit can only be retired as it is can-
celled by earnings and savings and by
liquidation of the stocks of conmiodities
held against it. A fall of prices would
reduce the amount of credit necessary
to carry new stocks in the future and
make cash resources go farther, but it
would involve losses upon existing

Payment and Elimination. — ^It is
difficult to make people see that the
existing great volume of bank deposits
must be reduced in precisely the same
manner as an over-issue of paper cur-
rency would be reduced, namely, by
pasrment and elimination. The de-
posits were created by the loans and
should be used in part to pay the loans.

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Thb Causb and Fbogbbs of Inflation


That would bring baiiking conditions
back to where they were when the
inflation began. When a man borrows
$10»000 at a bank and takes credit for
it in his account, the deposits as well
as loans of that bank go up $10,000,
and when he checks it out the deposits
of other banks will go up correspond-
ingly, and that $10,000 of credit will
stay in circulation, precisely as though
it were paper money, until $10,000 of
real savings — capital — ^is devoted to
its eUmination.

This makes deflation slow business.
The people have become accustomed
to using more credit. The new bank*
iug ^stem, which makes for a more
economical use of reserves, favors a
larger use of credit than under the old .
system, and the profits of bankers will
be enhanced by having their funds fuAy
employed. In order to secure defla*
tion, the banks should take up the
slack as fast as the demand for credit
relaxes and not let it out again; but
banking in the United States is on
a highly competitive basis, and the
probability is that when money be-
comes ea^ the bankers will reduce
interest rates and compete sharply to
get their funds into use.

The process of deflation is compli-
cated also because we are involved in
a world situation and subject to the
play of world influences upon prices,
credits and gold reserves. In the past
we never lost gold in large amoimts,
except to Europe, and we had a
considerable degree of control over that
movement by reason of the fact that
the European market would always
take our securities at a price. Now,
we have a fair degree of control over
direct European demands by reason of
Europe's indebtedness to us^ but new

demands for gold have developed from
South America and Asia.' Europe
owes us and we owe South America and
Asia, but we cannot use our credits in
Europe to settle with our creditor^.
The latter are drawing on us heavily
and lowering our bank reserves. Our
remedy is to lower our prices and
sell more goods in Asia and South

Nominally, the United States is on
the gold basis, but that is only because
of the great store of gold accumulated
in the past. While it lasts we will be
able to maintain gold payments. That
wages and prices in this country are
not on a gold basis is evident from the
fact that gold production is rapidly
declining. Only well developed mines
which have afforded an unusual margin
of profit in the past can continue to
operate at present costs. The coal,
copper, silver and lead operators can
afford to pay present mining costs
because the market prices of their
products have risen, but the price of
gold remains 23.22 grains to the
dollar, as before the war. The pro-
duction of gold in the United States
has fallen below our consumption in
the arts, and will continue to decline
until wages and prices return to the
gold basis.

Effects of Credit Restriction on
Wages and Prices

With the banking system expanded
to the limit of reserves and with
reserves dedimng, the outlook is for
a continued constriction of credit. It
maat be considered that in a growing
coimtry, like the United States, where
the volume of production and trade is
constantly increasing, the volume of
credit 13 normally increiisin|^. If the

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The Annals of the American Acadeict

country is to do business on the gold
standard, wages and prices must be
in terms of the gold standard; in other
words, they must come down, and if
the volume of credit is restricted they
will be eventually brought down. But
what will the public have to say about
this credit restriction and the eflPect
upon wages and prices? That is the
next important question.

Every period of falling prices and
business depression in the history of
this country has brought on an attack
upon the banking and monetary sys-
tems. No other public question or

question of governmental policy is so
adapted to serve the purposes of politi-
cal and social agitators and revolu-
tionaries as the money question. Will
the old and insidious greenback and
free silver arguments be revived and the
attack on the existing gold standard be
renewed? Will the $24,000,000,000
of fresh government indebtedness — ^the
Liberty bonds recently proclaimed as
the best security in the world — ^be paid
by common consent in gold of the
existing standard, as they come due, or
will there be a struggle to change the

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By Jacob H. Hollander, Ph.D.

Johns Hopkins University

THE American citizen is swiftly
awakening to the meaning and
import of the word inflation in relation
to every-day lifei Instead of being
regarded as "a high-brow fancy of
the professors " to be toler^tly ignored
by the public and summarily dis-
missed by hard-headed men of affairs,
it is now generally accepted as the
glaring evil of our war economy —
responsible for high prices, business
profiteering, speculative excesses and
for the economic injuries and social
injustices that make up the popular
unrest with which the coimtry is now

There are definite reasons for the
delayed recognition of the extent and
effect of inflation. On the one hand,
governmental authority has systemat-
ically obscured the fact and denied the
inference. At intervals, inflation has
been held forth bogey-fashion as the
penalty which would follow non-
adoption of the official policies. But
measures, frankly inflationist in effect,
have been freely resorted to whenever
administrative purpose or opportimist
convenience dictated. On the other
hand, expert economic opinion — ^bar-
ring a few notable exceptions — ^has
been slow in making its influence felt.
Reaction from a false scent, concentra-
tion upon a specialized formula, absorp-
tion in governmental service and
perhaps the intricacy and novelty of a
new type of inflation have made the
economist a less prompt, perhaps a less
certain guide than in other popular
economic vagaries.

Fbxmary Cause of Inflation
The indictment of inflation as a
consequence of fiscal bungling in our
war economy rests squarely upon the
doctrine that a relative increase in the
volume of currency is the cause and
not the effect of rising prices. With
this conclusion the great body of
theoretical economists and practical
financiers in this country and abroad
are now in agreement. A few irre-
conciables still sanction the dissent
which Professor Laughlin and his
disciples have so earnestly and so
unconvincingly set forth. Something
less than this has been invoked by the
Federal Reserve Board to justify the
increasing note issues of the Federal
Reserve Banks. But even here there
has been a perceptible weakening in
asseveration; and it seems not unrea-
sonable to assume that in about
the same interval of time the ad-
vocates of the English bank restric-
tion became converts to the doctrines
of the Bidlion Report of 1810, and the
defenders of Secretary Chase's fiat
issues yielded to the logic of greenback
prices — ^there will be admission on the
part of fiscal stand-patters ^at our
huge creations of bank credit and note
currency have been the direct cause of
swollen prices!^

The facts as to inflation can be set
forth in a paragraph: As compared
with the spring of 1914 — ^the eve of the
World War — ^the people of the United
States are carrying on their business
at the present time with practically
twice as much circulating medium and


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The Annals of the American Academy

bank deposits. There has been an in-
crease in the actual circulating medium
of the country from $3,402,015,427
on June 80, 1914, to $5,846,171,213 on
February 1, 1920; an increase in the
deposits of national banks, state banks
and trust companies from $13,430,000,-
000 on June 30, 1914, to $25,731,000,-
000 on June 30, 1919, and an increase
in the individual deposits subject to
check of the national banks alope from
$8,470,747,000 on June 30, 1919, to
$9,682,618,000 on November 17, 1919.
Altogether it is Ukely that the coun-
try is now transacting its business
with $15,000,000,000 more circulating
medium and deposits than five years

This huge addition to the nation's
money has been for fiscal convenience
and not for commercial requirement.
The direct consequence of the attempt
to play the business game with twice
as many chips has been to cut in half
the commodity-buying power of the
money unit, evidenced by a rise in
general prices to 249 in February, 1920,
as compared with 100 in 1914.

CoxTBSE OF Inflation

There have been three stages in the
course of our inflation, each marked
by an unsoimd administrative policy:

(a) from the outbreak of the World
War in August, 1914, to the entry of
the United States into the great strug-
gle, an incoming flood of gold was
permitted to serve uncorrected as the
basis of a towering credit structure;

(b) in the eighteen months of our
active belligerenpy lavish supplies of
fiat credit by bank loans through
certificate borrowing were created in
the interest of fiscal opportunism in-
stead of economic requirement; (c)

ftom the armistice of November, 1918,
almost up to the present the policies of
the Federal Reserve Board as to credit
control have been frankly dominated
by the convenience of the Treasury.

Fr(m the Otdhreak of the World War
to the Entry of Untied States into

Thanks to huge exports of munitions
and supplies to the belligerents and
the sharp decline in commodity imports
from the war area, an undreamed-of
stream of gold poured into the United
States during the period of our neu-
trality. Largely in consequence, the
volume of coin, including bullion in the
Treasury, increased from $2,638,496,-
956 on June 30, 1914, to $3,807,161,348
on June 30, 1918. This increase in
our stock of monetary gold of more
than one billion dollars was magnified
by the changed reserves of the banks,
consequent upon the operation of the
Federal Reserve System and the gold-
centralizing amendment of June 21,
1917. Had our financial administra-
tors been more skilled in world bank-
ing, prompt attention would have been
paid to the significant price movements
that followed such changes. Increased
reserve percentages would have been
urged and higher discount rates would
have been imposed to check the
inflating effect of the gold flood.
Nothing of this was done, and we
passed from the uninformed state that
marked our neutrality financing to the
outright error that marred our war

From the Entry of United States into
World War to the Armistice

The worst blunder of our war-time
financing, in its subsequent effect upon

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social well-being, was the Treasury's
large reliance upon bank borrowing
during the period of active belligerency
and indeed for some time thereafter.
To supply itself painlessly with ample
borrowed funds and to keep the money
market artificially within favorable
limits, a huge voliune of credit currenc-y
was created by bank loans, taking the
form of issues of Treasury certificates
of indebtedness in anticipation of loan
proceeds and tax revenues. In an-
other place I have described the
mechanism whereby this was accom-
plished.^ What could at that time
only be proposed tentatively can now
be asserted definitely, for events have
confirmed the forecast with almost
startling exactness.

Through the devices of payment
"by credit," redeposit of funds, exemp-
tion of government deposits from
reserve requirements and preferential
rediscount rates upon war paper-:-
anticipatory certificate borrowing from
the banks, as practiced by the Treas-
ury, involved the direct creation of a
volume of additional bank credit in
the form of pubUc deposits dictated
entirely as to time and amount by
fiscal convenience and entirely unre-
lated to commercial need. Such emis-
sions of fiat credit were dispersed
among individual deposit accounts in
the course of public expenditure, pro-
ducing a direct expansion of credit
and currency without ' succeeding
contraction incident to certificate

From Armistice to Present Day

The infiation due to the gold fiood
from warring Europe in the period of

^ War Borrowing: A Study of Treasury Cer-
tificates of Indebtedness. (Macmillan, 1919.)

our neutrality and to the reliance upon
fiat credit in connection with war bor-
rowing in the period of our belliger-
ency may perhaps be explained, though
insufficiently, on the score of the igno-
rance of our financial administrators as
to the potency and far-reaching effect
of the great economic forces they Were
invoking. Not even this justification
can be found for the amazing renewal
in our post-war financing of the fiatism
of the war period, by the resumption
of certificate borrowing eight months
after the armistice in accordance with
Secretaiy Glass's program of July 23,
1919. At the time the Treasury so
resumed its poU<*y of bank borrowing
the inflationist effect of such procedure
had been established to the point of
outright demonstration by analysis
of banking operations in the United

Online LibraryJSTOR (Organization) American Academy of Political and Social ScienceAnnals of the American Academy of Political and Social Science → online text (page 30 of 59)