자료: J. M. Keynes, A Tract on Monetary Reform (1923)
※ This is a reading note with excerpts taken, and personal annotations and remarks added, in trying to understand the above text. So, visit the above source links to see the original.
※ 발췌 / excerpts of which: Chapter 3, p. 74 (p.83 on PDF) ~
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Chapter 3
The Theory of Money and of the Foreign Exchanges
The Theory of Money and of the Foreign Exchanges
The evil consequences of instability in the standard of value have now been sufficiently described. In this chapter we must lay the theoretical foundations for the practical suggestions of the concluding chapters. Most academic treatises on monetary theory have been based, until lately, on so firm a presumption of a gold standard régime that they need to be adapted to the existing régime of mutually inconvertible paper standards.
I. The Quantity Theory of Money
This theory is fundamental. Its correspondence with fact is not open to question.[2] Nevertheless it is often misstated and misrepresented. Goschen's saying of 60 years ago, that “there are many persons who cannot hear the relation of the level of prices to the volume of currency affirmed without a feeling akin to irritation,” still holds good.
[2] “The Quantity Theory is often defended and opposed as though it were a definite set of propositions that must be either true or false. But in fact the formulae employed in the exposition of the theory are merely devices for enabling us to bring together in an orderly way the principal causes by which the value of money is determined” (Pigou).
The Theory flows from the fact that money as such has no utility except what is derived from its exchange-value, that is to say from the utility of the things which it can buy. Valuable articles other than money have a utility in themselves. Provided that they are divisible and transferable, the total amount of this utility increases with their quantity;ㅡit will not increase in full proposition to the quantity, but, up to the point of satiety, it does increase.
If an article is used for money, such as gold, which has a utility in itself for other purposes, aside from its use as money, the strict statement of the theory, though fundamentally unchanged, is a little complicated. In present circumstances we can excuse ourselves this complication. A Currency Note has no utility in itself and is completely worthless except for the purchasing power which it has as money.
Consequently what the public want is not so many ounces or so many square yards or even so many ￡ sterling of currency notes, but a quantity sufficient to cover a week's wages, or pay their bills, or to meet their probable outgoings on a journey or a day's shopping. When people find themselves with more cash than they require for such purposes, they get rid of the surplus by buying goods or investments, or by leaving it for a bank to employ, or possibly, by increasing their hoarded reserves. Thus the number of notes which the public ordinarily have on hand is determined by the amount of purchasing power which it suits them to hold or to carry about, and by nothing else. The amount of this purchasing power depends partly on their wealth, partly on their habits. The wealth of the public in the aggregate will only change gradually. Their habits in the use of moneyㅡwhether their income is paid them weekly or monthly or quarterly, whether they pay cash at shops or run accounts, whether they deposit with banks, whether they cash small cheques at short intervals or larger cheques at longer intervals, whether they keep a reserve or hoard of money about the houseㅡare more easily altered. But if their wealth and their habits in the above respects are unchanged, then the amount of purchasing power which they hold in the form of money is definitely fixed. We can measure this definite amount of purchasing power in terms of a unit made up of a collection of specified quantities of their standard articles of consumption or other objects of expenditure; for example, the kinds and quantities of articles which are combined for the purpose of a cost-of-living index number.
So far we have assumed that the whole of the public requirement for purchasing power is satisfied by cash, and on the other hand that this requirement is the only source of demand for cash; neglecting the fact that the public, including the business world, employ for the same purpose bank deposits and overdraft facilities, whilst the banks must for the same reason maintain a reserve of cash. The theory is easily extended, however, to cover this case. Let us assume [:]
So long as k, k' , and r remains unchanged, we have the same results as before, namely, that n and p rise and fall together. The proportion between k and k' depend on the banking arrangements of the public; the absolute value of these on their habits generally; and the value of r on the reserve practices of the banks. Thus, so long as these are unaltered, we still have a direct relation between the quantity of cash (n) and the level of prices (p).[1]
So far there should be no room for difference of opinion. The error often made by careless adherents of the Quantity Theory, which may partly explain why it is not universally accepted, is as follows.
KHNW p025-3. {{
Every one admits that the habits of the public in the use of money and of banking facilities and the practices of the banks in respect of their reserves change from time to time as the result of obvious developments. These habits and practices are a reflection of changes in economic and social organisation. But the Theory has often been expounded on the further assumption that a mere change in the quantity of the currency cannot affect k, r, and k' ,ㅡthat is to say, in mathematical parlance, that n is an independent variable in relation to these quantities. It would follow from this that an arbitrary doubling of n, since this in itself is assumed not to affect k, r, and k' , must have the effect of raising p to double what it would have been otherwise. The Quantity Theory is often stated in this, or a similar, form.
Now “in the long run” this is probably true. If, after the American Civil War, the American dollar had been stabilised and defined by law at 10% below its present value, it would be safe to assume that n and p would now be just 10% greater than they actually are and that the present values of k, r, and k' would be entirely unaffected. But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.
}}
In actual experience, a change of n is liable to have a relation both on k and k' and on r. It will be enough to give a few typical instances.[:] Before the war (and indeed since) there was a considerable element of what was conventional and arbitrary in the reserve policy of the banks, but especially in the policy of the State Banks towards their gold reserves. These reserves were kept for show rather than for use, and their amount was not the result of close reasoning. There was a decided tendency on the part of these banks between 1900 and 1914 to bottle up gold when it flowed towards them and to part with it reluctantly when the tide was flowing the other way. Consequently, when gold became relatively abundant they tend to hoard what came their way and to raise the proportion of the reserves with the result that the increased output of South African gold was absorbed with less effect on the price level than would have been the case if an increase of n had been totally without reaction on the value of r.
In agricultural countries where peasants readily hoard money, an inflation, especially in its early stages, does not raise prices proportionately, because when, as a result of a certain rise in the price of agricultural products, more money flows into the pockets of the peasants, it ends to stick there;ㅡdeeming themselves that much richer, the peasants increase the proportion of their receipts that they hoard.
Thus in these and in other ways the terms of our equation tend in their movements to favour the stability of p, and there is a certain friction which prevents a moderate change in n from exercising its full proportionate effect on p.
On the other hand a large change in n, which rubs away the initial friction, and especially a change in n due to causes which set up a general expectation of a further change in the same direction, may produce a more than proportionate effect on p. After the general analysis of Chapter 1 and the narratives of catastrophic inflations given in Chapter 2, it is scarcely necessary to illustrate this further,ㅡit is a matter more readily understood than it was ten years ago. A large change in p greatly affects individual fortunes. Hence a change after it has occurred, or sooner in so far as it is anticipated, may greatly affect the monetary habits of the public in their attempt to protect themselves from a similar loss in future, or to make gains and avoid loss during the passage from the equilibrium corresponding to the old value of n to the equilibrium corresponding to its new value. Thus after, during, and (so far as the change is anticipated) before a change in the value of n, there will be some reaction on the values of k, k', and r, with the result that the change in the value of p, at least temporarily and perhaps permanently (since habits and practices, once changed, will not revert to exactly their old shape), will not be precisely in proportion to the change in n.
The terms inflation and deflation are used by different writers in varying senses. It would be convenient to speak [:]
The moral of this discussion, to be carried forward in the reader's mind until we reach Chapter 4 and 5, is that the price level is not mysterious, but is governed by a few, definite, analysable influences.[:]
The usual method of exercising a stabilising influence over k and k', especially over k', is that of bank-rate. A tendency of k' to increase may be somewhat counteracted by lowering the bank-rate, because easy lending diminishes the advantage of keeping a margin for contingencies in cash. Cheap money also operates to counterbalance an increase of k', because, by encouraging borrowing from the banks, it prevents r from increasing or causes r to diminish. But it is doubtful whether bank-rate by itself is always a powerful enough instrument, and, if we are to achieve stability, we must be prepared to vary n or r on occasion.
Our analysis suggests that the first duty of the central banking and currency authorities is to make sure that they have n and r thoroughly under control. For example, so long as inflationary taxation is in question n will be influenced by other than currency objects and cannot, therefore, be fully under control; moreover, at the other extreme, under a gold standard n is not always under control, because it depends on the unregulated forces which determine the demand and supply of gold throughout the world. Again, without a central banking system r will not be under proper control because it will be determined by the unco-ordinated decisions of numerous different banks.
At the present time in Great Britain r is very completely controlled, and n also, so long as we refrain from inflationary finance on the one hand and from a return to an unregulated gold standard on the other.[1] The second duty of the authorities is therefore worth discussing, namely, the use of their control over n and r to counterbalance changes in k and k'. Even if k and k' were entirely outside the influence of deliberate policy, which is not in fact the case, nevertheless p could be kept reasonably steady by suitable modifications of the values of n and r.
II. The Theory of Purchasing Power Parity
The Quantity Theory deals with the purchasing power or commodity-value of a given national currency. We come now to the relative value of two distinct national currencies,ㅡthat is to say, to the theory of the Foreign Exchanges.
KHNW_p023-2, cf: {{
When the currencies of the world were nearly all on a gold basis, their relative value (i.e. the exchanges) depended on the actual amount of gold metal in a unit of each, with minor adjustments for the cost of transferring the metal from place to place.
}}
When this common measure has ceased to be effective and we have instead a number of independent systems of inconvertible paper, what basic fact determines the rates at which units of the different currencies exchange for one another?
The explanation is to be found in the doctrine, as old in itself as Ricardo, with which Professor Cassel has lately familiarised the public under the name of “Purchasing Power Parity.”[1]
If, therefore, we find that the internal and external purchasing powers of the home-currency are widely different, and, which is the same thing, that the actual exchange rates differ widely from the purchasing power parities, then we are justified in inferring that equilibrium is not established, and that, as time goes on, forces will come into play to bring the actual exchange rates and the purchasing power parities nearer together. The actual exchanges are often more sensitive and more volatile than the purchasing power parities, being subject to speculation, to sudden movements of funds, to seasonal influences, and to anticipations of impending changes in purchasing power parity (due to relative inflation or deflation); though also on other occasions they may lag behind. Nevertheless it is the purchasing power parity, according to this doctrine, which corresponds to the old gold par. This is the point about which the exchanges fluctuate, and at which they must ultimately come to rest; with one material difference, namely, that it is not itself a fixed point,ㅡsince, if internal prices move differently in the two countries under comparison, the purchasing power parity also moves, so that equilibrium may be restored, not only by a movement in the market rate of exchange, but also by a movement of the purchasing power parity itself.
At first sight this theory appears to be one of great practical utility; and many persons have endeavoured to draw important practical conclusions about the future course of the exchanges from charts exhibiting the divergences between the market rate of exchange and the purchasing power parities,ㅡundeterred by the perplexity whether an existing divergence from equilibrium will be remedied by a movement of the exchanges or of the purchasing power parity or of both.
In practical applications of the doctrine there are, however, two further difficulties, which we have allowed so far to escape our attention,ㅡboth of them arising out of the words ^allowance being made for transport charges and import and export taxes^. The first difficulty is how to make allowance for such charges and taxes. The second difficulty is how to treat purchasing power over goods and services which ^do not enter into international trade at all^.
The doctrine, in the form in which it is generally applied, endeavours to deal with the first difficulty by assuming that the percentage difference between internal and external purchasing power at some standard date, when approximate equilibrium may be presumed to have existed, generally the year 1913, may be taken as an approximately satisfactory correction for the same disturbing factors at the present time. For example, instead of calculating directly the cost of a standard set of goods at home and abroad respectively, the calculations are made that $2 are required to buy in the United States a standard set which $1 would have bought in 1913, and that ￡2.43 are required to buy in England what ￡1 would have bought in 1913. On this basis (the pre-war purchasing power parity being assumed to be in equilibrium with the pre-war exchange of $4.86＝￡1) the present purchasing power parity between dollars and sterling is given by $4＝￡1, since 4.86×2÷2.43＝4.
The obvious objection to this method of correction is that transport and tariff costs, especially if this term is taken to cover all export and import regulations, including prohibitions and official or semi-official combines for differentiating between export and home prices, are notoriously widely different in many cases from those which existed in 1913. We should not get the same result if we were to take some year other than 1913 as the basis of the calculation.
The second difficultyㅡthe treatment of purchasing power over articles which do not enter into international tradeㅡis still more serious. ( ... pp.91-92, pp.101-102 on PDF ... ) Yet applied in this wayㅡnamely, in a comparison of movements of the ^general^ index numbers of home prices in two countries with movements in the rates of exchange between their currenciesㅡthe theory requires a further assumption for its validity, namely, that in the long run the home prices of the goods and services which do not enter into international trade, move in more or less the same proportions as those which do.[1]
( ... pp. 93-106, pp.??-115 on PDF ...)
III. The Seasonal Fluctuation
Thus the Theory of Purchasing Power Parity tells us that movements in the rate of exchange between the currencies of two countries tend, subject to adjustment in respect of movements in the "equation of exchange," to correspond pretty closely to movements in the internal price levels of the two countries each expressed in their own currency. It follows that the rate of exchange can be improved in favour of one of the countries by a financial policy direct towards a lowering of its internal price level relatively to the internal price level of the other country. On the other hand a financial policy which has the effect of raising the internal price level must result, sooner or later, in depressing the rate of exchange.
The conclusion is generally drawn, and quite correctly, that budgetary deficits covered by a progressive inflation of the currency render the stabilisation of a country's exchanges impossible; and that the cessation of any increase in the volume of currency, due to this cause, is a necessary pre-requisite to a successful attempt at stabilising.
The argument, however, is often carried further than this, and it is supposed that, if a country's budget, currency, foreign trade, and its internal and external price levels are properly adjusted, then, automatically, its foreign exchange will be steady.[1] So long, therefore, as the exchanges fluctuateㅡthus the argument runsㅡthis in itself is a symptom that an attempt to stabilise would be premature. When, on the other hand, the basic conditions necessary for stabilisation are present, the exchange will steady itself. In short, any delibertate or artificial scheme of stabilisation is attacking the problem at the wrong end. It is the regulation of the currency, by means of sound budgetary and bank-rate policies, that needs attention. The proclamation of convertibility will be the last and crowning stage of the proceedings, and will amount to little more that the announcement of a ^fait accompli^.
There is a certain force in this mode of reasoning. But in one important respect it is fallacious.
Even though foreign trade is properly adjusted, and the country's claims and liabilities on foreign account are in equilibrium over the year as a whole, it does not follow that they are in equilibrium every day. ( ... pp. 108-115, pp. 117-124 on PDF ... )
IV. The Forward Market in Exchanges
( ... pp. 115-132, pp.124-141 on PDF ... )
Out of the various practical conclusions which might be drawn from this discussion and figures which accompany it, I will pick out three.
1. Those exchanges in which the fluctuations are wildest and the merchant is most in need of facilities for hedging his risk are precisely those in which facilities for forward dealing at moderate rates are least developed. But this is to be explained, not necessarily by the instability of the exchange in itself, but by certain accompanying circumstances, such as distrust of the country's internal arrangements or its banking credit, a fear of the sudden imposition of exchange regulations or of a moratorium, and the other analogous influences mentioned above(pp. 126-7). There is no theoretical reason why there should not be an excellent forward market in a highly unstable exchange. In those countries, therefore, where exchange regulation is still premature, it may be nevertheless be possible to mitigate the evil consequences of fluctuation by organising facilities for forward dealings.
This is a function which the State banks of such countries could usefully perform. For this they must either themselves command a certain amount of foreign currency or they must provide facilities for accepting short period deposits in their own currency from foreign bankers, on conditions which inspire these bankers with complete confidence in the freedom and liquidity of such deposits. Various technical devices could be suggested. But the simplest method might be for the State banks themselves to enter the forward market and offer to buy or sell forward exchange at a reasonable discount of premium on the spot quotation. I suggest that they should deal not directly with the public but only with approved banks and financial houses, from whom they should required adequate security; that they should quote every day their rates for buying and selling exchange either one or three months forward; but that such quotation should take the form, not of a price for the exchange itself, but of a percentage difference between spot and forward, and should be a quotation for the double transaction of a spot deal one way and a simultaneous forward deal the otherㅡe.g. the Bank of Italy might offer to sell spot sterling and buy forward sterling at a premium of 1/8% per month for the former over the latter, and to buy spot sterling and sell forward sterling at par. For the transaction of such business the State banks would require to command a certain amount of resources abroad, either in cash or in borrowing facilities. But this fund would be a revolving one, automatically replenished at the maturity of the forward contracts, so that it need not be on anything like the scale necessary for a fund for the purpose of supporting the exchange. Nor is it a business which involves any more risk than is inherent in all banking business as such; from exchange risk proper is free.
With free forward markets thus established no merchant need run an exchange risk unless he wishes to, and business might find a stable foothold even in a fluctuating world. A recommendation in favour of action along these lines was included amongst the Financial Resolutions of the Genoa Conference of 1922.
I shall develop below (Chap. 5) a proposal that the Bank of England should strengthen its control by fixing spot and forward prices for gold every Thursday just as it now fixes its discount rate. But other Central Banks also would increase their control over fluctuations in exchange if they were to adopt the above plan of quoting rates for forward exchange in terms of spot exchange. By varying these rates they would be able, in effect, to vary the interest offered for ^foreign^ balances, as a policy distinct from whatever might be their bank-rate policy for the purpose of governing the interest obtainable on ^home^ balances.
2. It is not unusual at present for banks to endeavour to distinguish between speculative dealings in forward exchange and dealings which are intended to hedge a commercial transaction, with a view to discouraging the former; whilst official exchange regulations in many countries have been aimed at such discrimination. I think that this is a mistake. Banks should take stringent precautions to make sure that their clients are in a position to meet any losses which may accrue without serious embarrassment. But, having fully assured themselves on this point, it is not useful that they should inquire furtherㅡfor following reasons.
( ... ... )
3. A failure to analyse the relation between spot and forward exchange may be, sometimes, partly responsible for a mistaken bank-rate policy. Dear moneyㅡthat is to say, high interest rates for short-period loansㅡhas two effects. The one is indirec and gradualㅡnamely, in diminishing the volume of credit quoted by the banks. This effect is much the same now as it always was. It is desirable to produce it when prices are rising and business is trying to expand faster than the supply of real capital and effective demand can permit in the long run. It is undesirable when prices are falling and trade is depressed.
The other effect of dear money, or rather of deerer money in one centre than in another, used to be to draw gold from the cheaper centre for temporary employment in the dearer. But nowadays the only immediate effect is to cause a new adjustment of the difference between the spot and forward rates of exchange between the two centres. If money becomes dearer in London, the discount on forward dollars diminishes or gives way to a premium. The effect has been pointed out above of the relative cheapening of money in London in the latter half of 1922 in increasing the discount on forward dollars, and of the relative raising of money-rate in the middle of 1923 in diminishing the discount. Such are, in present circumstances, the principal direct consequences of a moderate difference between interest rates in the two centres, apart, of course, from the indirect, long-period influence. Since no one is likely to remit money temporarily from one money market to another on any important scale, with an uncovered exchange risk, merely to take advantage of 1/2 or 1% per annum difference in the interest rate, the direct effect of dearer money on the ^absolute^ level of the exchanges, as distinguished from the difference between spot and forward, is very small, being limited to the comparatively slight influence which the relation between spot and forward rates exerts on exchange speculators.[1] The pressure of arbitragers between spot and forward exchange, seeking to take advantage of the new situation, leads to a rapid adjustment of the difference between these rates, until the business of temporary remittance, as distinct from exchange speculation, is no more profitable than it was before, and consequently does not occur on any increased scale; with the result that there is no marked effect on the absolute level of the spot rate.
The reasons given for the maintenance of a close relationship between the Bank of England's rate and that of the American Federal Reserve Board sometimes show confusion. ( ... ... )
If an article is used for money, such as gold, which has a utility in itself for other purposes, aside from its use as money, the strict statement of the theory, though fundamentally unchanged, is a little complicated. In present circumstances we can excuse ourselves this complication. A Currency Note has no utility in itself and is completely worthless except for the purchasing power which it has as money.
Consequently what the public want is not so many ounces or so many square yards or even so many ￡ sterling of currency notes, but a quantity sufficient to cover a week's wages, or pay their bills, or to meet their probable outgoings on a journey or a day's shopping. When people find themselves with more cash than they require for such purposes, they get rid of the surplus by buying goods or investments, or by leaving it for a bank to employ, or possibly, by increasing their hoarded reserves. Thus the number of notes which the public ordinarily have on hand is determined by the amount of purchasing power which it suits them to hold or to carry about, and by nothing else. The amount of this purchasing power depends partly on their wealth, partly on their habits. The wealth of the public in the aggregate will only change gradually. Their habits in the use of moneyㅡwhether their income is paid them weekly or monthly or quarterly, whether they pay cash at shops or run accounts, whether they deposit with banks, whether they cash small cheques at short intervals or larger cheques at longer intervals, whether they keep a reserve or hoard of money about the houseㅡare more easily altered. But if their wealth and their habits in the above respects are unchanged, then the amount of purchasing power which they hold in the form of money is definitely fixed. We can measure this definite amount of purchasing power in terms of a unit made up of a collection of specified quantities of their standard articles of consumption or other objects of expenditure; for example, the kinds and quantities of articles which are combined for the purpose of a cost-of-living index number.
- Let us call such a unit a “consumption unit” and assume that the public require to hold an amount of money having a purchasing power over k consumption units.
- Let there be n currency notes or other forms of cash in circulation with the public, and
- let p be the price of each consumption unit (i.e. p is the index number of the cost of living),
- it follows from the above that n＝pk.
So far we have assumed that the whole of the public requirement for purchasing power is satisfied by cash, and on the other hand that this requirement is the only source of demand for cash; neglecting the fact that the public, including the business world, employ for the same purpose bank deposits and overdraft facilities, whilst the banks must for the same reason maintain a reserve of cash. The theory is easily extended, however, to cover this case. Let us assume [:]
- that the public, including the business world, find it convenient to keep the equivalent of k consumption units in cash and of a further k' available at their banks against cheques,
- and that the banks keep in cash a proportion r of their potential liabilities (k' ) to the public.
n＝p ( k＋rk' ).
So long as k, k' , and r remains unchanged, we have the same results as before, namely, that n and p rise and fall together. The proportion between k and k' depend on the banking arrangements of the public; the absolute value of these on their habits generally; and the value of r on the reserve practices of the banks. Thus, so long as these are unaltered, we still have a direct relation between the quantity of cash (n) and the level of prices (p).[1]
[1] My exposition follows the general lines of Prof. Pigou (Quarterly Journal of Economics, Nov. 1917) and of Dr. Marshall(Money, Credit, and Commerce, I. iv.), rather than the perhaps more familiar analysis of Prof. Irving Fisher. Instead of starting with the amount of cash held by the public, Prof. Fisher begins with the volume of business transacted by means of money and the frequency with which each unit of money changes hands. It comes to the same thing in the end and it is easy to pass from the above formula to Prof. Fisher's; but the above method of approach seems less artificial than Prof. Fisher's and nearer to the observed facts.We have seen that the amount of k and k' depend partly on the wealth of the community, partly on its habits. Its habits are fixed by its estimation of the extra convenience of having more cash in hand as compared with the advantages to be got from spending the cash or investing it. The point of equilibrium is reached where the estimated advantages of keeping more cash in hand compared with those of spending or investing it about balance. The matter cannot be summed up better than in the words of Dr. Marshall:
In every state of society there is some fraction of their income which people find it worth while to keep in the form of currency; it may be a fifth, or a tenth, or a twentieth. A large command of resources in the form of currency renders their business easy and smooth, and puts them at an advantage in bargaining; but on the other hand it locks up in a barren form resources that might yield an income of gratification if invested, say, in extra furniture; or a money income, if invested in extra machinery or cattle.”[?or “] A man fixes the appropriate fraction “after balancing one against another the advantages of a further ready command, and the disadvantages of putting more of his resources into a form in which they yield him no direct income or other benefit.” “Let us suppose that the inhabitants of a country, taken one with another (and including therefore all varieties of character and of occupation), find it just worth their while to keep by them on the average ready purchasing power to the extent of a tenth part of their annual income, together with a fiftieth part of their property; then the aggregate value of the currency of the country will tend to be equal to the sum of these amounts.”[1]
[1] Money, Credit, and Commerce, I, iv. 3. Dr. Marshall shows in a footnote as follows that the above is in fact a development of the traditional way of considering the matter: "Petty thought that the money 'sufficient for' the nation is 'so much as will pay half a year's rent for all the land of England and a quarter's rent of the Housing, for a week's expense of all the people, and about a quarter of the value of all the exported commodities.' Locke estimated that 'one-fiftieth of wages and one-fourth of the landowner's income and one-twentieth part of the broker's yearly returns in ready money will be enough to drive the trade of any country.' Cantillon(A.D. 1765), after a long and subtle study, concludes that the value needed is a ninth of the total produce of the country; or what he takes to be the same thing, a third of the rent of the land. Adam Smith has more of the scepticism of the modern age and says: 'it is impossible to determine the proportion,' though 'it has been computed by different authors at a fifth, at a tenth, at a twentieth, and at a thirtieth part of the whole value of the annual produce.' " In modern conditions the normal proportion of the circulation to this national income seems to be somewhere between a tenth and a fifteenth.
Here is on p. 79 (and PDF on p. 88)
So far there should be no room for difference of opinion. The error often made by careless adherents of the Quantity Theory, which may partly explain why it is not universally accepted, is as follows.
KHNW p025-3. {{
Every one admits that the habits of the public in the use of money and of banking facilities and the practices of the banks in respect of their reserves change from time to time as the result of obvious developments. These habits and practices are a reflection of changes in economic and social organisation. But the Theory has often been expounded on the further assumption that a mere change in the quantity of the currency cannot affect k, r, and k' ,ㅡthat is to say, in mathematical parlance, that n is an independent variable in relation to these quantities. It would follow from this that an arbitrary doubling of n, since this in itself is assumed not to affect k, r, and k' , must have the effect of raising p to double what it would have been otherwise. The Quantity Theory is often stated in this, or a similar, form.
Now “in the long run” this is probably true. If, after the American Civil War, the American dollar had been stabilised and defined by law at 10% below its present value, it would be safe to assume that n and p would now be just 10% greater than they actually are and that the present values of k, r, and k' would be entirely unaffected. But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.
}}
Here is somewhere below the middle of p. 80 (PDF on p. 88)
In actual experience, a change of n is liable to have a relation both on k and k' and on r. It will be enough to give a few typical instances.[:] Before the war (and indeed since) there was a considerable element of what was conventional and arbitrary in the reserve policy of the banks, but especially in the policy of the State Banks towards their gold reserves. These reserves were kept for show rather than for use, and their amount was not the result of close reasoning. There was a decided tendency on the part of these banks between 1900 and 1914 to bottle up gold when it flowed towards them and to part with it reluctantly when the tide was flowing the other way. Consequently, when gold became relatively abundant they tend to hoard what came their way and to raise the proportion of the reserves with the result that the increased output of South African gold was absorbed with less effect on the price level than would have been the case if an increase of n had been totally without reaction on the value of r.
In agricultural countries where peasants readily hoard money, an inflation, especially in its early stages, does not raise prices proportionately, because when, as a result of a certain rise in the price of agricultural products, more money flows into the pockets of the peasants, it ends to stick there;ㅡdeeming themselves that much richer, the peasants increase the proportion of their receipts that they hoard.
Thus in these and in other ways the terms of our equation tend in their movements to favour the stability of p, and there is a certain friction which prevents a moderate change in n from exercising its full proportionate effect on p.
On the other hand a large change in n, which rubs away the initial friction, and especially a change in n due to causes which set up a general expectation of a further change in the same direction, may produce a more than proportionate effect on p. After the general analysis of Chapter 1 and the narratives of catastrophic inflations given in Chapter 2, it is scarcely necessary to illustrate this further,ㅡit is a matter more readily understood than it was ten years ago. A large change in p greatly affects individual fortunes. Hence a change after it has occurred, or sooner in so far as it is anticipated, may greatly affect the monetary habits of the public in their attempt to protect themselves from a similar loss in future, or to make gains and avoid loss during the passage from the equilibrium corresponding to the old value of n to the equilibrium corresponding to its new value. Thus after, during, and (so far as the change is anticipated) before a change in the value of n, there will be some reaction on the values of k, k', and r, with the result that the change in the value of p, at least temporarily and perhaps permanently (since habits and practices, once changed, will not revert to exactly their old shape), will not be precisely in proportion to the change in n.
The terms inflation and deflation are used by different writers in varying senses. It would be convenient to speak [:]
- of an increase or decrease in n as an inflation or deflation of cash ;
- and of a decrease or increase in r as an inflation or deflation of credit.
- The characteristic of the "credit-cycle" (as the alteration of boom and depression is now described) consists in a tendency of k and k' to diminish during the boom and increase during the depression, irrespective of changes in n and r, these movements representing respectively a diminution and an increase of “real” balances (i.e. balances, in hand or at the bank, measured in terms of purchasing power); so that we might call this phenomenon deflation and inflation of real balances.
Price Level Cash Circulation Bank Deposits
October 1920 150 ￡585,000,000 ￡2,000,000,000The value of ^r^ was not very different at the two datesㅡsay about 12%. Consequently our equation for the two dates works out as follows [1] :
October 1922 100 ￡504,000,000 ￡1,700,000,000
October 1920 n＝585 p＝1.5 k＝230 k'＝1333
October 1922 n＝504 p＝1 k＝300 k'＝1700
[1] For 585＝1.5(230＋1333×0.12), and 504＝1(300＋1700×0.12)Thus during the depression ^k^ rose from 230 to 300 and ^k'^ from 1333 to 1700, which means that the cash holdings of the public at the former date were worth 23/30, and their bank balances 1333/1700, of what they were worth at the latter date. It thus appears that the tendency of ^k^ and ^k'^ to increase had more to do, than the deflation of "cash" had, with the fall of prices between two periods. If ^k^ and ^k'^ were to fall back to their 1920 values, prices would rise 30% without any change whatever in the volume of cash or the reserve policy of the banks. Thus even in Great Britain the fluctuations of ^k^ and ^k'^ can have a decisive influence on the price level; whilst we have already seen (pp. 51, 52) how enormously they can change in the recent conditions of Russia and Central Europe.
The moral of this discussion, to be carried forward in the reader's mind until we reach Chapter 4 and 5, is that the price level is not mysterious, but is governed by a few, definite, analysable influences.[:]
- Two of these, n and r, are under the direct control (or ought to be) of the central banking authorities.
- The third, namely k and k', is not directly controllable, and depends on the mood of the public and the business world.
The usual method of exercising a stabilising influence over k and k', especially over k', is that of bank-rate. A tendency of k' to increase may be somewhat counteracted by lowering the bank-rate, because easy lending diminishes the advantage of keeping a margin for contingencies in cash. Cheap money also operates to counterbalance an increase of k', because, by encouraging borrowing from the banks, it prevents r from increasing or causes r to diminish. But it is doubtful whether bank-rate by itself is always a powerful enough instrument, and, if we are to achieve stability, we must be prepared to vary n or r on occasion.
Our analysis suggests that the first duty of the central banking and currency authorities is to make sure that they have n and r thoroughly under control. For example, so long as inflationary taxation is in question n will be influenced by other than currency objects and cannot, therefore, be fully under control; moreover, at the other extreme, under a gold standard n is not always under control, because it depends on the unregulated forces which determine the demand and supply of gold throughout the world. Again, without a central banking system r will not be under proper control because it will be determined by the unco-ordinated decisions of numerous different banks.
At the present time in Great Britain r is very completely controlled, and n also, so long as we refrain from inflationary finance on the one hand and from a return to an unregulated gold standard on the other.[1] The second duty of the authorities is therefore worth discussing, namely, the use of their control over n and r to counterbalance changes in k and k'. Even if k and k' were entirely outside the influence of deliberate policy, which is not in fact the case, nevertheless p could be kept reasonably steady by suitable modifications of the values of n and r.
[1] In the case of the United State the same thing is more or less true, so long as the Federal Reserve Board is prepared to incur the expense of bottling up redundant gold.Old-fashioned advocates of sound money have laid too much emphasis on the need of keeping n and r steady, and have argued as if this policy by itself would produce the right results. So far from this being so, [:]
- steadiness of n and r, when k and k' are not steady, is bound to lead to unsteadiness of the price level.
- Cyclical fluctuations are characterised, not primarily by changes in n or r, but by changes in k and k'.
- It follows that they can only be cured if we are ready deliberately to increase and decrease n and r, when symptoms of movement are showing in the values of k and k'.
II. The Theory of Purchasing Power Parity
The Quantity Theory deals with the purchasing power or commodity-value of a given national currency. We come now to the relative value of two distinct national currencies,ㅡthat is to say, to the theory of the Foreign Exchanges.
KHNW_p023-2, cf: {{
When the currencies of the world were nearly all on a gold basis, their relative value (i.e. the exchanges) depended on the actual amount of gold metal in a unit of each, with minor adjustments for the cost of transferring the metal from place to place.
}}
When this common measure has ceased to be effective and we have instead a number of independent systems of inconvertible paper, what basic fact determines the rates at which units of the different currencies exchange for one another?
The explanation is to be found in the doctrine, as old in itself as Ricardo, with which Professor Cassel has lately familiarised the public under the name of “Purchasing Power Parity.”[1]
[1] This term was first introduced into economic literature in an article contributed by Prof. Cassel to the Economic Journal, December 1918. For Prof. Cassel's considered opinions on the whole question, see his Money and Foreign Exchange after 1914 (1922). The theory, as distinct from the name, is essentially Ricardo's.This doctrine in its baldest form runs as follows: (1) The purchasing power of an inconvertible currency within its own country, i.e. the currency's internal purchasing power, depends on the currency policy of the Government and the currency habits of the people, in accordance with the Quantity Theory of Money just discussed. (2) The purchasing power of an inconvertible currency in a foreign country, i.e. the currency's external purchasing power, must be the rate of exchange between the home-currency and the foreign-currency, multiplied by the foreign-currency's purchasing power in its own country. (3) In conditions of equilibrium the internal and external purchasing powers of a currency must be the same, allowance being made for transport charges and import and export taxes; for otherwise a movement of trade would occur in order to take advantage of the inequality. (4) It follows, therefore, from (1), (2) and (3) that the rate of exchange between the home-currency and the foreign-currency must tend in equilibrium to be the ratio between the purchasing powers of the home-currency at home and of the foreign-currency in the foreign country. This ratio between the respective home purchasing powers of the two currencies is designated their “purchasing power parity.”
If, therefore, we find that the internal and external purchasing powers of the home-currency are widely different, and, which is the same thing, that the actual exchange rates differ widely from the purchasing power parities, then we are justified in inferring that equilibrium is not established, and that, as time goes on, forces will come into play to bring the actual exchange rates and the purchasing power parities nearer together. The actual exchanges are often more sensitive and more volatile than the purchasing power parities, being subject to speculation, to sudden movements of funds, to seasonal influences, and to anticipations of impending changes in purchasing power parity (due to relative inflation or deflation); though also on other occasions they may lag behind. Nevertheless it is the purchasing power parity, according to this doctrine, which corresponds to the old gold par. This is the point about which the exchanges fluctuate, and at which they must ultimately come to rest; with one material difference, namely, that it is not itself a fixed point,ㅡsince, if internal prices move differently in the two countries under comparison, the purchasing power parity also moves, so that equilibrium may be restored, not only by a movement in the market rate of exchange, but also by a movement of the purchasing power parity itself.
At first sight this theory appears to be one of great practical utility; and many persons have endeavoured to draw important practical conclusions about the future course of the exchanges from charts exhibiting the divergences between the market rate of exchange and the purchasing power parities,ㅡundeterred by the perplexity whether an existing divergence from equilibrium will be remedied by a movement of the exchanges or of the purchasing power parity or of both.
In practical applications of the doctrine there are, however, two further difficulties, which we have allowed so far to escape our attention,ㅡboth of them arising out of the words ^allowance being made for transport charges and import and export taxes^. The first difficulty is how to make allowance for such charges and taxes. The second difficulty is how to treat purchasing power over goods and services which ^do not enter into international trade at all^.
The doctrine, in the form in which it is generally applied, endeavours to deal with the first difficulty by assuming that the percentage difference between internal and external purchasing power at some standard date, when approximate equilibrium may be presumed to have existed, generally the year 1913, may be taken as an approximately satisfactory correction for the same disturbing factors at the present time. For example, instead of calculating directly the cost of a standard set of goods at home and abroad respectively, the calculations are made that $2 are required to buy in the United States a standard set which $1 would have bought in 1913, and that ￡2.43 are required to buy in England what ￡1 would have bought in 1913. On this basis (the pre-war purchasing power parity being assumed to be in equilibrium with the pre-war exchange of $4.86＝￡1) the present purchasing power parity between dollars and sterling is given by $4＝￡1, since 4.86×2÷2.43＝4.
The obvious objection to this method of correction is that transport and tariff costs, especially if this term is taken to cover all export and import regulations, including prohibitions and official or semi-official combines for differentiating between export and home prices, are notoriously widely different in many cases from those which existed in 1913. We should not get the same result if we were to take some year other than 1913 as the basis of the calculation.
The second difficultyㅡthe treatment of purchasing power over articles which do not enter into international tradeㅡis still more serious. ( ... pp.91-92, pp.101-102 on PDF ... ) Yet applied in this wayㅡnamely, in a comparison of movements of the ^general^ index numbers of home prices in two countries with movements in the rates of exchange between their currenciesㅡthe theory requires a further assumption for its validity, namely, that in the long run the home prices of the goods and services which do not enter into international trade, move in more or less the same proportions as those which do.[1]
( ... pp. 93-106, pp.??-115 on PDF ...)
III. The Seasonal Fluctuation
Thus the Theory of Purchasing Power Parity tells us that movements in the rate of exchange between the currencies of two countries tend, subject to adjustment in respect of movements in the "equation of exchange," to correspond pretty closely to movements in the internal price levels of the two countries each expressed in their own currency. It follows that the rate of exchange can be improved in favour of one of the countries by a financial policy direct towards a lowering of its internal price level relatively to the internal price level of the other country. On the other hand a financial policy which has the effect of raising the internal price level must result, sooner or later, in depressing the rate of exchange.
The conclusion is generally drawn, and quite correctly, that budgetary deficits covered by a progressive inflation of the currency render the stabilisation of a country's exchanges impossible; and that the cessation of any increase in the volume of currency, due to this cause, is a necessary pre-requisite to a successful attempt at stabilising.
The argument, however, is often carried further than this, and it is supposed that, if a country's budget, currency, foreign trade, and its internal and external price levels are properly adjusted, then, automatically, its foreign exchange will be steady.[1] So long, therefore, as the exchanges fluctuateㅡthus the argument runsㅡthis in itself is a symptom that an attempt to stabilise would be premature. When, on the other hand, the basic conditions necessary for stabilisation are present, the exchange will steady itself. In short, any delibertate or artificial scheme of stabilisation is attacking the problem at the wrong end. It is the regulation of the currency, by means of sound budgetary and bank-rate policies, that needs attention. The proclamation of convertibility will be the last and crowning stage of the proceedings, and will amount to little more that the announcement of a ^fait accompli^.
There is a certain force in this mode of reasoning. But in one important respect it is fallacious.
Even though foreign trade is properly adjusted, and the country's claims and liabilities on foreign account are in equilibrium over the year as a whole, it does not follow that they are in equilibrium every day. ( ... pp. 108-115, pp. 117-124 on PDF ... )
IV. The Forward Market in Exchanges
( ... pp. 115-132, pp.124-141 on PDF ... )
*
Out of the various practical conclusions which might be drawn from this discussion and figures which accompany it, I will pick out three.
1. Those exchanges in which the fluctuations are wildest and the merchant is most in need of facilities for hedging his risk are precisely those in which facilities for forward dealing at moderate rates are least developed. But this is to be explained, not necessarily by the instability of the exchange in itself, but by certain accompanying circumstances, such as distrust of the country's internal arrangements or its banking credit, a fear of the sudden imposition of exchange regulations or of a moratorium, and the other analogous influences mentioned above(pp. 126-7). There is no theoretical reason why there should not be an excellent forward market in a highly unstable exchange. In those countries, therefore, where exchange regulation is still premature, it may be nevertheless be possible to mitigate the evil consequences of fluctuation by organising facilities for forward dealings.
This is a function which the State banks of such countries could usefully perform. For this they must either themselves command a certain amount of foreign currency or they must provide facilities for accepting short period deposits in their own currency from foreign bankers, on conditions which inspire these bankers with complete confidence in the freedom and liquidity of such deposits. Various technical devices could be suggested. But the simplest method might be for the State banks themselves to enter the forward market and offer to buy or sell forward exchange at a reasonable discount of premium on the spot quotation. I suggest that they should deal not directly with the public but only with approved banks and financial houses, from whom they should required adequate security; that they should quote every day their rates for buying and selling exchange either one or three months forward; but that such quotation should take the form, not of a price for the exchange itself, but of a percentage difference between spot and forward, and should be a quotation for the double transaction of a spot deal one way and a simultaneous forward deal the otherㅡe.g. the Bank of Italy might offer to sell spot sterling and buy forward sterling at a premium of 1/8% per month for the former over the latter, and to buy spot sterling and sell forward sterling at par. For the transaction of such business the State banks would require to command a certain amount of resources abroad, either in cash or in borrowing facilities. But this fund would be a revolving one, automatically replenished at the maturity of the forward contracts, so that it need not be on anything like the scale necessary for a fund for the purpose of supporting the exchange. Nor is it a business which involves any more risk than is inherent in all banking business as such; from exchange risk proper is free.
With free forward markets thus established no merchant need run an exchange risk unless he wishes to, and business might find a stable foothold even in a fluctuating world. A recommendation in favour of action along these lines was included amongst the Financial Resolutions of the Genoa Conference of 1922.
I shall develop below (Chap. 5) a proposal that the Bank of England should strengthen its control by fixing spot and forward prices for gold every Thursday just as it now fixes its discount rate. But other Central Banks also would increase their control over fluctuations in exchange if they were to adopt the above plan of quoting rates for forward exchange in terms of spot exchange. By varying these rates they would be able, in effect, to vary the interest offered for ^foreign^ balances, as a policy distinct from whatever might be their bank-rate policy for the purpose of governing the interest obtainable on ^home^ balances.
2. It is not unusual at present for banks to endeavour to distinguish between speculative dealings in forward exchange and dealings which are intended to hedge a commercial transaction, with a view to discouraging the former; whilst official exchange regulations in many countries have been aimed at such discrimination. I think that this is a mistake. Banks should take stringent precautions to make sure that their clients are in a position to meet any losses which may accrue without serious embarrassment. But, having fully assured themselves on this point, it is not useful that they should inquire furtherㅡfor following reasons.
( ... ... )
p. 136/137 (and p. 145/146 on PDF):
3. A failure to analyse the relation between spot and forward exchange may be, sometimes, partly responsible for a mistaken bank-rate policy. Dear moneyㅡthat is to say, high interest rates for short-period loansㅡhas two effects. The one is indirec and gradualㅡnamely, in diminishing the volume of credit quoted by the banks. This effect is much the same now as it always was. It is desirable to produce it when prices are rising and business is trying to expand faster than the supply of real capital and effective demand can permit in the long run. It is undesirable when prices are falling and trade is depressed.
The other effect of dear money, or rather of deerer money in one centre than in another, used to be to draw gold from the cheaper centre for temporary employment in the dearer. But nowadays the only immediate effect is to cause a new adjustment of the difference between the spot and forward rates of exchange between the two centres. If money becomes dearer in London, the discount on forward dollars diminishes or gives way to a premium. The effect has been pointed out above of the relative cheapening of money in London in the latter half of 1922 in increasing the discount on forward dollars, and of the relative raising of money-rate in the middle of 1923 in diminishing the discount. Such are, in present circumstances, the principal direct consequences of a moderate difference between interest rates in the two centres, apart, of course, from the indirect, long-period influence. Since no one is likely to remit money temporarily from one money market to another on any important scale, with an uncovered exchange risk, merely to take advantage of 1/2 or 1% per annum difference in the interest rate, the direct effect of dearer money on the ^absolute^ level of the exchanges, as distinguished from the difference between spot and forward, is very small, being limited to the comparatively slight influence which the relation between spot and forward rates exerts on exchange speculators.[1] The pressure of arbitragers between spot and forward exchange, seeking to take advantage of the new situation, leads to a rapid adjustment of the difference between these rates, until the business of temporary remittance, as distinct from exchange speculation, is no more profitable than it was before, and consequently does not occur on any increased scale; with the result that there is no marked effect on the absolute level of the spot rate.
The reasons given for the maintenance of a close relationship between the Bank of England's rate and that of the American Federal Reserve Board sometimes show confusion. ( ... ... )
Chapter 3 ends here on p. 139 (and p. 148 on PDF)
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