The Theory of Money and Credit

It is not easy to determine whether there are any who still adhere in good faith to the doctrine that traces back the depreciation of money to the activity of speculators. The doctrine is an indispensable instrument of the lowest form of demagogy; it is the resource of governments in search of a scapegoat. There are scarcely any independent writers nowadays who defend it; those who support it are paid to do so. Nevertheless, a-few words must be devoted to it, for the monetary policy of the present day is based largely upon it.

Speculation does not determine prices; it has to accept the prices that are determined in the market. Its efforts are directed to correctly estimating future price situations, and to acting accordingly. The influence of speculation cannot alter the average level of prices over a given period; what it can do is to diminish the gap between the highest and the lowest prices. Price fluctuations are reduced by speculation, not aggravated, as the popular legend has it.

It is true that the speculator may happen to go astray in his estimate of future prices. What is usually overlooked in considering this possibility is that under the given conditions it is far beyond the capacities of most people to foresee the future any more correctly. If this were not so, the opposing group of buyers or sellers would have got the upper hand in the market. The fact that the opinion accepted by the market has later proved to be false is lamented by nobody with more genuine sorrow than by the speculators who held it. They do not err of malice prepense; after all, their object is to make profits, not losses.

Even prices that are established under the influence of speculation result from the cooperation of two parties, the bulls and the bears. Each of the two parties is always equal to the other in strength and in the extent of its commitments. Each has an equal responsibility for the determination of prices. Nobody is from the outset and for all time bull or bear; a dealer becomes a bull or a bear only on the basis of a summing up of the market situation, or, more correctly, on the basis of the dealings that follow on such a summing up. Anybody can change his role at any moment. The price is determined at that level at which the two parties counterbalance each other. The fluctuations of the foreign-exchange rate are not determined solely by bears selling but just as much by bulls buying.

The etatistic view traces back the rise in the price of foreign currencies to the machinations of enemies of the state at home and abroad. These enemies, it is asserted, dispose of the national currency with a speculative intent and purchase foreign currencies with a speculative intent. Two cases are conceivable. Either these enemies are actuated in their dealings by the hope of making a profit, when the same is true of them as of all other speculators. Or they wish to damage the reputation of the state of which they are enemies by depressing the value of its currency, even though they themselves are injured by the operations that lead to this end. To consider the possibility of such enterprises is to forget that they are hardly practicable. The sales of the bears, if they ran against the feeling of the market, would immediately start a contrary movement; the sums disposed of would be taken up by the bulls in expectation of a coming reaction without any effect on the rate of exchange worth mentioning.

In truth, these self-sacrificing bear maneuvers that are undertaken, not to make a profit, but to damage the reputation of the state, belong to the realm of fables. It is true that operations may well be undertaken on foreign-exchange markets that have as their aim, not the securing of a profit, but the creation and maintenance of a rate that does not correspond to market conditions. But this sort of intervention always proceeds from governments, who hold themselves responsible for the currency and always have in view the establishment and maintenance of a rate of exchange above the equilibrium rate. These are artificial bull, not bear, maneuvers. Of course, such intervention also must remain ineffective in the long run. In fact, there is only one way in the last resort to prevent a further fall in the value of money—ceasing to increase the note circulation; and only one way of raising the value of money—reducing the note circulation. Any intervention, such as that of the German Reichsbank in the spring of 1923, in which only a small part of the increasing note expansion was recovered by the banks through the sale of foreign bills, would necessarily be unsuccessful.

Led by the idea of opposing speculation, inflationistic governments have allowed themselves to become involved in measures whose meaning is hardly intelligible. Thus at one time the importation of notes, then their exportation, then again both their exportation and importation, have been prohibited. Exporters have been forbidden to sell for their own country’s notes, importers to buy with them. All trade in terms of foreign money and precious metals has been declared a state monopoly. The quotation of rates for foreign money on home exchanges has been forbidden, and the communication of information concerning the rates determined at home outside the exchanges and the rates negotiated on foreign exchanges made severely punishable. All these measures have proved useless and would probably have been more quickly set aside than actually was the case if there had not been important factors in favor of their retention. Quite apart from the political significance already referred to attaching to the maintenance of the proposition that the fall in the value of money was only to be ascribed to wicked speculators, it must not be forgotten that every restriction of trade creates vested interests that are from then onward opposed to its removal.

An attempt is sometimes made to demonstrate the desirability of measures directed against speculation by reference to the fact that there are times when there is nobody in opposition to the bears in the foreign-exchange market so that they alone are able to determine the rate of exchange. That, of course, is not correct. Yet it must be noticed that speculation has a peculiar effect in the case of a currency whose progressive depreciation is to be expected while it is impossible to foresee when the depreciation will stop, if at all. While, in general, speculation reduces the gap between the highest and lowest prices without altering the average price level, here, where the movement will presumably continue in the same direction, this naturally cannot be the case. The effect of speculation here is to permit the fluctuation, which would otherwise proceed more uniformly, to proceed by fits and starts with the interposition of pauses. If foreign-exchange rates begin to rise, then, to those speculators who buy in accordance with their own view of the circumstances, are added large numbers of outsiders. These camp followers strengthen the movement started by the few that trust to an independent opinion and send it farther than it would have gone under the influence of the expert professional speculators alone. For the reaction cannot set in so quickly and effectively as usual. Of course, it is the general assumption that the depreciation of money will go still farther But eventually sellers of foreign money must make an appearance, and then the rising movement of the exchanges comes to a standstill; perhaps even a backward movement sets in for a time. Then, after a period of “stable money,” the whole thing begins again.

The reaction admittedly begins late, but it must begin as soon as rates of exchange have run too far ahead of commodity prices. If the gap between the equilibrium rate of exchange and the market rate is big enough to give play for profitable commodity transactions, then there will also arise a speculative demand for the domestic paper money. Not until the scope for such transactions has again disappeared owing to a rise in commodity prices will a new rise in the price of foreign exchange set in.

Etatism eventually comes to regard the possession of foreign money, balances as such, and foreign bills, as behavior reprehensible in itself. From this point of view, it is the duty of citizens—not that this is asserted in so many words, but it is the tone of all official declarations—to put up with the harmful consequences of the depreciation of money to their private property and to make no attempt to avoid this by acquiring such possessions as are not eaten up by the depreciation of money. From the point of view of the individual, they declare, it may indeed appear profitable for him to save himself from impoverishment by a flight from the mark, but from the point of view of the community this is harmful and therefore to be condemned. This demand really comes to a cool request on the part of those who enjoy the benefits of the inflation that everybody else should render up his wealth for sacrifice to the destructive policy of the state. In this case, as in all others in which similar assertions are made, it is not true that there exists an opposition between the interests of the individual and the interests of the community. The national capital is composed of the capital of the individual members of the state, and when the latter is consumed nothing remains of the former either. The individual who takes steps to invest his property in such a way that it cannot be eaten up by the depreciation of money does not injure the community; on the contrary, in taking steps to preserve his private property from destruction he also preserves some of the property of the community from destruction. If he surrendered it without opposition to the effects of the inflation all he would do would be to further the destruction of part of the national wealth and enrich those to whom the inflationary policy brings profit.

It is true that not inconsiderable sections of the best classes of the German people have given credit to the asseverations of the inflationists and their press. Many thought that they were doing a patriotic act when they did not get rid of their marks or kronen and mark or kronen securities, but retained them. By so doing, they did not serve the Fatherland. That they and their families have as a consequence sunk into poverty only means that some of the members of those classes of the German people from which the cultural reconstruction of the nation was to be expected are reduced to a condition in which they are able to help neither the community nor themselves.