The Theory of Money and Credit

The most obscure and incorrect concepts are current concerning the nature of the discount policy of the central banks-of-issue. Often the principal task of the banks is said to be the protection of their cash reserves, as if it would pay them to make sacrifices for such an aim as that. No less widespread, however, is the view that the banks’ obligation to follow a discount policy that takes account of the circumstances of other banks is imposed upon them merely by a perverse legislation and that the ideal of cheap money—in a double sense, namely, a low purchasing power of money and a low rate of interest—could be realized by the abandonment of certain out-of-date legal provisions.

It is unnecessary to devote very much time to the refutation of such views as these. After all that has been said on the nature of money and fiduciary media, there can hardly be very much doubt as to the aim of the discount policy of the banks. Every credit-issuing bank is obliged to fix the rate of interest it charges for loans in a certain conformity with that of the other credit-issuing banks. The rate cannot be allowed to sink below this level, for if it did, the sums of money needed by the bank’s rapidly extending clientele for making payments to customers of other banks would increase in such a fashion that the bank’s solvency would be imperiled. It is by raising the rate of discount that the bank safeguards its own capacity to pay. This end is certainly not attained by protecting the redemption fund, the small insignificance of which for maintaining the value of the fiduciary media has already been demonstrated, but by avoiding the artificial extension of the circulation of fiduciary media that would result from asking less interest than the other banks, and so also avoiding an increase in the demands for the redemption of the fiduciary media. The banks would still have to have a discount policy even if there were no legislative regulation of the note cover.

In Germany there has been a controversy as to whether certain measures of the Reichsbank are dictated by regard to the circumstances of the domestic money market or to those of the international. In the form in which it is usually put, the question is meaningless. The mobility of capital goods, which nowadays is but little restricted by legislative provisions such as customs duties, or by other obstacles, has led to the formation of a homogeneous world capital market. In the loan markets of the countries that take part in international trade, the net rate of interest is no longer determined according to national, but according to international, considerations. Its level is settled, not by the natural rate of interest in the country, but by the natural rate of interest anywhere. Just as the exchange ratio between money and other economic goods is the same in all places, so also the ratio between the prices of goods of the first order and those of goods of higher orders is the same everywhere. The whole system of modern international trade would be completely changed if the mobility of capital goods were to be restricted. In Germany there are many who demand such a prohibition or at least a considerable restriction of the investment of capital abroad. It is not our task to demonstrate what a small prospect of success a policy like this would have, or to show that the time is now past for a nation to decide whether or not it will take part in international trade. So long and insofar, however, as a nation participates in international trade, its market is only a part of the world market; prices are determined not nationally but internationally. The fact that the rate of interest in Germany may rise, not because any change has occurred in its determinants within the Reich but because there have been changes, say, in the United States, should not seem any more remarkable than, say, a rise in the price of corn that is due to the state of foreign harvests.

It has not been easy to reconcile policy with the extension and combination of national markets into a world market. Stronger than the resistance encountered centuries ago by the development of the town economy into the national economy is that which the nineteenth and twentieth centuries have opposed to the further stage of development into a world economy. Nowadays there is nothing like the feeling of homogeneity which previously overcame regional interests; the pronounced emphasis upon national antagonisms which sets the keynote of modern policy would perhaps stand in the way of attempts at economic unification even if there were no interests to which these attempts might prove injurious. From the point of view of the producer, low prices seem to be the greatest of all evils, and in every state those producers who are unable to meet competition strive with all the means at their disposal to keep the cheap commodities of the world market out of the national market. But whether they succeed in this in each individual case or not depends to a large extent on the strength of the political influence of the opposing interests. For in the case of every individual commodity, the producers’ interest in high prices is opposed by the interest of consumers in the opening of the market to the cheapening effect of foreign competition. The matter is only decided by the conflict of the two groups. The distribution of forces is otherwise when the problem of freedom of capital transactions is under discussion. We have already seen that creditor interests always get the worst of it when they clash with debtor interests. The interests of the capitalists are scarcely ever represented in monetary policy. Nobody ever objects to the importation of capital from abroad on the ground that it leads to a depression of the rate of interest in the home market and a reduction of the income of the capitalists; quite the reverse. The universally prevailing view is that it is in the interest of the community that the rate of interest should be as low as possible. In those European states with large capital resources, which so far as international dealings in capital are concerned need be considered only as creditors and not as debtors, this policy is expressed in the endeavor to put obstacles in the way of foreign investment. Undoubtedly, this is not the only point of view from which modern states judge the export of capital. Other considerations enter into the matter as well, some in favor of exportation, some against it. There is, for instance, the fact that it is frequently impossible to export commodities except by allowing the payment for them to be postponed, so that future goods are acquired in exchange for the present goods surrendered; and that for this reason alone it is consequently necessary to promote the export of capital or at least not to hinder it.10  Nevertheless, it must be insisted that the policy adopted by these states with regard to the export of capital is guided by the endeavor, among others, to keep the domestic rate of interest low. On the other hand, the same motive leads these states which because they are poor in capital have to play the part of international borrowers to encourage its importation.

The attempt to depress the domestic rate of interest by influencing the international movement of capital is particularly pronounced in the so-called money market, that is, in the market for short-term capital investments. In the so-called capital market, that is, the market for long-term capital investments, there is less possibility of effecting anything by intervention; in any case, any steps that may be taken become effective much more quickly in the former than in the latter. Consequently there is a greater propensity toward exerting an influence on the rate of interest on loans in the money market than in the long-term capital market. But the most important cause of the persistence of demands for the exertion of influence upon the money market lies in the universally prevalent errors concerning the nature of fiduciary media and of bank credit. When a relatively small efflux of gold induces the powerful central bank-of-issue of a rich country to raise the discount rate there is a tendency to think that there must be some other way than this, by which the efflux of gold could be prevented without involving the community in what is regarded as the injurious effect of a rise in the rate of interest. It is not seen that what is happening is the automatic adjustment of the national to the world rate of interest owing to the way in which the country is involved in international trade. That the country cannot be cut off from participation in international capital dealings simply and solely by measures of banking and currency policy, is completely overlooked. This alone can explain how it can come about in large exporting countries that the very persons who demand measures for “cheapening” credit are those who benefit most from the export trade. If those manufacturers, for whom every increase in the rate of discount that can be traced to events abroad is an inducement to plead for a modification of the banking system in the direction of releasing the central bank-of-issue from its obligation to provide gold for export on demand, would realize that the increase in the rate of interest could be effectively stopped only by a suppression of the export of capital and complete exclusion of the country from international trade, then they would soon change their minds. And it seems that these implications have already won some degree of general recognition, even if the literary treatment of the problem may still leave something to be desired. In Germany and Austria it was only the groups that demanded the seclusion of the national market that also demanded the “isolation” of the currency.

Further explanation is unnecessary. Nevertheless, it may not be supererogatory to examine one by one the measures that are recommended by those who favor a low rate of interest and to show how incapable they would prove of leading to the expected result.

• 10See Sartorious von Waltershausen, Das volkswirtschaftliche System der Kapitalanlage im Auslande (Berlin, 1907), pp. 126 ff.