BANKING SYSTEM

Ashburton Guardian, Volume 56, Issue 26, 12 November 1935, Page 7

BANKING SYSTEM

THE INFLATION PERIOD.

EVILS OF UNSTABLE PRICES.

The following is the fourth bulletin. issued by the Associated Banks of New Zealand:—. Tlie economic vicissitudes of recent years have shown in their full extent and gravity the evil effects of variations in price levels. At every turn of the tide of prices countless individuals reap unmerited gain, while others suffer equally undeserved losses; their economic positions being altered, not as the result of calculable factors which they have undertaken to meet, but in consequence of movements in the value of money which they do not desire, did not initiate, have no power to control, and frequently do not comprehend. “A study of history,” says the Macmillan Report, “would we believe confirm the opinion that it is in the changes in the level of prices, and in the consequential alteration in the position of debtors and creditors, entrepreneurs and workers, peasants and the tax gatherer, that the main secret of social trouble is to be found.” The evil is of old standing; but when, as in recent years, movements in the price level acquire greatly increased spread and momentum, and produce wide fluctuations in values with great rapidity, it becomes difficult to carry on economic life on a basis of rational calculability at all.

What are Inflation and Deflation? A condition of rising prices, when money is falling in purchasing power, is usually called inflation; and, conversely, a condition of falling prices, when money is gaining in purchasing power, constitutes deflation. These terms are converse one to another, indicating opposite aspects of the same fundamental phenomenon; and while they cannot be defined with scientific precision in any formula completely impervious to technical objection, inflation may, with sufficient accuracy for practical purposes, he described as a rise in price levels brought about by monetary causes. It is the creation of price levels higher than would otherwise have prevailed as a result of an increase in the volume of available currency, including in the term currency not only metallic money and bank notes, hut also bank deposits subject to transfer by cheque. Deflation can be defined along similar lines in the opposite sense. This definition is admittedly lacking in exactitude, though greater precision does not seem possible. A rise in prices due to monetary causes is inflationary, but it is difficult, if not impossible, to segregate purely monetary causes from factor's of a non-monetary character, for the reason that monetary causes set up reactions in nonmonetary factors, and vice versa. A variation in price levels, moreover, may be actively influenced by alterations in the rate of turnover or yeloeity of circulation of money, without any alteration in its absolute amount. If prices are rising, for instance, people rush in to buy what they want, for fear that prices may rise still further while they wait, thus increasing monetary turnover; and, conversely, if prices are falling, people tend to delay purchases in the hope of buying on still lower terms later on, thus slowing down the rate of monetary circulation, and in each direction accentuating the dominant price trend. There is considerable interaction between money and prices, for, while increasing money supplies may result in higher price levels, higher price levels and more active business may call for increasing supplies of currency and credit.

Inflation Under the Gold Standard. In the days when all important currencies were rigidly linked to gold, and maintained at a fixed value in terms of gold, inflationary movements were initiated by changes in the volume of gold available, relatively to the volume of business in the widest sense. In. periods of rapid gold production relatively to the volume of trade, prices rose; and, conversely, when growth of business outstropped gold production, prices fell. These movements, though by no means negligible in effect, were relatively narrow in scope, gradual in impact, and capable of adjustment without very serious economic strain. Now that so many important currencies are no longer linked to gold, the possibility and, indeed, actuality, of serious variations in the amount of available currency are much greater than under the gold standard regime, because the supply of paper money is much more variable, and, in particular, much more easily expanded, than the supply of gold. Moreover, an oversupply of gold was up to a point self-corrective, whereas an oversupply of paper money is not.

Inflation Under Paper Money Conditions.

The volume of gold is independent of Government fiat, while the volume of paper money is a controllable factor; and, especially in difficult times, the temptation to increase it for fiscal reasons is found to be one that Governments in embarrassed financial circumstances are unable to resist. The ultimate source of currency and credit creation, in most modern jurisdictions, now that the gold standard has been so generally abandoned, is a central or reserve bank, amenable to ultimate State control. Subject to any statutory restrictions on its power to create notes or credit (and it is always open to the Government to modify or abrogate such restrictions), it is possible for the central bank and the Government in conjunction to expand the monetary supply to any desired extent, either directly by increasing the note issue and/or the available volume of central bank credit, or indirectly by manipulating in the first instance the external value of the currency through exchange control. When this power is exercised inflation is the certain result.

Evi'ls of Inflation.

The principal evil of inflation is its effect in bringing about a partially concealed and unintended re-distribu-tion of wealth within the community subject to the process. Incomes are measured in money, and money is valued for its purchasing power. If this

purchasing power is varied solely by alterations springing from variations in the quantity of money, some sections are thereby benefited, and some are injured. Broadly speaking, inflation, by reducing the purchasing power of money, benefits the debtor sections of the community at the expense of creditor interests, while deflation lias the opposite effect. In times or rising prices, business men, farmers, anti others whose incomes are not fixed by contract, or are readily Variable, gain at the expense of the investing class, the workers, and those living on salaries and other incomes that are either fixed indefinitely, or cannot be easily varied. As most business people buy first and sell afterwards, in a period of inflation they stand to gain not only their normal profit, but a bonus accruing from the inflationary rise of prices in the interim; while, conversely, those who sell their services, including the use of their capital, at a fixed price for a considerable term, keep on losing as buyers through the rising price level. It is true that some of the apparent gain and loss is illusory, but some is real.

The working class and the investing public tend to lose ground to the employing class and the borrowing public in a period of inflation. "While industrial workers are usually able to force wage concessions in such periods, these are not, as a rule, equivalent to tiie real loss they sustain. In times of deflation the workers would appear to gain, but tliey seldom do. For one thing, such periods are usually accompanied by hard times aiid difficult trading conditions, so that unemployment is more prevalent, and wage reductions are difficult to resist with success. In deflationary periods tlie creditor class makes a gain, but if the gain becomes pronounced it imposes an almost intolerable overhead for interest on business and production, and leads to widespread bankruptcy, interest reductions, tardly recoveries, and often to open or disguised debt repudiation. Inflation reduces the weight of Government debt, and deflation increases it, without any change in the nominal figures. In a period of inflation debt service can be met by a diminishing proportion of the real national income, while in a period of deflation it takes an increasing proportion of such real national . income. Inflation tempts Governments to financial extravagance, deflation, if serious, forces them to repudiate, in some form or another, past interest contracts; 'and neither process is socially, economical!} 7 or ethically desirable

Requirements of Stable Money. The desideratum of a monetary system is that money should mirror values, and not distort them. While the problem of securing a stable price is not easy ill either theory or practice, steady price levels, whatever rational definition or test of steadiness is adopted, are preferable to prices that fluctuate up or' down because of variations in the supply of available currency. It is preferable, in other words, that money should play, as far as possible, a neutral role in the proceeds of the dlistribujtioai of the national income ; that it should as far as possible, be confined to its essential functions as a medium of exchange and a transfer agent for values; and that it should, incidentally, serve as a table standard of values for purposes of deferred payments. This it can do with efficiency only if it is stable in value itself. Sound monetary policy should be directed to the attainment of this objective.

Inflation and Public Finance. The persistent political bias, under a paper money regime, is towards inflation. Such issues, as and when accepted by the public, enable the Government on whotee behalf they are emitted to borrow, without security or liability for payment of interest, the amounts represented l by the issue, and also tend automatically to lighten the burden of the national debt by diluting the value of currency in which it is measured. To the Government the issue is in the nature of a forced loan, but to the citizen it seems more analogous to a concealed income tax of a, highly inequitable type, and of a most unfair incidence. It operates as a sort of undiscriminating income tax proportionate to income, without adjustment to family circumstances or other remedial abatement, and without graduation to different income levels, thus pressing disproportionately on the poorer classes, and payable in the main by the fixed-income sections of the community. Regarded as a tax, it is therefore unfair in incidence, while considered as an alleviant of overhead debt burden it cannot be defended on ethical or any other rational grounds whatever. The process has been vividly described by Keynes in the following passage', slightly condensed from the original:— l

“By a continuing process of inflation, Governments can confiscate, secretly and unobserved an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. . . As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors . . . become so utterly disorganised as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lot-' tery.” «

Summary andi Conclusions. The curse of inflation is profiteering, and the curse of deflation is unemployment. ’ Inflation sows the wind of boom and leaves deflation to reap the whirlwind of collapse and tedious, and prolonged recovery. Both processes are socially and economically noxious, and both could be avoided, or greatly mitigated in intensity, by a monetary and banking system permitted to operate, in a neutral economic atmosphere, on sound banking principles without Governmental interference or the attempt to employ currency and bankingmachinery for fiscal purposes or as a subsidiary implement of public finance.

LIMITS TO CREDIT EXPANSION.

The essential- function of bankers is to act as money merchants—receivers and distributors of credit. They are borrowers . on the one hand and lenders upon the other, their borrowings being represented by the deposits appearing to the credit of their cus-

turners, and their lendings appearing as assets of various kinds—bills discounted, overdrafts, advances and investments. The development of credit has, it is true, given elasticity to the banking systems, so that deposits often, if not generally, reflect advances rather than advances being governed by the volume of deposits available. There are, however, definite limits to the expansion of both sides of a bank’s balance-sheet in this way, limits which are set ultimately by the proportion of legal tender money which it is necessary to keep for cash purposes. In developed banking systems, where the ultimate control of such cashjresources is in the hands of a central Bank, the extent to which commercial banks may expand credit is in the last resort determined by the limits within which the central' bank can provide such resources without endangering the stability of the country’s currency. While an upper limit is set to credit expension in this way, the experience of recent years throws considerable doubt upon the power of a central bank, by enabling the commercial banks to secure cash resources cheaply and abundantly, to set a lower limit of credit contraction. Moreover, in its expansion of deposits and advances, a commercial hank must bear in mind the immediate nature of the liability it incurs to its depositors, and must therefore keep its assets so distributed as to avoid the danger of too large a proportion of them being unrealisable in sufficient time to meet a drain of depositors if such should develop. World Economic Survey of the League of Nations.