UBC Theses and Dissertations

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UBC Theses and Dissertations

The sterling rate of exchange since the war Morrison, Loyle Alexander 1922

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by /.tty/* A  U ****** M""' s*i THE STEELING BATE OF EXCHAHGB SIHCS THE BUD OF THE WAR. •7 Loyle Alexander Morrison. >B1S submitted for the Degree of MASTER OF ABTS la the Department of BOOIOHIGS. The Unirersit y o f Britis h Columbi a April, 1922 . BIBLIOGRAPHY. Base and Uoulton - America and the Balanoe Sheet of Europe. Baatable - theory of International Trade. Gannan - Honey. Friedman - International Finance and its Reorganization. Ooaohen - Foreign AXchanges. Hobson - The Export of Capital. Leri - History of British Commerce. Plgore - Political Economy of War. Withers - the War and Lombard Street. Periodical Artiolea. B. M. Anderson - Ghaae Economic Bulletin. Federal Reaerre Monthly Paiah - The Contemporary Review, September, 1919. Journal of Royal Statist!oal Society, September, 1909, and January, 1911. Oraaaond - Quarterly Rerlew, July, 1918. Taussig - Quarterly Journal of Economics, May, 1917. Hobson - The Economic Journal, June, 1915. Report III, Prepared for Brussels Monetary Conference, Currency Statistics. Round Tabl e "a^-azin e -  Decembe r 1920 , A e Internationa l Financia l Jonferenoe a t Brussel s an d I t s Lessens . December 1921 , Currenc y an d Foreig n Exchang e Problem. Graham -  The  Quarterl y Journa l -  jruary , 1922 , Internationa l Trad e under B e predated itoper . COKTEHTS. CHAPTER I -  FOREIGN EXCHAHGE UHDEB TEE GOLD STANDARD AL'D UHDXR IHCCJT7ERTIBLE PAPER, CHAPTER II - THE PRICE OF STERLING EXCHANGE IS HEY. YORK. CHAPTKH III- THB INFLATION 07 THE BRITISH CURRENCY. CHAPTER 17 - THE TBAJL BAUHCE 07 GREAT BRITAIN, CHAPTER 7 -  THE RELATION 07 THE CONTINENTAL EXCHANGES TO STERLING. CHAPTER 7 1 -  TH E CORRECTIO N O F TS  JiXCRANGES . MB 8TEMJI 0 BAT S O F SXCHAMB SIICB BDtroor m  WAS . OUfOBZ. r o m a sxams n u na f a aou > STIUMJD) in v a n xioamaai m tuau flaw yagpoo o o f thi o thooi o i o t o dloaaa o tta o notoni fo r th o fell  l a th o prlo o o f otorlla g • • •••!!§• aiao o tho oloo o o f th o wor, oa d th o aoaanro o aoooooor y t o roator o tho atorlia g rat a t o It o pr o amr condition . Bio th o MP j o f forolg n amhaag o ha s boo n woll oomr -od b y oooaaal o wrltoro oa d I t l o no t l a th o bop o o f addin g anything t o tha t tboos y tha t I  har o doroto d tbi o ahapto r t o a otatoaaat o f I t . A  brtof atataaaa t o f th o thoor y l o doolrabl o la antorla g o a th o ooaoldoratlo a o f th o prooon t onbjoot , a a attoatioa aboal d b o dlrooto d t o son o point s whlo h ar o oapooial -ly iaportaa t l a ooaaootio a wit h th o prooon t oondltlona . fOroiga gwnbaag t i o th o aaobaaia a whio h ba a grow n ap fo r th o oottloaaa t o f latoraatloaa l laaobtodaooo . th o olBplo tor n oTOhaag o aaaaa th o barto r o f ooaaaditlo o fo r ooaaadltloo, o r fo r a  partiaala r Ha d o f ooaaodlty , aanay . - 2  -foreign exchange has, however, oome to refer to a particular kind of exchange, the exchange of olaima arising oat of the transfer of commodities between countries. Money has been defined aa "that which passes from hand to hand throughout the coBssanity in final discharge of debts and full payment for commodities,being accepted equally without reference to tha character or credit of the peraon who offers it! Shar e are a number of things which fill these requirements la domestio trade, such aa gold, silver and aoppar ooiaa, aad legal tender notesi but between countries there are oaly two, geld aad silver. Thes e are money, net en aooouat ef any stamp which they amy bear bat en account of the value ef their bullion content. Althoug h these metals only have the requirements of money in international trade, they are not used in the settlement ef all international transactions. As the bank aete aad cheque are need in domestic trade on account of their convenience and economy, ao baa the bill-of-exchaage oome to be used in foreign trade. Aa the stock of gold and silver money in most oountriea would only cover in value a portion of the goods which they import annually, no country can for long pay for its iaporta oat of ita stock ef geld or silver money. Oountrie a which produce gold and silver may export them year after year, aad these metals may be aa important item in tha trade of auch • - 3  -countries. Gol d and silver are than, however, exported llks any other commodity, and their export does not represent a withdrawal from the money atook. Countrie s pay for their Imports by their exports. I f money had to be shipped in pay-ment for all oosnsroial transaotlons there would be a oonstant flow of the preolous metals to and from every country,- a flew to til* country to settle its credits and one from the oountry to settle Its debts. I t is this oost of a double shipment of gold er silver which is saved by the system of foreign exchange. the principle en which the foreign exchanges operate is that the exporters in say country may, in as far as possible, receive payment for the articles they have exported from those who* having imported from foreign countries, owe money abroad, and only the balanoe either way need be settled in actual money, geld or silver. I t is unnecessary here to enter on a complete explanation of the operations of the exchanges, but the principle may be readily understood by considering a simple hypothetical situation, in which two oountries only have dealings with one another. Conside r ths United States as having shipped goods to sad reoelved goods from Great Britain only, end Or eat Britain as having shipped goods to and reoelved goods from United States only, th e American exporters draw on their British oustomers for the value of the goodst the form - 4  -by which thoy draw is oallod a hill of exchange. Th e holder ef this hill is entitled to receive so much British currency from the party against whom it is drawn. Th e American ex-porters now sell their hills to American importers, thus re-oelTlng payment for their goods, th e American Importers send these hills to their British creditors who present them to the British importers against whom they are drawn, and so re-solve payment for their goods. I f American exports hare ex-ceeded imports, there will he some hills against British im_ partere for whloh there are me buyers, and gold will haws to ha shipped from treat Britain to redeem them. I f American im-ports hare oxooodod exports. Importers la the United States will wish to bay more bills than there are available, and those warn are unable to find bills will hare to ship gold to meet payments. l a either ease it is only the balance whloh need be settled la gold. the total commercial transactions ef a country do not, however, take place between that and one other country. Tory often the country to whloh another has shipped a large volume of goods is not oae from whloh it has received much in the way of commodities. Th e operation of the exchanges may he farther illustrated by another example. Conside r Great Britain as having Imported tea million dollars worth of goods from the Halted States, and to have exported five million dollars worth - 5  -of goods to the United States and fire million dollars worth to France. Franc e has exported fire Million dollars worth of goods to the United States. Fir e million dollars worth of goods* im-ported ¥7 Oreat Britain, will be paid for as in the previous illustration, and the other fire million by bills of exchange against France, fh e American exporters who receive these French bills will sell them to the Amerloan Importers who received goods from France, who will send them to their French creditors. The French exporters will present them to the French Importers •gainst whom they are drawn, ffan s a country may pay for its imports by bills drawn against a country to whloh it is a creditor, and If credits to all other countries exactly balance debts to all other countries, no gold need be shipped to or from it in payment. I t is only those countries whioh have a total excess of debts whioh need ship gold, and only those whioh have a total excess of oredlte whloh will receive it. I have assumed that all the exporters from one country to another will draw on their customers, and that the exporters in the second country will wait to reoeive bills from their customers. I n practice the operations are carried out in b) th ways in all countries, according to the arrangement be-tween the parties. Th e effect on the trade balance and gold •blpments is the same whichever way the transaction is carried out* - 6  -Exchange dealings are facilitated by the work of exohange dealers and brokers. The y buy bills from whoever has then to sell aad sell them to those who require them. Siao e they are constantly la touch with the exchange market they marrow fluctuations in price* sad on account of the volume of their business they are able to operate oa a very small per-centage of profit. The rate of exohange expresses at any time the value of one country's currency la terms of aaother's la settling inter-aatiemal debts. Thus , when sterling exohange is quoted in lew Ierk at fear dollars aad twenty cents, people can bay bllls-of-QTOhange on London at toe rate of four dollars aad twenty cents to the pound, and anyone la United States having a debt of one pound to a party la lagland nay settle his obligation with four dollars sad twenty oents,for he amy buy a blll-of-exchange and •end this to his creditor. The rate of exohange, like all other prloes, is determined by the supply of, aad the rtomsnrt for, bllla-of. exchange; therefor e let us see wheaoe comes the demand for, end the supply of, these bills. S o far we have spoken of bllls-of-exohange as arising only out of exports; this is only true if we consider as exports certain so-called invisible items which are mot usually thought of la this regard. Th e supply of bills-of-exohangs la any oouatry is created by all transactions - 7  -whioh, but far the system of foreign exchange* would require • the shipment of money into the country. Al l such transactions can usually he put under one of the following headst commodity exports, the haying hy foreigners af the country's securities, pay—at af interest as foreign securities held in the country, payment far eerrloae dene hy the country's ships or financial housee far foreigners, payment of expanses of foreigners in the country,or serrloes rendered ta foreign ships and remitt-aaces haaa ay the oitisans 9t  th e eauntry living abroad, flhaaa mn th e transactions ant af which the supply of exchange arises, ami aw any inoreaee is thaae transactions will tend ta decrease the price af hllla-af-axchaage against foreigners; that is, the mine af ferelga currencies in terns of the hone currency. Ike wsmiitrt far exchange ia oreated hy all transactions whioh aaejisr the people af a country the debtors of foreigners, and thaae are Just the eppoeite kinds of transactions to those •numerated aborej thes e arej oommodity inports, purchase of ferelga securities by people in the country, payaent of interest an the eauntry*s securities held abroad, payaent for services dona by foreign ships or financial houses for the country, expenses of the country's oitlsens in foreign countries or earrioee rendered its ships In foreign parts and remittances by inmigrante ta their homes. I t is out of these operations that the il named for bills-of-exohange cornea, and therefore amy - 8  -increase In these transaotione will tend to raise the price of bllls-of-exohange, that is, the value of foreign currencies in terra of the hone currency. Bxe effect of taking up a country*s securities in a foreign country perhaps needs special consideration. Thi s operation is usually looked upon as a credit to the country taking the securities; this it is* but, for the year in which the transaction takes place, the operation will be a debit on that country's trade balance, for it represents an amount for which the exports, visible and invisible, will hare to exceed imports. Loan s and the purchase of securities are therefore represented as an import item to the country making or purchas-ing them, an expert to the country receiving or selling them. Let us now oonslder the operation of the exchanges between oountrles which are on the gold standard. Althoug h this is far from the ease at the present time, the only way to understand many of the terms used in treatises on questions of exchange is to oonslder commercial transactions between countries which have a common denominator of value. Tha t common denom-1. inator of value was, before the war, gold. A  country is said (1) A few oountrles were before the war on the silver standard, but I have not considered it necessary to enter fully into the effeot of this on their exchange rates with gold standard oountrles because these exchange rates will be subject to fluctuations for the same causes which effeot the rates between gold standard oountrles, but will also be subject to further fluctuations due to alterations of the value of silver in terms of gold. 9 -to b e o n th o gol d standar d whe n i t s ourrono y i s exchangeabl e fo r geld a t a  fixe d ratio * Thu s Brit is h currenc y o f a l l kind s wa s be -fore th e wa r exchangeabl e a t th e rat e o f 113.00 1 grain s o f pur e geld t o th e pound . America n currenc y wa e an d i s exchangeabl e a t th e rat e e f 23.2 2 grain s o f pur e gol d t o th e dol lar . Ch e Brit ish pound , therefore , represente d th e earn s gol d a s 4*66-2/ 3 dollars* th i s i s wha t i s mean t b y th e pa r o f exchange , th e propor -tion whic h th e gol d conten t o f on e country* s uni t o f currenc y i s t o another's * Why,i t w i l l b e asked , shoul d th e rat e o f ex -change var y a t a l l betwee n countrie s bot h o n th e gol d standard ? Xxohange rate s var y unde r thes e condition s o n accoun t o f th e eost o f shippin g geld * A s lon g a s th e suppl y o f an d th e deman d for bills-of-exohang e ar e equa l a s betwee n Unite d State s an d Great Britain , ther e w i l l b e no  variatio n i n th e rat e o f ex -change, whe n bot h countrie s ar e o n th e gol d standard ; bu t whe n the suppl y o f b i l l s doe s no t equa l th e deman d gol d w i l l hav e t o bo shippe d fro m on e countr y t o th e other . I n th i s cas e gol d I t s e l f w i l l b e mor e valuabl e b y th e cos t o f shipmen t i n th e country t o whic h i t i s t o b e shippe d tha n i n th e othe r country . SO, too , thos e b i l l s whic h represen t th e comman d ove r gol d i n the countr y whic h i s receivin g gold , w i l l b e appreciate d i n value i n term s o f th e othe r country' s currency . Bills-of-exohang e against an y countr y fluctuat e i n valu e accordin g t o th e deman d for an d th e suppl y o f them i bu t th e l imi t t o whic h the y ma y r is e « 10 -or fall is determined by the cost of shipping gold between the oonntrles. A  nan in United States would not pay more for a bill-of-exchanges against London than the oost of the gold plus the oost of shipment.because he oould liquidate a debt in England with gold at that prlae. Sh e oost of shipping gold under modern conditions has been reduced to a very small amount; be-fore the war it cost about two cents a pound to ship gold from London to Jew York. Therefor e when gold was leaving United States to go to England the exchange could not go abore 4.88-1/2 (approximately)* and when geld was leaving England to go to United States the exchange rate oould not fall below 4.84-1/2 (approximately).* When countries are on the gold standard, the fluctu-ations of exchange rates are for the above reasons not wide, and so the different currencies used offer little discouragement to international trade. Once the gold supply has been adjusted to the monetary needs of each country, further movement of gold is discouraged, exoept to adjust the volume of gold to a permanent change of in-dustrial condition. Trad e is responsive to any small departure 1. Unde r abnormal conditions when immediate payment is demanded and no one wishes to wait the time required to send gold, the exchange may go beyond these points. Thus , at the beginning of the war, sterling exchange in lew York is said to have reached 7.00 dollars. - 1 1 -from equilibria of the credits and debts of a country, For , if the balance is not 8trade without gold shipment, exchange on the country which the gold is leaving will be below par value la tents of the currency of that country to which the geld is going. Therefore , the people of that country will have to pay sore of their noney for foreign goods than previously, and to that extent will be discouraged froa importing. Simi -larly, foreigners will be encouraged to buy in the country on aeeount of the increased buying power of their money in that market. I n the country to which the gold is going, Just the opposite imfluenoes will be at work* Importin g will be encour-aged, and exporting discouraged. I f these influences are not sufficient to restore the balance of imports and exports the drain of geld from one oouatry will continue, and due to the 1. decreased supply of money prices will fall. O n this account . foreign buyers will be further encouraged. I n the country or countries receiving gold the opposite influences will again be at work. I n practice in ordinary times, the fluctuations are farther confined through the action of the banks in raising and lowering interest rates when the exchange rate denotes a great gold movement. Th e effect of this is to correct the trade condition before the diminished gold supply would do so. Onl y when there is aa increase or decrease in the trade of some countries 1. Quantit y Theory of Honey. - 1 2 relatively to other* will there bo any groat morement of gold. If there la an lnoreaee In the trade of one oountry relatively to ethers, prloeo will tend to fall,owing to the eoarolty of geld relatively to the new condition of trade t exports will be atlanlated and gold will oome into the oountry until the prloe level la in about the same relation to that of other oountrlea aa it waa before. Complet e adjustment of prloe levels between eeontrlee la ef sours* newer effected, it ia interfered with by tariffs, and one adjustment la never completed before another aete im* Sh e reeponslToneas ef the exohaage rate to the balanoe •f exports and imports, risible and invisible, keeps the con-ditions from departing far from normal. A  small balanoe of payments to be nmde in gold, that la, small in aomparison with total exports or imports, will be large in comparison with the total monetary supply, and will therefore start lnfluenoea at work whloh will oorreet the trade balanoe. Shis, of oonree, doee not mean that merchandise im-ports and export* tend to equilibrium. A  young oountry nay for years have a balanoe of imports whloh is covered by the invest-ment of foreign oapital. I n time, however, the ooamodlty balanoe will have to turn in the oppoelte direction in-order that interest payments earn be mads. A a old* developed oountry will, under normal conditions, not be able to maintain a balanoe of lmporta in the asms way* beoeuae they will not usually offer profitable - 1 3 fielda of investment. The workings of tha exchanges whan some of the countries under oonaideration have an inconvertible paper ourrenoy la of far more direct lntereat at the present time, and ia a •Mb. aora ooaplex study. Th e fluotuatlone in ratea are, at suoh a time, Tory vide, and the causes of fluctuations difficult to looate and to arrange In order of importance. At present the United States is the only great country of tha world whloh maintains the gold standard of its currency. The holder of a Canadian dollar bill, or ot  a  British paper pound, or a frenoh frano note, cannot exchange his paper for any fixed quantity of gold, 9i e value of the paper expressed In gold ia variable, aa ia ita value expressed in any other commodity. Bio holder of a bill-of-exohange against suoh a country has a claim for ao much of ita currency, but this is redeemable in no fixed quantity of gold. Therefore , there ia no limit to which ita value may fall in terms of gold, or of the ourrenoy of another country. Inconvertibility of the currencies of most countries of the world has been brought about by a great increase in the volume of paper and bank deposits, relatively to the gold reserve. It is a principle of finance that a volume of negotiable credit may be maintained in circulation in a country in excess of the gold held to redeem it, without having ita value depart from the - 1 4 -value of the gold in which it is redeemable. Thi s volume was, in most of the belligerent oountries, exceeded during the war, and In order to jarevent the drain of all their gold from their countries the governments had to relieve themselves of the obli-gation of redeeming their notes. A s soon as this was done all gold was driven from circulation *, and gold was quoted at a 2. premium in terms of paper. Si e greater the volume of such inconvertible paper, the less becomes the value of the unit of 3. currency. The value of bills-of-exohange against a oountry having an inconvertible paper currency in a gold standard oountry #111 correspond roughly to their value in gold,since the currency of a gold standard oountry is a oommand over gold. At bottom the factor on whioh rests the price of ex-change on a oountry under an inconvertible paper regime is the purchasing power of the inconvertible paper money within the country, relatively to the purchasing power of the currency in 4. whioh the price is expressed ,  for the price at which people. 1. Qresham' s Law. 2. nominall y the British pound is still convertible, but the restrictions placed on the export and melting down of the gold, so obtained, render it useless for anything but circulation within the oountry. thu s the value of the gold coins to the individual is ttie same as the value of the paper unit of currency, and not the bullion value. 3. Quantit y Theor y o f Money . 4. Purchasin g Powe r Parit y -  Professo r Gusta v Casae l -  Annal s of th e America n Academy o f Politica l an d Socia l Science , Ma y 1920. - 1 5 Uio hol d billo-of-oxohaag o agalaa t th o ooontry , v i l l diopoa a o f thorn, wil l d o pond o n th o Yalu o o f th o goad a whia h tha y aa n go t for th o aarraaa y oro r whloh tha y haw o ••—ml . fn o purahaala g powar o f th o oarrona y fall a a o th o Talon o lnorooooo , ha t th o TOtaM i o so t th o onl y olonon t whlo h dotomlno o parohaala g powor . Iho purohaola s powo r l o l a tar n affaoto d b y th o rat a o f oxohoago . lapaalally i o thi o tra o l a th o oaa o o f a  ooontr y lik o Xaglaad , whoro ano n a  larg o proportio n o f th o artlolo o o f ni— i • • ar o hoaght an d aold l a forolg a aarkato . Mbli a ooafldaaa a ha o a groat affao t o n parohaala g powor . fa n papo r lo , afta r a l l , a praanaa t o pa y a a waoh gold aalllon , an d th o halla f whlo h poopl o hawo l a th a abilit y aa d good fait h o f thal r gowaraaan t wil l ln -flwoaoo th a walm a e f th a aarraaay . I f poopl o axpaa t a  fartha r laaaa a f papar , tha y wil l attanp t t o oxohoag o thal r aota a waaro -oror poaaihl a fo r goodo , aa d thl a wi l l ltaal f lawa r parohaala g powor. I f th a poopl o onpoo t a  rodaatlo n i a th o walna * o f ah a papar, tha y wil l oxpoo t a a appraalatlo a o f it a ralao . aa d wil l aooaaolato a a wao h aa paaaihl a i a aatlalpatlo n o f a  rlo o i a •alaa. fal a withdrawa l fro n Inwadla U airoalatlo a wil l oana a a rlaa i a parohaala g powor . flho prlaa a f billa-of-axohaaga , haalda a haia g aahjaa t to flaotaation a o n aaoowat o f altaratlan o l a th a parohaala g powor o f th a anrrana y oro r whloh tha y gir o aoanaad , i a laflnanoa d 1. aadaraa n Onaa a Boononta lo l lot l a -  Januar y l t t t . - u  -«y «tto r ttUn.  St o i i f l l — n i t  fa i ^ | im l a tt o abil i ty to  M l I t o toato toll  Uraat l y affao t th a U It o M M vay a s palli a aaafltto m v i t k U «t o oantr y afftot o M r . tawaVM  arto—a l palli a a i totoraal palli a aaafltoaaa , it o aria s a f • i l l top—I  fra a i t o laiatosla i pssa r parity . flto tolaaaa  a t laaaaiat o yayaaat o l a m wlt o 41 i it aa a i a faraat sara r a f to ca t arailt o to  Praaa s to . Qata r tt o fU tto n a a H j wit h tt o , tot  gal * I s a  aalvaraall y tort  wall a t gal A aa a to  aallaato i fa r St o af aaatoaa a fra a fa l l la r tor.  Bato r a gali ito Ma Ltlaa amis* ttor a U  a - 1 7 -In foreign markets, or wants created in foreign countries for whloh the debtor oountry has goods to supply. Al l this talces tins, and meanwhile the exchange rate may deport a long way from pur-chasing power parity. Whil e the balance is being corrected, the excess in the supply of bills-of-exohange on the oountry over demand will be held by speculators, and the price at whloh they are held will be determined by the risk which they feel they are taking. It is sometimes thought that, when exchange on a oountry is very araoh below its par value* Imports into the country are discouraged and exports encouraged. Th e inaccuracy of this idea lies In the fact that when a oountry has an inconvertible paper currency, par value has no meaning exoept to measure the extent of Hie depreciation* Trad e will be only influenced eithor way in s o far as the rate of exchange rises or falls above or below purchas-ing power parity. Bve n then, export or import will only be en-couraged in so far as the purchasing power of the currency is re-flected in exportable commodities. Th e fact that an American can get one thousand roubles worth of Russian exchange for his dollar does not enaourage him to buy in Russia unless he can get more goods of a kind he desires for the one thousand roubles, so bought* than for his dollar in America or some other oountry. Th e price of exchange in relation to purchasing power parity is determined •y the confidence o f people outside the country relative to the - 1 8 -oonfidenoe of the people inside the country, and by the balance of immediate payments. During a period of inoreasing inflation, the increasing volume of currency will tend to increase Imports and deorease ex-ports* because prices internally will first feel the effeot of the increased supply of money, and so the deorease in purchasing power will preoeed the fall in the price of the country*• bilis-of-exohange. Similarly , during the process of deflation, exports will be encouraged and Imports discouraged. The mere fact of an inconvertible paper currency, and consequently an apparent very unfavorable exchange rate, does not tend to produce a favorable trade balance. I f such were the case, the flow of gold to the country to pay for the excess of exports would restore convertibility, and so the condition of the currency would tend to correct itself. Fo r the effeot of inconvertible paper currency nad depredated exchange rates on trade balances, particular oases must be considered separately, and all the in-fluences being taken into consideration and the importance of each estimated, some conclusion may be drawn as to the result on trade conditions. The detrimental effects of inconvertible paper currency, in so far as it acts through the exchanges, are doe not so much to the apparent very unfavorable exchange rate against the country as to the Instability of any rate. Sh e consequent risk to all who - 1 9 -hara ooaneroia l dealing * wit h for e ignore act a a * a  rrrea t barrla r to trada . Thaa a rlak a na y b e partl y insure d a^alnat , bu t eve n than th e insuranc e ooot a money , an d thl a adde d azpana e l a a  dla -oourageaent t o th e interchang e o f ooanodltlaa . Th e eoonomi o welfare o f th e worl d depand a o n a  oomple x dlYieio n o f labor * an d ao o n th e exahang e o f ooanodltlaa . fo r thl a reaao n th e atabll laa -tlon o f exahang e rat* a l a o f prln a iaiportano e I n th e reatoratlo n of praeperity . - 2 0 -CHAPTER II . THE PRICE Of  STEELING EXCHANGE IK HEW YORK. At the beginning of the war the prioe of sterling ex-ohange soared away above par value. Snglan d had great oredits in almost every country in the world, and the British oredit houses, expecting that gold movements would be interfered with, demanded the instant payment of their dues. Th e demand for sterling ex-change was so great, and the British oreditors so anxious not to bare to await the time required to ship gold, that oable transfers on London rose to over seven dollars tc the pound. Thi s even between gold standard countries. Th e exchanges were unable to 1. •apply the bills required, and had to be closed. With, the increased demand for American goods, and the falling off In the British export trade, the price of sterling exchange fell, and since there was no free movement of gold the fall was not limited to the cost of gold shipment. Th e British government started to support the exchange rate in 1915, but the rate did not become stabilized until early in the spring of 1916, when, through the action of the British government, the rate was held at 4.76-7/16 dollars. The method of stabilizing the price of sterling was by 1. Th e War and Lombard Street - Hartley Withers. - 2 1 -am agreement with the J. P. Morgan Company, whereby all bille-of-exohange offered were takan at the rate agreed upon. I t followed that no one would dispose of bills on London for less. Ih e Mile-ef-exohange so bought were covered by a loan from the United States to tha British government. Ibi s pegging of exchange, aa It la called, was carried out for tha purpose of ensuring the flaw of munitions and food supplies from the United States, and to prevent apeoulators from manipulating tha exchange market. While, for thia reason, tha action was no doubt justified, it must be recognised that the arrangement had the effect of keeping the purchasing power In United States of the British currency above tha level to which it otherwise would have fallen. I t acted aa a subsidy on imports, and encouraged consumption which was un-warranted by the true economic oondition of tha country. ' Wit h tha government control of shipping, however, the extravagance was reduced to a minimum, ainoa only those things considered necessary were allowed to be imported* Wham the governmental control of shipping was withdrawn it was recognised that the Britlah government could not go on increasing its debt in tha United States and to that extent en-oouraging ita people to live beyond the income of the country* Therefore on March Slat. 1919. the eupport of the exchanges was 1. Chapte r III. - 2 2 -withdrawn. Sterlin g exchange In lew Tork fell rapidly. Ther e have boon wldo fluctuation* in tho prioe of exchange since that tine. Di e lowest point to which it fell was 3.19 dollars on February 4th, 1920, and the highest point to which it had risen, np to the end of 1921, was 4.24-1/2 dollars on December 12th, 1921. tinoo tho beginning of tho present year sterling has shown a com-paratively steady upward tendency, being usually above 4.30. fhe course of storling exchange on Sow Tork is represent-ative of the course of exchange on gold standard countries. A s was pointed out *, the rate of exchange between gold standard countries is Had ted to a narrow margin of fluctuation, so that the rates of exchange between Qroat Britain and two gold standard countries will more closely together. British exchange in the late belligerent Continental laropees countries — Prance , Italy, Germany, Austria, etc., has boom usually above par. Thes e countries hare also been on incon-vertible paper currencies, and as Inflation of paper has been in excess of the inflation of the British paper, the depreciation of tho value of the unit of circulation has been greater. Th e price of exchange on such countries has fallen roughly in the proportion of the increase in volume of currency. Th e degree of inflation is, of course, only the most general reason for the prevailing rate of exchange. Fluctuation s over short periods of 1. Chapte r I. - 2 3 -tine must be leaked for in the other influences given in Chapter I. Bte exchange rate is a ratio expressing the value of one ourrenoy la terms ef another, and is therefore effected by changes in the foreign oamhaags ralue of either currency. I s the British ourrenoy has beam the object of leas uncertainty and smaller fluctuations la domeetio value that the money ef the Continental European ooaatrlee, the alterations la the price of sterling exchange in tana ef the omiismsj t  thes e countries must be sought mostly la the Hsemslsl IsanstrlBV as m pelltioal oondltion of the other eoemtry, rather than la that ef Great Britain. - 24 , -CHAPTEB III. 2KB IMLATION OP TUB BIUTISH CURHEHCY. The word inflation in regard to currenoy is used with too widely different meanings. I n one sense it is used to indloate any increase in the volume of the ourrenoy. I n this sense in-flation may oocur and yet all the forma of currenoy be convertible into the gold whloh they profess to represent inflatio n is due merely to the increase in the gold used for monetary purposes beyond the requirements of the country's trade relatively to the money and trade of other countries. Thi s fact is reflected in the purchasing power of gold In the country, and the effect of the prioes on foreign trade will, in a comparatively short period, oorreot the distribution of gold. I n a second sense inflation refers to an inoreaae in the volume of negotiable credit implements (paper money and bank deposits) to such an extent that these imple-ments are presented for redemption in gold in greater quantity than oan be redeemed. Th e credit implements, therefore, become Inconvertible into gold, and the country is said to have an in-convertible ourrenoy. Suc h currency is. of course, useless for circulating purposes in foreign countries, and so the excess cannot be drawn off as excessive gold would be under the other kind of Inflation. - W i -l t l a I n th e aana a o f a n In-reaa e I n th * volca * o f negotiable oredl t tha t Inflatio n l a applicabl e t o th e ourrenale e • f Croa t Britain , Jranoe , Oeraany , eta . Baa quantit y theor y o f wone y ha a b«c n th e ob.'ec t o f •any attack * o f la te , th e theor y ua y vei l b e doubted . I f I t l a atated I n auo h a  wa y a a t o awa c tha t th e TT1C # lerv l '-11 1 r l ee •sal fall*I n .flXaO i proportio n t o a n lnoreaa e o r de<-rea» e 5 n th e • • l a w o f olroulatln g awdlua u Th a theor y atate a tha t th e t.eneru l prloo lara l v l l l var y direotl y a a th e Tolua w o f ourreca y I f th e demand fo r money , l . a . , trad e an d th e velocit y o f circulation , l — l a a th e aame . Trad e an d th e reloolt y o f clroulatlo n am y thern -eelvea b o affoota d b y a n lnoreaae , o r decrease . I n th e eurreuay, — oopoolally l a tfci e tru e wha n th e ourreno y oonalat a o f lnoonvertlbl e paper. *  I n aplt e o f th le , however , ther e oa n b e n o doub t tha t there l a a  tendano y fo r prloo a t o rla e whe n th e volum e o f tsurreoe y lnoreaae a, an d fa l l wha n th e volum e deoreasea i a  i U d ; o f prloo o during th e wa r give s ampl e proo f t o th e quantit y tneor y o f mone y to tal e oa r tent. Prlo e lerel a har e tende d t o ad.tua t theaaelve e t o tha volum e o f currency . Th e prlo o o f M l la o f exohaar a i n aaaariaiiaa wit h th e theor y develope d i t Oaapte r I  ha a followe d th e imrnlmalag, powe r parit y wor e o r lee a oloeely . According t o th e quantit y theor y o f woney . th e offoo t o f 1. I t l a generall y admitte d tha t th e Iran  oh aoalgaat a greatl y roduood trade . Th e lnaeourlt y o f th e valu e o f th e pape r mad e peopl e unwilling t o ••nhang o anythin g fo r th e aaclgmata . - 2 6 -inflation an prioaa ahould be the same whether Inflation be due to increase in gold or inoreeee of inconvertible oredit circulation; prices will rise in accordance with the inoreaae in the volume of currency. Ihi e is probably not absolutely true beoause (1) the purchasing power at horn* of an inflated convertible currency la naintalned by its purchasing power abroad* and (2) an inconvertible paper currency will fluctuate in purchasing power according to the pr—pacta of ita future — a a the redewption appears remote or near lta value will vary. la foreign purchaaing power* ae indicated In the rate of exchange* the effect of the two kinds of inflation is by no •ease the came, l o matter what the volume of a convertible currency, the evfthamwc rate on a gold standard country is limited by the cost of geld ahlpmsnt. Whe n a currency la inconvertible, the exchange rate tends to conform to purchasing power parity, but fluctuatlona around that point are not limited* there are three principal waya in which governments may obtain funds to carry on their activities. Ihes e ares taxation, borrowing, and creating oredit in their favor. B y taxation a portion of the funde of individuals la openly eeised, by the method of loans funds of the oitlsena or of foreigners are borrowed* ami by the method of creating credit a portion of the Inn nam of individuals la seised by reducing the buying power of their currency. Oredit may be created by a a over meant by leaning paper money, or - 2 T by having deposits in banks created in its favor. Whateve r method of obtaining funds is used* if a government is to be solvent* tax-ation in the end must be used to pay for the funds reoelved by the other methods. Most of the belligerent countries were, during the war, forced to resort to the third method of securing funds to males up for the excess of their expenses over what they were able to obtain by taxation and loans. Th e increase in credit implements owing to this has rendered the currencies of these countries in-convertible. The British government was no exception; in as far as possible the war was financed by taxation and loans on the part of Qreat Britain, but the creation of credit had also to be resorted to. Th e British method was to have deposits created to the govern-ment's credit at the bank of England. A s the government paid for its supplies, etc., these deposits were, of course, transferred to private accounts- and the debt was represented as an overdraft at the Bank of England. T o a minor degree the coverament also had deposits created to Its credit through supplying treasury notes to the banks. The effect of inflation of the British currency Is shown In both purchasing power and exchange rate. O n account of being regarded with less uncertainty, the purchasing power an d exchange rate have recorded more nearly than in any other country - 2 8 -the degree of inflation. Peopl e both inside and outside the United Kingdom hare felt little doubt in the ability and intention of the British government to pay all its debts and restore the gold standard of the country's currency, and also as to the ability of the country to attain prosperity. Therefore , the purchasing power of the British currency and the sterling rate of exchange in New York have expressed more nearly than have the conditions of most other inconvertible currencies the financial condition of the country. While the prioe of sterling exchange in New York was pegged at 4.76, the degree of inflation was, of course, not re-flected in the exchange rate. Also , on account of the great extent to which articles of foreign trade enter into internal ooaneroe of Great Britain, the purchasing power of the currency did neither conform to the degree of inflation. The currenoy of a country is usually thought of as con-sisting sf coins and government and bank notes. Ther e is another form of currency, however, — ban k deposits. Th e transferability of the bank depoelt by means of the cheque gives it the power of acting as currency. Ban k deposits subject to cheque are the •currency need in a class of transactions, and as long as these deposits sad the other forms of currency are exchangeable for one another the volume of deposits in relation to the volume of other forms of currency will depend on the demands made for each kind of - 2 9 -• f currency . Owin g t o th a restrict ion s place d o n not e issu e i n Emglsnd befor e th a was , th a chequ e ha d om e t o b e use d rar y largel y In makin g payments . In Grea t Britai n previou s t o th a wa r th e ourrano y con -s is ted of i Gold. . * 123,000,00 0 Silver .  34,000,00 0 Paper. 57,000,00 0 Deposits a t Ban k o f Englan d 71,357,00 0 * a t othe r Bank s 1,070,681,00 0 At th e en d o f 191 9 th a Brit is h ourrano y consiste d of t Silver .i r 77,000*00 0 Paper. . . . 469,000,00 0 Deposits at Bank of England 199,000,00 0 1. * a t other Banks 2,398,000,00 0 Gold has been entirely withdrawn from oiroulatlon. Comparison of these statistics shows that the coin and paper oiroulatlon has inoreased from h 214,000,000 to fc 536,000,000, or 260& bank deposits had inoreased from a- 1,142,038,00 to m 2,597,000,000, or Just orar 200£. Th e graatar inoraaaa in tha coin and note oiroulatlon than in bank deposits ia probably due to tha restrictions before the was on note issue, and that now the note is sometimes used in payment where formerly the cheque 1. Currenc y Statistics prepared for International Financial Conference - Brussels, 1921* - 3 0 -would hare been. The total lnorease In ourrenoy has been from & 1*866,088,000 to U. 3,133,000,000, or about 210#. Th e prloe lerel, as indloated in the index number at the end ot  1919 , was 808, as compared to 100 for 1913. Thu s while the volume of ourrenoy had Increased to over twice its former volume, the price level had risen to more than three times its former level. Th e difference between the rise in prices and the inflation is probably due to a decrease in trade. The American ourrenoy has always been convertible, but on account ef the great lnorease in the country*s gold, the pur-chasing power of money had by the end of 1919 fallen to less than one half its former value. Th e price level was 238, as compared with 100 for 1913. Th e coins and notes had increased in volume from |13,760,000,000 be #28,289,000,000. * Th e editors of the report of the Brussels Conference attribute the fall in purchas-ing power beyond the degree of inflation to the increasing use ef the cheque. The relation of purchasing power to the exchange rate is well Illustrated in the exchange between England and Hew York. Thus, while the purchasing power of the British pound was 32-1/2$ of its power in 1913, the purohaeing power of  th e American dollar 1* Ourreno y Statistics prepared for International Financial Conference - Brussels, 1921. - 3 1 -was 42j ( o f i t s pre-wa r power . Th e depreciatio n o f th e Britis h pound i n term s o f th e America n dolla r wa s therefor e 9" 1 / 2 x  100 , 42 or 2ZjL.  Th e exchang e rat e ove r th e las t par t o f 191 9 show s American mone y t o har e bee n a t a  premiu m i n term s o f sterl in g o f from 26.9j t t o 21.6^ . A comparison of the figures of the other European belligerent currencies shows, if not as close, at least a general relation between inflation, purchasing power, and exchange rate. The greater derlation of the price IOTOI and exchange rates of their currency from the degree of Inflation would appear to be Omo to the greater balance of immediate payments against thorn, and the uncertainty in which their financial policies is regarded. The fundamental reason for the fall in the price of sterling exchange would therefore appear to be the inoonverta-bility and fall in purchasing power of the British currency, due to the gorernmental method of finance. - 3 2 -CHAPTER 17 . ZHB TRADE BALAHCE 0? MEA T BRITAIK . Rxamination o f th e exchang e rate s i n l igh t o f purchasin g power show s tha t afte r th e governmen t ha d cease d t o contro l th e rate I t wa s usuall y depreciate d mor e i n term s o f America n mone y than l a term s o f I t s pre-wa r purchasin g power , thi s allowin g fo r the depreciatio n I n purchasin g powe r o f th e America n currency . Similarly, th e Frenc h fran o wa s usuall y lowe r i n term s o f th e British poun d tha n I n term s o f i t s pre-wa r purchasin g power . S o was th e I ta l ia n l i r e , Germa n mark , e tc . Th e reaso n fo r th i s i s to b e foun d i n th e trad e balance . Under th e gol d standar d w e sa w tha t an y balanc e o f pay -ments wa s mad e i n gold , an d tha t therefor e th e pric e o f exchang e could no t f a l l belo w pa r b y mor e tha n th e cos t o f gol d shipment . Under inconvertibl e paper , a  balanc e o f payment s mus t be^oarrie d on credi t agains t th e countr y o f th e unfavorabl e balance , an d o n account o f th e slownes s wit h whic h industrie s ar e adapte d an d good s •applied th e exchang e rat e ma y var y quit e widel y fro m i t s purchas -ing powe r parity . Bio Unite d State s ha s hel d u p t o th e presen t tim e some -thing l ik s thre e an d one-hal f b i l l i o n dollar s wort h o f mature d l i a b i l i t i e s agains t th e countrie s o f Europe . *  Thi s mean s tha t 1 . Ohas e loonosd o Bulleti n -  B . M . Anderson . - 3 3 -there i s alway s thi s grea t su a availabl e wit h whio h t o pa y fo r American imports , naturally , mor e suc h credi t w i l l b e onl y given a t a  ver y lo w rate . 9 M greate r par t o f thi s thre e an d one-hal f b i l l io n dollars wort h o f floatin g debt , a s i t i s sai led , i s hel d agains t Great Britain , fo r th e Unite d State s ha s show n l i t t l e readines s to aooop t th o orodl t o f Europea n ooontrie s othe r tha n th e Unite d llngdonu Grea t Britai n ha s extende d he r oredl t t o th e nation s o f Inropo V y buyin g th o ozohang e agains t then , an d th e mature d l i a b i l i t i e s , o r floatin g debt , o f Grea t Britai n i n th e Unite d States i s greate r tha n th e trad e balanc e o f Grea t Britai n woul d of i t s e l f hav e oroated . Lot n o examin e th e conditio n o f Britis h foreig n trad e before th o war , t o se e ho w th e balanc e wa s struck . Cramtoond , fo r 1. the yea r 1910 , ooapote s th o Britis h trad e balanc e a s follows ! Orodlt Item s (I n Million s o f Pounds) . Tlslbls Export s Commodities h  43 0 Bmlllon an d Spool s 6 4 lo-oxports 10 4 Invisible Export s Interest o n foreig n Investment s 17 8 Marnings o f Britis h Merchan t Marine . 10 0 Earnings o f Bank s an d Financia l houses abroad . 6 6 fOIAL 99 1 1 , Bt o Quarterl y Bovlo w -  July , 1911 . - * 4 -await Itwa a (l a Bl l loa a o f rowada) . flalala Xapart a tloa . * «T t BolUaa aa d fpaal a 7 1 larlalaU Oaattal lawasta d abroa d 1T 0 of foroUj a aa d Ooloala l baafca an d lataraa t o a Irltlali laraahwit a hol d 1* t tew  aaa a aaabl a t o flad  a a aatlamt a o f th a trad a t Da l tad tjagda w alao a th a war , bu t fro m rarion a aonraa a bar s Had ta a fallo w lac fo r th a yaa r 19*0 1 Oradlt Itaaa . flalala Bapart a x Ltlaa . * 1 ,DO9.974,00 0 larlalaU lataraat o a Paraic a laraataaat.. . Ifi0,000,00 0 2 . of Irl t •arohaa l ago o f tOO.000,000 * financial Hoaaaa... . 66 t000,000 VOCAL i .m.m.M Q 1. roaara l Baaarr o ammthl j -  January . 1 1 I . Si r Oaorg a Jals h U  th a Ooatamparar y Barlow , Sartambar . 1919 , aad Br . •aTiai n l a BOLaaa* s aacaalaa , aatlamt a tha t arltla h la . rat aaaa U abroa d amwo falla a a y aaoa t ona-q*mrt«r . A t ta a mt a a t whlah Oroa t Brltal a am a lnraatlaf f prio r t o th a war th a tota l aarw -iaaja o f Brltla h lawwaaaaat a l a 19 U ama t haw a amount* * t o abou t BOO snlllama. S. t l r Oaoti a Jmla h l a th a Oomtawporar y Barlow , Soptambar . 1919 . that ahll a tnwaaf a ha a boa a aroatl y radaoa d [probabl y a w ***** it) fralfh t rata * haw a laoroaaa d aboa t aava m tlaaa . 1 this a a a  juaaa t i at Ira aatlamta . 1910 Balaaao . - 3 6 -Debit Itea* . Visible Import s 4  1,936,740.COO 1* Oonraoditlee l ar i s lb l e Iaport s Xarnlngs o f foreig n Bank s 2 s and financia l Ho n see 16.0<T.t>C f 1.961.T40.P0r fha balanc e thu s compute d i s , o f course , onl y th e roughest kin d o f e s t l a s t s , ba t authoritie s see m t o b e agree d tha t the Britis h trad e balanc e ha s bee n maintaine d e n a  soun d b-Ms . * ana ou r figure s woul d appea r t o b e i n agreement . fha 19t l balanc e a s fa r a s v i s ib l e item s i s eve n aor e favorable t o Grea t Britain . *  Bot h iaport s an d export s har e bee n reduced b j abou t one-hal f i n aons y value . The balano e o f payment s agains t Grea t Britai n t o th e United State s i e therefor e no t t o b e accounte d fo r b y th e conditio n of he r ow n trade , bu t becaus e sh e ha s grante d oredit , o f a  kin d similar t o tha t whic h sh e ha s receive d fro : th e Unite d j tates . t o the Bnropea n countrie s whic h hav e ver y unfarorabl e trad e bal«no«s . The Unite d Jtate s ha s a  sufficien t balano e i n he r favo r t o cove r the mature d l i a b i l i t i e s whic h sh e hold s agains t th e Europea n countries , principally Orea t Brltai m Orea t Britai n ha s not , an d th e deb t against ba r i s thu s a  depreciatin g influenc e o n sterl in g ezonange . 1. Federa l Baeerv e Monthl y -  Januar y 1922 . 2 . Take n fro m 191 0 Balanoe . 3 . MT . koisnn a -  loLsaa' s loathly , an d Si r G . Pais h -  Contemporar y Brrlev, Septembe r 1919 . 4 . federa l Baearv a Monthl y -  January , 1922 . - 3 6 -CHAPTER 7. IRS BELAT10H OF THE CONTINENTAL EXCHANGES TO STERLING. Reference has been made in Chapter 17 to the depressing influences of the exchanges of Continental European countries on sterling. Thi s is worthy of some additional consideration. At the beginning of the war Great Britain accepted the role of banker to her Allies. This , she did not only by granting loans to the governments, but also by the pruohase of bills of exchange against them. Th e British government saw that trade would be paralysed if the usual credit were not forthcoming from London and, in order therefore to maintain her own trade and to enable her allies to obtain the goods they needed, she encouraged the British 1. banks and financial houses in buying up bills of exchange. Thi s encouragement was given by the government's action of guaranteeing the price of bills of exchange. A s the war went on the productivity of the belligerent countries declined and their imports came to greatly exoeed exports so that there was always a greater supply of bills-of-exchange against them than the demand for them. Londo n was always the beet market for this surplus, and it always accumulated there. 1. Hartle y Withers - The War and Lombard Street. - 3 7 Whan th e Unite d State s entere d th e wa r the y beoais e th e ahie f source o f flnanoe * for th e l l l l e e , an d 1  4u wer e grante d b y the n t o a l l th e nation s o f th e Entente . Afte r th e olos e o f th e war , however , the Unite d State s stoppe d grantin g o f governmenta l loans . Privat e f ine) l a th e Unite d State s har e show n l i t t l e desir e t o gran t o r edit to peopl e o f Europea n countrie s othe r tha n (trea t Britain , an d s o British financier * har e I n th e en d ha d t o tak e u p practicall y a l l the b i 11 s-of-earchange agains t Europe . This actio n o f Grea t Britai n i n flnanain g th e lat e bell igerent oountrio o ere n a t th e oos t o f lowerin g th e valu e o f her ow n currenc y I s no t onl y desirabl e i n orde r t o enabl e th e lat e bell igerent oountrio o t o obtai n th e goods , whic h the y ar e e o great -ly l a nee d of , bu t I s neoessar y t o Britis h prosperity . Speakin g o f this 81 r Oeorg e Pals h says t "I n thi s situatio n th e nation s whic h haw* eithe r no t suffere d fro m th e wa r o r har e suffere d bu t l i t t l e are fac e t o fac e wit h th e fac t tha t unles s the y oontlnu e t o suppl y produce an d good s t o th e nation s s o severel y injure d b y th e wa r a very larg e par t o f th e populatio n o f Europ e wi l l starve,an d tha t 1. the Europea n market s fo r thei r good s w i l l b e destroyed. " England l a now,a s i t ha s bee n fo r years , th e Internationa l an—j market , an d starl in g exchang e ha s bee n depresse d belo w par -nhaslnf. powe r parit y o n account , no t s o muc h o f a n advers e trad e balance a f Grea t Britain , bu t becaus e exchang e o n Londo n ha s com e U re f lec t th e torade  balanc e o f Europe . Orea t Britai n stand s I n quite a  soun d financia l position , bu t sh e owe s he r 1  — H a te debt s 1 . Oontamporar y Bevie w -  September , 1919 . - 3 8 -to a  oountr y whic h owe s nothing , an d ha s he r immediat e credit s I n oountrlee whic h har e nothin g a t presen t wit h whlo h t o pay . This proces s woul d no t har e bee n possibl e t o carr y o n had I t no t bee n fo r th e oredi t inf lat io n I n Grea t Britain , fo r with a  balanc e O f payment s alway s agains t he r I n thi s way , i f th e fjr paymen t gold ha d bee n access ib le / I t SKIS * har e bee n Tor y greatl y reduced . 9 M credi t inflatio n whic h ha s occurre d throug h thi s accumulatio n Of Continenta l bille-of-exohang e ha s lowere d th e pric e o f sterl in g exchange, an d throug h i t th e purchasin g powe r o f th e Britis h currency. Whether the price of exchange follows the purchasing powor parity, or whether purchasing nower parity follows the ex~ nhsngo rate, may be a matter of question* but the depressing effect of inflation oa both purchasing power and price of exchange is well illustrated la the case of Great Britain. on exchan^ rates The effect of the German indemnity/and war loans has not been of Tory groat importance, so far, except in the case of Germany. U p to the present no interest has been paid on war loans, aad only a small portion of the indemnity. Th e small indemnity payment caused a Tory severe fall in the quotation of the marie Since all the nations itiioh owe indemnity and most of those which hare loans to pay hare already unfavorable trade balances, the pay-•eat must toad to further depreciate the value of their currencies in exchange. - 3 9 -The governments of the countries whiah bars received large loans,and whloh hare Indemnities to pay, hare been unable to flnanoe their current expenses out of taxation* and bare been foroed to resort to farther Issues of paper, slnoe the olose of the ear. I f they are required to sake large Interest or lndeisnlty payments they must resort to further Inflation. Th e governments may thus receive the funds with whloh to pay their obligations, but this Is by no means a settlement by the country. I t merely adds to the government's liabilities at home in the shape of paper currency, and to the country's floating debts abroad. Th e only way in which these countries may pay their debts is by developing an excess of experts orer imports, and th e only way in whloh the governments of these countries may obtain the funds with whloh to pay them, without further inflating their currencies, is by tax-ation. Tha t the debtor countries can do this in the near future is impossible; that they can ever do it is doubtful. It will be seen from the above that the prloe of sterling exchange is not dependent on the condition ef the United Kingdom alone, and that any plan to stall Use th e sterling exchange rate must also include the correction of conditions on the oontinent of Europe. - 4 0 -GHA.PTEB 71. THE C0BEEJTI0K OP THE EXCHANGES. The recognition of the detrimental effects of fluctuating exchange rates on trade and industry have led many people to formulate plans for their correction. W e have seen that tiie con-dition of sterling exchange is not due to British trade and finan-cial conditions alone, and that sterling cannot be stabilised by the action of Great Britain only. I f the gold standard of the British currency were restored, the stability of exchange between the United Kingdom,and the United States, and other gold standard countries would be restored, but sterling exchange would be subject to as Tiolent fluctuations in Paris and Berlin as exchanr,-e on the United States is now in those places. Furthermore , we have seen that the possibility and desirability of maintaining the gold standard of the British currency is questionable, unless the stabil-ity of the Continental European currencies is also established. The unstable condition of the exchange rates is itself an erll which requires to be remedied, but it is the result of other conditions which it tends to aggravate. Th e price of billo-of-exohange against most of the countries which engaged in the war is depreciated on account of the inconvertibility of their curren-cies Into gold. Shi s has been brought about by the methods of governments! finance necessitated by the war. Th e fluctuating 41 exchange rate s ar e barrier s i n th e retur n t o prosperity . Th e im -poverished conditio n o f th e countrie s render s thei r govertanent s usable t o flnano e themselve s ou t o f taxation , an d consequentl y the y must resor t t o mor e issue s o f pape r money , i n orde r t o pa y thei r expenses. Thu s th e depreciatio n o f th e currenc y i s farthe r in -creased. Among th e suggestion s fo r correctin g th e exchange s mad e are a  sombe r fo r th e adoptio n o f internationa l currencies . Suc h i s the Tanderll p suggestion . "Mr . 7anderli p propose s t o inaugurat e a great financia l Institutio n wit h a  capita l o f fl,000,000,00 0 pai d In l a gold * th e gol d t o b e use d a s reserv e fo r th e issu e o f $6,000,000,000 l a note s fo r circulatio n i n th e stricke n countries. " The pla n ha s th e followin g faults t (1 ) Th e gol d t o bac k suo h a ourronay woul d har e t o cam e fro m th e Unite d States , an d the y sho w no grea t desir e t o suppl y i t ; (2 ) Unles s th e government s withdre w the lega l tende r privilege s fro m thei r presen t pape r issue s th e 2 . new currenc y woul d no t ente r int o circulatio n an d would thu s only b e use d fo r payment s betwee n countries . Th e trader s vroul d b e famed wit h th e sam e fluctuation s i n th e price , i n thei r currency , of th e Internationa l currenoy , a s the y ar e now , i n th e variation s In th e prio e o f exchange . I t i s ver y improbabl e tha * th e Europea n countries woul d b e wi l l in g t o thu s repudiat e th e obligation s 1 . Anderso n .  Ohas e Boonomi o Bulletin , January , 1922 . 2 . Oresmam' s Law . - 4 2 -repreeented by their circulating paper, and they oould not redeem them except by a further great increase of their debt to other countries. I f they could stand this additional debt, and the funds were available in ether countriea the outstanding paper oould be reduoed ta the volume which oould be maintained convertible, and no further motion would be necessary. Other plans for International ourreneies propose a ourranoy met backed by gold, but by land values. ' fiie supporters of suoh suggestions point out that much of the ourrenoy of the oountrlea of the world is unsupported by actual gold or silver, •worn whom their currencies are convertible. The y aay that the value Of the ourrenoy ia maintained by its limited quantity, and met by its redemption in gold or silver. Wha t suoh people nagleot to notice lo that it la the convertibility of ourronoie* into the precious metals whioh assures people that the quantity issued will mot bo exoeeslvo* th e convertibility of the ourrenoy is an auto-matic cheek on too groat an expansion i n volume; the scheme would substitute for this ohock the decisions of an administrative board* The plan would solve the difficulty of the exchanges by providing ample supplies of ourranoy, eecured by a mortgage on real property; but way suoh ourreneies backed by the property of individuals would have more value than the preeent ourrenciee backed by the total assets of countries is difficult to see. I o ourrenoy 1. J . r. Jacobs - The Annalist, December, 19th, 1921. - 4 3 -has ever proven satisfactory which was not redeemable in seme portable commodity of value. Another suggestion is to restore stability through the pegging of exchanges, as was done during the war. Such , a course would certainly prevent exchanges from fluctuating widely, but that It would mitigate the evils to which fluctuating exchange rates are due is very doubtful, th e pegging of exchange rates depends for its support on foreign borrowing* and it is questionable if the funds would be forthcoming for the purpose. Thi s is a difficulty in the way of putting suoh a plan in operation. Th e beneficial effect of the gold standard of currency on trade is that is auto-matically acts to oorreot trade balances, but does not aot with suoh violence as to demoralise trade entirely. Unde r the inconvertible paper standard the exchange rates are subject to variations on account of the balance of immediate payments, in that a balance of payments against the country will depress the exchange rate below purchasing power parity, while a balance to the country will raise the exchange rate above purchasing power paxity. Bu t the exchanges are subject to ether influences also, and respond so greatly to these influences that they are a restriction on all kinds of trade, even that whioh would restore the balance. Unde r a i*>gt&&  exchange there is no tendency to keep the balance whatever. I f the exchange rate is pegged above purchasing power parity Imports are encouraged at the expense of an Increase of the governmental debt abroad. I f - 44 -the exchange rates are pegged below purohaaing power parity the people mist pay very highly for their necessary imports, and com-peting industries in other countries are at a very great disadvan-tage la foreign markets. Sons optimists think that trade conditions will be re-stored of themselves, through the influence of the exchange rate* on imports, and exports. Condition s in Surope of late tend to support this view, but this Is only because the balance of immediate payments has depressed the price of exchange against these countries very mnoh below purohaaing power parity. Export s will therefore be stimulated until the nrioe of exchange rises approximately to purchasing power of the ourrenoy. Foreig n trade will never, however, restore the ourrenoy to its nominal gold parity, and therefore convertibility will not be restored by this means alone* A s long as a country*s ourrenoy remains Inconvertible, the rate of exchange on such a country will be subject to very great variations, except in the oase of pegged exchanges. Ihe wide fluctuations in the price of exchange against the European countries are due to the inconvertibility of the ourrenoy of these countries in gold, and this inconvertibility is due to the increase in the bank deposits and paper mc-iey. Th e only method of bringing the rates of exchange back to the stability of pre-war days is the restoration of gold redemption,and this can only be tone by a reduction of the volume of the depreciated currencies. - 4 5 -The reduotion may take plaoe in either or both of two waysj by reducing the roaabor of outstanding units of the currency, or de-claring a liwer gold parity of the unit of currency. Fo r most of the European countries the reduction of the volume of currency by the calling In of the excess circulation would appear to be an almost impossible task, for their governments, seeing that so far most of the governments have been unable to defray even their current ex-penses by taaation. Thei r task would be made very much more easy if they undertook redemption at about the present gold value of the currency, W * have seen that It is not ao much the depreciation of the oarrsnoy which la detrimental to trade as the Instability of any rate of exchange. Th e maintenance of any gold parity woald stabilize the vat* of exchange and in tiire all 'rices would become adjusted to the new unit of currency. The recent rise in the orlce of sterling exchange and the fact that the British government has not found it necessary to re-sort to the creation of new credit to any extent, show that, in the case of Great Britain, the lowering of the gold parity of redemption Is not necessary. Sterlin g is at a discount of about 1<# in Hew York. I t would be foolish to give such a blow to the British re-putation for stability as the adoption of a lower gol* parity of the pound would involve, except in case of absolute necessity. Ths oass of moat other European countries is very dlffsrsatt thsl r currencies are much mors greatly depreciated, they - 4 6 _ hare a  grea t volum e o f foreig n wa r debt s an d fe w externa l aaseta , and fa r fro * bein g abl e t o reduc e thei r circulatio n the y har e bea n forced t o pa y par t o f thei r curren t expense s b y fres h Issue s o f paper money . The ste p o f adoptin g o f a  lowe r gol d parit y o f th e oorreno y la on e whic h mos t government s w i l l heaitat e t o take,Invokin g a s i t does a  partia l repudiatio n o f th e governments ' an d othe r peoples ' debts. Ther e i s I n th i s a  oertal n amoun t o f Injustic e t o pas t creditors. Bsople , wh o loane d mone y befor e th e depreciatio n o f th e currency, wi l l b e force d t o accep t paymen t i n currenc y commandin g a smaller quantit y o f gol d an d havin g l e s s purchasin g "tower . Th e changing purchasin g powe r o f mone y ha s alway s bee n a  sourc e o f in -just ice , however , an d thi s woul d onl y mea n a  standardiratio n o f th e gold valu e o f th e cu-reno y a t i t s presen t leve l . Th e restoratio n o f the ol d gol d parit y o f th e currenc y woul d Involv e a  simila r injust ic e to thos e wh o hav e contracte d debt s sinc e th e depreciatio n o f th e currency fo r I n liquidatin g thei r lebt a the y woul d b e reouire d t o pay currenc y havin g a  rsuo h greate r purchasin g powe r tha n tha t whio h they borrowed . Th e grea t bon d issue s o f th e wa r were take n ut > with a depreciatec " currency . Ther e woul d certainl y b e a  ver y prea t in -justice t o ta x payers , shoul d the y b e require d t o pa y th e Interes t and prlnoipl e o f thes e i n a  currenc y havin g th e pre-wa r gol d value . These injust ice s nigh t b e avoide d b y makin g som e discriminatio n I n the valu e o f loan s accordin g t o th e tin e a t whic h the y wer e made . - 4 7 -hot th a gre* t tranefereMllt: - o f debt a l a th e shap e o f bonds , mortgages, a  t o ,, mica s I t larooeibl e t o ascertai n wha t th a purchas -ing powe r o f th a ourranoy . wit h whic h tha y war a bough t b y th a prooont holder * waa . Whateve r th a injuatlo e th a lowerin g o f th a gold parit y o f th a ourrano y » » W inrelre . I t l a naoaasar y I f tax -at iea canno t b e iaoraaaa d anoog h t o ratIr a th a axoaa a o f aradl t l a tha praaan t onrrenolee . Boo h haar y taxatio n woul d h a aor a burdan -aaaa an d probabl y aor a iaaqoitabl a tha n th a reconntio n o f apaol a paymenta a t a  lowa r parity * la orda r fo r an y gol d parit y o f th a ourrano y to  b a nevln -tainad anoug h apaol a roeerr o eas t b a suprlle * t o radaa a an y ourrano y which l a praaaata d fo r radaaptlon . Th a exist in g col d raaarra a l a aoat o f th a Baropaa n countrie s ar a lowe r tha n ooulr t aaaur a th a oon -1. v e r t l b l l i t y o f th a ourrano y l a eve n a  rar y aodarat a oriala . Tha resumptio n o f apaol a mynent a o n an y gol d narlt y w i l l maaa tha t paymen t fo r a l l mature d l i a b i l i t i e s hel d abroa d wi l l b a immediately demande d fo r t  ar a w i l l b a n o expectatio n o f a  grea t rlae i n th e nrlo e o f M1 1 e-of-exohani>e I n th e future . Therefor e a l l suoh mature d l i a b i l i t i e s ma t b e replaoe d b y 1  >ng tar n loana . In eate r tha t th a onrrenole e o f th e oountrle a o f denre -olated onrranela a na y no t b a agai n rendere d inconvertible , th e goraraaanta moa t flnano e th e eelTe a entirel y ou t o f taxation . I f waay ar a agai n foroe d t o resor t t o laaua a o f <mve r aone y t o financ e the io lTaa, th a oarraaa y aua t b a farthe r dapraoiata d an d agai n TI aeper t o f th a lraaaal a Monetar y Conference . - 4 a -rendered inoonvert ible . /a y balaa^in j o f gover/fcu&n t Budget s i n -volves measure s o f a n i n d u s t r i a l , a  p o l i t i c a l , an d a  f inancia l na ture . Industr ie s shoul d b e organize d s o tha t ther e woul d b e les s expenditure :ieoee3ar y o n th e r a r t o f government s o n accoun t o f un -employment. Th e cancel lat io n o f wa r debt s an d indemnitie s woul d re l ieve taxat io n problem s ua.teria.lly . Thi s woul d b e t o a l l nation s an econoni o advantage , bu t i s l i ke l y t o b e decide d o n p o l i t i c a l 1. ra ther tha n economi c i s sues . T.n e reductio n o f governmen t expen -Idture o f a l l kind s woul d r o l i e / o taxatio n 3o--iethin g /ugh l b e don e by th e decreas e o f armaments , bu t t h i s i s a ls o a  p o l i t i c a l Question . TThatever i 3 don e alon ^ l i ' ie s o f reducin g eXjOenditure , th e 'government s and peopl e *ais t lear n tha t publi c e x tenses iius t b y a i d ou t o f taxation o r t-e y canno t avoi d th e disadvantage s o f th e flact;uAtin g purchasing oowe r oi " thei r ourrenoie s an d unstabl e oxcliang e r a t e s . She ra t e o f excliaug e i s a n inde x ->~  financia l an d in -dus t r i a l condition s an d eve n i f th e Jieas-are s abov e wer e take n th e s t a b i l i t y o f exchan, ^ coul d no t b e maintaine d unles s som e innrovaoi t v,r>re iiad e i n industry . Export s inus t h e sufflo»fcn t t o _,a y fo r I're -po r t s . 8houl d thes e measure s b e taken , however , trad e an d industr y w i l l b e rel ieve d fro m th e check s o f widel y varyin g excham^ e rate s and fo r tha t reaso n th e countr y w i l l b e i n a  muc h be t t e r positio n t o maintain the i r tr-.d e balances . The s t a b i l i s a t i o n o f s t e r l i n g exchang e de"end s o n th e s t a b i l i s a t i o n o f th e exohange s o f th e pr incipa l 2urpeea n countr ies . 1. Bas s an d Haulto n "amerlo a an d tn e Balanc e Shee t o f Europe" . - 4 9 -On the part of Great Britain essentially the saiae measures are required, but the carrying out of these measures would not be so difficult, for the inflation of the British circulating oredit is not ao great, and therefore ao great a reduction of the rolume of •aoh oredit ia not required. Th e British trade balanoe and balanoe of budgets baa been nearly, if not quite, maintained, and therefore these things offer small difficulties to the restoration of the oonrertibillty of the ourrenoy. 


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