THE GOLD STANDARD.

Hauraki Plains Gazette, Volume XXXVI, Issue 4828, 1 April 1925, Page 3

THE GOLD STANDARD.

modern meaning of money. banking and credit evplained No. 2. Following is the .continuation of the- speech delivered by the Rt. Hon. K. McKenna, chairman of the Midland Bank-, Ltd., on the principles of the gold standard, the first part of which appeared in our last issue :— CENTRAL BANK CONTROL. The cash held by the banks consists of currency and balances at the Ban* of England. We shall not go far asiiay if we confine our attention to the Bank of England balances and leave currency out of consideration, as the causep which affect the foiniei usually govern the amount of the latter What is it that sends these balances up and down? For an answer I get back to the old formula, applying it now to the special case of th? Bank of England. When the Bank of England makes a loan or discounts a bill or buys a security, or, indeed, anything, it creates a deposit, which in the ordinary course of trade becomes a deposit of one of the banks with the Bank of England itself. In the same way, when the loan is paid off or the bill met or the -security sold, a deposit of some bank with the Bank of England to the amount of the loan, bill, or security is cancelled. Thus th- action of the Bank of England m lending or calling in, buying or selling regulates the cash held bj the other banks, and inasmuch as this cash is the basis of their, loans to the public it follows that the Bank of England ultimately controls the amount of deposits, that is to saj, the amount of mondy. The capacity to increase or diminish the quantity of money, and thereby to depreciate or enhance its value, is inherent in the ordinary, powers of a central bank. If the currency is on the gold standard this power can only be exercised within narrow limits, as the movement of gold will vciy soon act as a check ; but where this standard is not in operation the full responsibility for maintaining the value of money falls upon the central bank. The obvious guides to the central bank in directing its policy are the movements of the price level and the geneial istate of trade' and employment. The price level is not of itself sufficient indication, as rising prices may be due not to an over-abundance of money, but to an under-supply of goods available for purchase, consequent, for instance, upon a temporaryshortage'in the world supply of food and raw materials. In such a case a restriction of credit would tend to keep prices down, but it would be at the expense of trade, and would-lead to increased unemployment. On the other hand, falling prices might be due to exceptional abundance of natural products, and in that case'an increase of credit would have an in-flationary-effect. Constant vigilance is needed on the part of the central bank to ensure that the causes of rising or falling prices are correctly diagnosed; Nor does the need foi vigilance end here. Many central banks do commercial business for their own customers. They not only meet the needs of the money market in the temporary fluctuations of supply and demand, but they make domestic and foreign loans on their own account quite independently of the market conditions at the moment. Such loans may cause excessive ease of money; their repayment excessive stringency; and unless care is taken to ' counteract these effects when necessary by a sale or purchase of securities trade will be unduly stimulated or unduly depressed. GOLD AS REGULATOR OF credit. 1 have dealt- with the factors governing our present currency whicn, so far as it consists of currency notes, is only limited in its qauntity by the control of credit. In the customary phrase of the day it is a “managed” currency of the United States, must limited in amount by legal enactments, which, usually lakes the form of a restriction of issue except against gold. Beyond the fiduciary issue, £lB,150.9’00 before the war and £19,750,000 now, Bank of England notes have to be covered pound for pound by goldFederal Reserve notes, the principal currency of the United tSates, must have a minimum cover of 40 per cent, in gold; and 30 per' cent, must be held against the notes now being put into circulation by the Reichsbank. Similarly the new currencies which are being established in other parts of Europe all have some definite relation to gold, conforming in this respect to the principle of limitation of issue almost universal before the war. The pre-war restriction on the Bknk of England note issue operated in practice as a restriction on credit in consequence of the maintenance by the bank of a fairly constant ratio of reserve to liabilities. Since the introduction of the currency note, however, there has been no such strict adherence to a customary proportion. In other countries credit control has been provided for in some cases by statutory requirement. Thus the Federal Reserve Banks of the United States are obliged to maintain a minimum cover of 35 per cent, in legal tender against the demand deposits held with thdm by their member banks,- and the new Reichsbank Act prescribes a reserve of 40 per cent, in defined liquid, assets against day to day obligations.

When a currency is on a gold basis its value is fixed in relation to one commodity only, namely, gold. We are apt to think that the value of gold is constant because so many grains are always exchangeable for a sovereign. •, But how unstable it may be in relation to commodities in general is shown by the recent history of the dollar, the purchasing power of which jn 1914 was two and a half times greater than in 1920. It will be found that while through the centuries gold in terms of goods and services has ■ continuously depreciated, it has undergone considerable fluctuations in ■ quite short periods of time. The value of gold, like that of any other commodity, varies with changes in sup-

ply, demand, and cost of production. Each of these factors is constantly undergoing slight modifications, but from time to time great events occur which cause a permanent change in their relationship. Of this nature was the discovery of the South African mining field, and more recently the reduction in the effective demand for gold arising from the mobilisation during the war of hoarded stores in the belligerent countries. CHANGES IN VALUE OF GOLD.

We are all familiar with the conditions under which an ordinary trada commodity falls in value. Sellers offer more than buyers will take at the current price and the price is reduced. But in the case of gold the process is not so simple. Sellers of gold can always obtain the full statutory price for their commodity in a gold standard currency, and there must be a depreciation of the currency, that, is to say, an upward movement in the price level, before there can he a reduction in the real return for the gold. How this depreciation happens is worth considering. The explanation is much simplified in present circumstances by the fact .that there is now only one completely free gold market, the United States, and we can therefore restrict our view to what occurs in that country. When gold, whether of native or foreign production, is offered for sale to any of the Federal reserve banks, it will be bought at its full rate of so many grains weight for a dollar. As the Federal reserve banks are; central banking institutions, we remember that the effect of a purchase by any one of them is to create sb much additional cash standing to the credit of the member banks. It is hardly necessary to repeat, that this cash becomes the basis of additional loans, which create new deposits, or, in otliar words, increase the purchasing power of the public. Increased purchasing power unaccompanied by greater production leads to higher prices, and thus we complete the chain of events by which a purchase of gold is connected with a decline in value of the currency.

It is obvious that, if the Reserve Bank sells securities or reduces the bills in its portforio by an amount equal in value to the gold it buys, the two transactions cancel each other so far as they affect the balances of the member banks. In such case the Reserve Bank has substitut'eW goid in its assets for securities or bills. Nothing more will have happened ; there is no change in the deposits of the member banks, no increased purchasing power in the hands of the public, and no decline in value of the dollar. - But the Reserve Bank cannot adopt this course except at a sacrifice of profit, it must exchange its profit earning assetp for gold which bears no interest, a policy which-obviously cannot be carried beyond a certain point. There is a limit to the reduction in profit-earning jissets, and even a Reserve Bank has to consider the desirability of defraying expenses out of income and of meeting the demands upon it for dividends. EFFECT OF GOLD IMPORTS. During a. period of fifteen months the effect of an inflow of gold in creating an expansion Of credit was successfully counteracted, and it is interesting to note the actual course of events as recorded in the consolidated statement of the twelve Federal Reserve Banks. In April, 1923, 23 per eent. of the total assets consisted securities, 60 per cent, consisted of pire s([iq se qons ‘sjossb Suiiubo jo goid, and the remaining 17 per cent Qf other non-earning assets. In July, 1924, the corresponding figures showed 17 per cent, earning assets, 66 per cent gold, and 17 per cent, other nonearning assets. Since then earning assets have increased to 24, per cent., which has meant an upward movement in the balances of the member banks, and a very considerable' addition to the purchasing power of the public. The figures suggest that the Federal Reserve Board felt last summer that they had gone far enough in tlie policy of sacrificing earning assets in order to neutralise the effect of the incoming gold.

The larger movements In the sterl-ing-dollar exchange have followed the course of the policy of the Federal Reserve Board. That policy has determined rates for money in the United States. When rates of interest were high floating balances were held in New York, and dollars bought in order to lend in that centre. When rates were low dollars! w r ere sold and floating balances in sterling retained in order to lend in London. Thus money rates may exercise a powerful though temporary influence on the exchange through the transfer of balances. Ultimately the rate of exchange must approximate to the relation between the price levels in the two countries, but although * this, is the dominant factor, there are other influences to which the exchange, is sensitive,,and which operate upon it before the movements in price level can exercise their full effect. There its, moreover, such a thing as intelligent anticipation, and those whose business it is to understand the underlying conditions affecting exchange take their view of the market and act accordingly long in advance of any change in commodity prices. The recent rise of sterling in relation to the dollar has gone considerably ahead of changes in price level, but if the rise is maintained we may be sure the price levels will finally conform to the new relation of value between the currencies.

SUPERIORITY OF GOLD STANDARD

Let me summarise in a sentence what I have said so far. I have endeavoured to explaind the meaning of a managed currency and the method of maintaining its value by regulating the quantity of money through, the control of credit, and I have shown that during the last three years a managed currency has been kept more stable than one based on gold. We can supplement this favourable view by the further observation that considerable economy is effected by its use, as there’ is no need to incur the cost involved in buying and holding gold as a reserve. But when so much has’been said, and it must be granted that'it is a great deal, the case for A managed currency must be regarded

as closed. On the other hand, the gold standard has in existing circumstances great and striking advantages. In the first, place it establishes an international measure of value, common to the whole world and universally accepted. It is atuoinatic in its operation, and it relieves the central banks of a responsibility which, notwithstanding our own fortunate experience, might not always be discharged with the knowledge and judgment indispensable for the prosperity of national trade. It is not, however, wholly inelastic. There is still scope under it for an exercise of discretion by the central institution, as we have ■seen in the recent action of the Federal Reserve Board. In our own country the effect of a movement Of gold can to a considerable extent be counteracted by the Bank of- England raising or lowering the ratio of renerve to liabilities.

But in the present state of knowledge and feeling one of the greatest advantages of the gold standard is its moral effect. A nation will think better of itself, will almost regard itself as more honest, if its currency is convertible into gold.. The fear of being forced off the gold standard acts as a. salutary check on the extravagance of Governments who might be willing to (ace a mere fluctuation in exchange, but would not dare to suspend specie payment. It is a real advantage to a nation to have a currency founded upon a value which is universally recognised; it inspires confidence and facilitates international transactions. Even if the gold standard were hot preferable for other reasons its universality would be decisive in its favour. The argument may, it is true, be founded on psychological and not on economic grounds, but it is none the less powerful, as we have not yet reached the stage where economic considerations alone guide us in judging the desirability of any particular method or system. So long as nine people out of ten in every country' think the gold standard the best, it is the best. If in the future .there should be an immense increase or decrease in the output of gold, and consequently a startling rise or fall in prices, reconsideration of the subject might be forced upon public attention, but at present there is no single nation, so far as I know, which is now off the gold standard, that does not regard the return to it. as the most desirable of all financial measures.