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portant enough to be worth the trouble. In so far as the purchasing power of gold can be stabilized, that in itself will stabilize the dollar without changing the quantity of gold in it. Something can be done in this direction by a skillful handling of the problem of credit and credit currency.

It was shown earlier in this chapter that the enlarged use of credit enables a country to carry on a given amount of business with less gold than would be necessary if no credit or less credit were used. This furnishes a clue to the solution of the problem. If the use of credit were restricted, it would take so much gold to do the money work as to affect appreciably the total demand for it. So much would have to be withdrawn from the arts to supply the need for currency as to make a genuine scarcity. The users of gold in the arts would have to bid for it in order to hold an adequate supply. This would tend to give it a higher purchasing power.

Since about 1897 the purchasing power of gold the world over fell continually until 1920. This was doubtless due mainly to remarkable increase in the world's production of gold which began about ten years earlier. At the same time, however, the use of credit instruments had been growing in the principal goldusing countries, and a smaller percentage of the world's business was being transacted with actual gold as the medium of exchange. This tended to reduce the demand for gold below what it would otherwise have been. These two forces, working together, produced a steady decline in the purchasing power of gold and a steady rise in commodity prices.

During the World War there was a phenomenal increase in the use of credit currency which resulted in the almost complete nonuse of gold. The principal gold-using countries of Europe practically abandoned the gold standard, at least temporarily, and went on to a paper-money basis; that is, they issued such quantities of credit currency and sent such quantities of gold abroad in international payments as to make it impossible to redeem paper with gold. Paper money of course depreciated, even in terms of gold, and prices in those countries, quoted in terms

of depreciated paper currency, soared much higher than in this country, where prices continued to be virtually gold prices, since we maintained the parity of gold and paper. Those European countries practically released all their gold and threw it onto the markets of the world, much of it coming to this country, literally flooding our market with it.

In the United States we found ourselves with more gold than we knew what to do with. Instead of using this vast supply of gold as currency, which would seem to have been the part of wisdom, we took pains to use very little of it, using, instead, more credit currency than ever, especially in the form of Federal Reserve notes. The monetary policy seems to have been aimed principally or almost exclusively at the maintenance of the parity of gold and paper and not at all at the maintenance of stable prices or at stabilizing the purchasing power of gold. We seem to have taken some pride in the fact that our paper currency has not depreciated in terms of gold, overlooking the fact that gold itself depreciated in terms of commodities. The fact that any kind of a dollar will purchase as much as a gold dollar is of course a matter of some importance, but it would have been much more satisfactory if the gold dollar had not lost so much of its purchasing power and prices had not risen to such unprecedented heights. If the increased volume of business occasioned by the war had been carried on without any increase, or even with some decrease, of our credit currency, it would have taken so much gold to do the work-in other words, it would have so increased the demand for gold-as to give it a purchasing power much higher than it had. We should thus have been saved from the enormously inflated prices of the war period and the train of evils that followed them.

That there would have been some difficulties with such a policy goes without saying. It is merely a question whether we think that the evils of inflation and deflation are serious enough to justify the cost of preventing them or not. In order to stabilize or help to stabilize the purchasing power of gold

it is necessary that the use of it or the demand for it shall increase in times when its value is falling and decrease when its value is rising. The way to increase the demand for it when its purchasing power is falling and commodity prices are rising is to use fewer substitutes, thus forcing people to use more gold. The way to decrease the demand for it when its purchasing power is rising and commodity prices are falling is to use more substitutes and release some of the gold from circulation. In other words, when commodity prices are rising (which means that the purchasing power of gold is falling), credit currency should be reduced until the increased demand for gold would arrest its further fall; and when commodity prices are falling, more credit currency should be issued until the decreasing demand for gold would arrest its further rise. This would require not only expert statistical calculation and management but also great wisdom on the part of the people to avoid political tinkering with the process, but the difficulties are inherently no greater than those involved in changing the quantity of gold in the dollar.

Two kinds of elasticity. One of the first difficulties is a purely educational one; namely, that of correcting our ideas of an elastic currency. As ordinarily used, that term means a currency that expands when business is unusually active and contracts when business slows down. Such a currency is said to respond to the needs of business. When buyers are active and anxious to buy a great deal, this kind of a currency gives them the means of buying. When buying is inactive and buyers are not trying to buy much, they do not need so much money, and it should therefore decrease in quantity. It is commonly assumed that this adjustment of the supply of money to the demand for it is desirable. It is not improbable that over long periods of time more business will be done, with less inconvenience and friction, when the currency behaves in this way than when it behaves otherwise. It enables people to "make hay while the sun shines," to "get while the getting is good," etc., but it also forces them into periods of inaction and

business stagnation. In short, this sort of elasticity in the currency increases business activity when it is active and retards it when it slows down. The policy outlined in the preceding pages would do the opposite; that is, it would retard business activity when it was active and stimulate it when it showed a tendency to slow down. It is a question whether this is not a better kind of elasticity.

As to the actual methods by which credit currency can be made to decrease, or kept from increasing when business is very active, an easy but not very effective method is that of changing the rate of bank discount. When business is active and the demand for bank credit keen, the banks would naturally, if they were permitted to follow their own interests, raise their rates of discount, which means, virtually, that they would charge a higher rate of interest on their loans. This would have the effect of discouraging borrowing and reducing the use of bank credit below what it would be if rates were low. Again, when business is inactive and the demand for loans decreases, the tendency is to lower the discount rates or to lend bank credit on easier terms. The Bank of England, for many years before the World War, exercised great control over the monetary situation by pursuing this simple policy. Our Federal Reserve Banks have performed the same function to a certain extent, though sometimes interfered with by the mistaken policy of the Secretary of the Treasury.

CHAPTER XXVIII

BANKING

Promises to pay. Where business is done on the basis of voluntary agreement among free citizens it is probable that many kinds of agreement will be made. Among these many forms there will probably be promises to pay money or to deliver some desirable object at some future time. In order that such promises may be accepted, one or both of two conditions must exist. First, and most important, the receiver of a promise may have confidence in the maker of the promise, both as to his honesty and his ability to fulfill his promise. Second, the receiver of the promise may have confidence in the power and the willingness of the government to compel the maker of the promise to keep it. Unless one or both of these forms of confidence should exist, promises to pay are not likely to have much value or to be accepted widely.

Need of institutions to deal in promises to pay. In all countries where confidence exists (that is, where men are generally honest and governments reasonably efficient) these promises come to play a large part in free and voluntary exchange. The mass of such promises and the habit of dealing in them have come to be called the system of credit. The most common of these promises are promises to pay money. So common have they become, and there is so large a volume of them, that they call for special institutions or business establishments to deal in them. These establishments are now called banks. The term "bank" originally meant the bench before which the money changer sat, with his coins stacked up before him. When he failed in business his bench was broken up, hence the word "bankrupt."

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