1922 Encyclopædia Britannica/Inflation

INFLATION.— As with most economic terms in popular use, analysis shows that "inflation" has different meanings with varying contexts. It is sometimes used as equivalent to a general rise in prices, but a general rise in prices may be due to causes primarily associated with commodities, e.g. scarcity. Even if the term is confined to money (metallic and representative) it is possible that a general rise of prices may take place which although due to monetary causes cannot properly be described as due to inflation. In former times a frequent cause of a rise in prices was the debasement of metallic money. Debasement does not of necessity mean depreciation, and the depreciation need not be in exact proportion to the debasement. Much of the reasoning of Thorold Rogers, in his great work on the History of Agriculture and Prices, on the debasement of the English currency by Henry VIII. was vitiated by the failure to recognize that debasement of money in general only acts on prices in so far as the debasement leads to an increase in quantity. Such an increase in the quantity of money consequent on debasement is not usually called inflation, though clearly analogous.

A general rise in prices may also take place through an increase in the metal or metals available for money although there is no debasement of the coinage. The rise in prices in the 16th century so far as due to the new silver, and in the 19th century the rise due to the new gold in two periods, can hardly be described as caused by inflation. The gold standard implies that values are measured in terms of a certain weight of gold of a certain fineness in any country in which the gold standard is effectively maintained. In different countries values on the gold standard are compared by the amount of fine gold in the standard coins.

Very great discoveries of gold, or even the artificial production of gold, would not of necessity mean any departure from the maintenance of the gold standard. Prices might rise indefinitely and the value of gold relatively to things in general fall indefinitely, but it would seem a misuse of language to speak of the "inflation" of gold. Such an increase of gold may and probably will cause an increase in prices, but in neither case is the increase of gold properly called inflation.

In the interpretation of popular terms there is, of course, no decisive test, as the usage varies; but by the application of the historical method the origins of the different meanings may be traced, and the search for the meanings will, as Sidgwick showed, throw light on the corresponding facts.

Before the World War the term "inflation" was in general applied to paper money. The paper money was thought to be inflated when the amount was greater than if the paper were strictly convertible or definitely related to the metallic standard. From this point of view inflation would now mean an abandonment of the gold standard, together with a consequential increase in the quantity of the currency in which prices are expressed. This is the interpretation given to inflation by Francis A. Walker. "A permanent excess of the circulating money of a country over that country's distributive share of the money of the commercial world, is called inflation" (Political Economy, 1887). His subsequent treatment shows that Walker had in view an excess of paper money consequent on partial or complete inconvertibility.

In theory it is possible to control an inconvertible paper currency in such a way that there should be neither specific nor general depreciation as compared with gold. But experience shows that, in general, when notes have been made inconvertible they have been subjected to over-issue, with consequent depreciation, specific or general, or both. Over-issue in this sense is another name for inflation.

It seems best, however, to distinguish between the fact of over-issue and the consequent depreciation. Over-issue might take place with inconvertibility, but the depreciation, whether specific or general, might be delayed. The annulment of the restraints imposed by the gold standard allows inflation to take place, but the degree of the depreciation (if any) depends on the quantity of the new paper money (with the credit based on it) and the demand for it.

In the natural course of the progress of a nation, with the increase of population and trade, a greater amount of money is required for cash transactions. With the gold standard in effective working order the additional money required might be obtained by the expansion of convertible notes and of the various forms of bankers' credit, without any departure from the effectiveness of the gold standard. Such was the case in the United Kingdom from the definite establishment of the gold standard with the resumption of cash payments (1821) to the outbreak of the World War in 1914. There was also, it is true, an increase in the amount of gold in circulation and held in reserve, but only sufficient to secure the absolute convertibility of the notes and other forms of credit.

In the same way in periods of speculation and of trade activity there is, no doubt, an abnormal demand for currency and credit, and both are extended until the limitations imposed by the gold standard are reached. If these limits are overstepped there is a monetary crisis. We speak of cycles of expansion and of depression of trade (in the widest sense), but it is only when the expansion of the "money" used exceeds certain limits that it can be properly called inflation. There may be a legitimate expansion to meet the legitimate expansion of trade.

We are well advised under modern conditions to confine the term "inflation" to such abnormal increases of currency and credit as transcend the limits imposed by the gold standard. Over long periods there may be a normal increase of money and of money-substitutes, and there may also be normal increases from time to time for short periods according to the activity of trade or exchange in the widest sense. Such increases of currency and of credit would not properly be called inflation.

The term "inflation" as applied to paper money may be compared with the debasement of standard coins. Debasement is in general a symptom of disease or disorder of the monetary system. It is a departure from the standard (or specific depreciation); and if, as usually happens, it is associated with an increase in the quantity of the money after a point it must lead to general depreciation of the currency. If not associated with an increase of quantity the debasement would be simply equivalent to the institution of a seigniorage. In the same way inconvertible notes may be regarded as coins with a seigniorage of 100% (Walker); in other words the amount of fine metal supposed to be attached to the paper is nil. Nothing is left of the standard coin but the name. In this case the value of the paper is determined by its quantity related to the effective demand for it.

It is clear from the foregoing discussion of the meaning of the term that "inflation" is closely associated with other monetary expressions and is sometimes loosely used as equivalent to one or more of them. We speak of inflated values (or prices) of commodities, as for example in comparing present foreign trade returns with the pre-war figures. In periods of financial speculation it is usual to speak of the inflation of securities. Prof. W. R. Scott, in his History of Joint Stock Companies, constantly uses the term inflation in describing the rise in the prices of shares in the period of the South Sea Bubble (1720). It may, perhaps, be said that values of securities are inflated when they bear no proper relation to their earning capacity or to their exchange value under normal conditions.

The term "inflation" is also commonly associated with depreciation, and the terms are loosely used as synonymous. Here, however, it is necessary to distinguish between the different meanings of depreciation. A currency might be specifically depreciated as regards gold (the standard) simply through discredit, although there was no abnormal increase of quantity. The terms depreciation and appreciation are often applied to gold itself. Gold was said to be depreciated in the third quarter of the 19th century through the gold discoveries, and appreciated in the last quarter through the falling-off in production. But it would be straining the use of words to speak of the inflation and deflation of gold in these periods. During the World War and afterwards there was a great rise in world prices (measured in gold) and in the United States there was a vast increase of the amount of gold for monetary uses. In the United States there was no specific depreciation of paper money relatively to the gold. Gold there had no premium.

The rise in American prices in terms of gold is partly accounted for by the expulsion of gold from Europe by the floods of inconvertible paper. The question arises whether it is correct to speak of this increase in the American gold currency as inflation. There has been, no doubt, an abnormal increase of gold currency as compared with pre-war periods, but there has been no abandonment of the gold standard. Coincidentally, however, with this great influx of gold the passing of the Federal Reserve Act enabled a given amount of gold to support a larger amount of credit, and this extension of credit facilities may be regarded as equivalent to a partial abandonment of the gold standard as compared with pre-war conditions.

At this point the general question arises as to variations in the meaning of convertibility and inconvertibility. There have been in the past all kinds and degrees of suspended and deferred convertibility. The, beginnings in Europe of the gold-exchange standard (so well described by Mr. J. M. Keynes in Indian Currency and Finance, ch. 2) show also the beginnings of inconvertibility. These incipient gold-exchange standards prepared the way for the ready acceptance of inconvertible paper on the outbreak of the World War (see "Essay on the Abandonment of the Gold Standard," by Prof. J. S. Nicholson, in War Finance, p. 34). In the same way the Federal Reserve Act may be said to have prepared the way for an inflation of credit (see E. W. Kemmerer, High Prices and Deflation).

In the preceding account of inflation it was implied that under modern conditions the term was only properly applied to cases in which the abnormal increase of money was due to inconvertibility or to the abandonment of the gold standard. The application, however, of the idea of continuity to convertibility and inconvertibility shows that the term inflation may be extended so as to cover the expansion of credit and currency which has taken place in the United States. And in practice most writers speak of inflation in that country as being only less in degree as compared with Europe.

In the United Kingdom during the war the transition from convertible to inconvertible paper was made by such gradual and concealed steps, both in law and in practice, that it is hardly possible to say when the virtual abandonment of the gold standard was officially recognized, if indeed it ever was. was only after the war when the foreign exchanges had been decontrolled and when war demands and war scarcities no longer seemed sufficient to account for the great rise in prices, that the abnormal increase of paper money consequent on the abandonment of the gold standard came to be regarded as one of the principal contributory causes of the rise in prices, and it began also to be acknowledged that the currency had been inflated.

In the United Kingdom the great use of cheques and bankers' credits concealed the progress of the inflation as regards the notes. It was commonly said that the increase in the notes was not sufficient to explain the increase in the prices, and that only sufficient notes were issued to provide the small charge for the governmental credits. In this way we arrive at the position that the inflation in the United Kingdom was primarily an inflation of credit and not of currency. In other countries, e.g. Russia, Austria, France and Germany, the enormous issue of inconvertible notes had the usual effects in a more direct manner. The case of the United Kingdom, however, is not so different when analyzed as at first sight may appear. Before the war, when the gold standard was effectively maintained, the necessity of securing the absolute convertibility of all forms of credit, and of keeping London a free market for gold, imposed rigid limits '(after a point) on the expansion of credit. If in the war the bankers had not been able to provide notes for the cheques presented (for funds for wages and other cash transactions) the whole system of credit expansion would have broken down. The notes took the place of gold for all internal payments, for many foreign payments borrowing was resorted to.

Once the notes had effectively taken the place of gold in the United Kingdom, that is to say when gold was no longer used by the public as money for cash purposes, the principle of convertibility was maintained as regards all the other forms of credit and "representative" money. There was never afte the first week of the war any hint of a banking crisis. No on repudiated the notes, and the whole monetary system worked with the greatest smoothness. The only difference was that the ultimate convertibility into gold, if required and as and when required, was no longer recognized in practice But this one exception was fatal to the stability of the monetary system. In normal times before the war the action of the gold standard was so effective and so quiet that even bankers and those engaged in high finance took it for granted, just as a perfectly healthy man takes for granted the circulation of the blood and the other vital processes. To the present generation real working of the gold standard was only revealed when the abandonment had been effected. This abandonment gave to the monetary system the power of indefinite expansion, and the necessities of the State in the war and its extravagances after the war made the potential expansion an actuality.

The real meaning of the gold standard and the dangers abandonment or relaxation were admirably expressed in own day by Ricardo. Ricardo was all his life engaged in high finance, and in monetary affairs was the leading practical authority. Although he is commonly regarded as the founder of abstract economics, always at the back of his mind was the practical working of the principles which he propounded. He lived through the period of the bank restriction when the notes of the Bank of England were made inconvertible, and he had this experience to test his reasonings. Two sentences bring out very clearly Ricardo's conception of a standard and of the limitations imposed by a standard on the expansion (or inflation) of paper money. "In the present state of the law [he is referring to the bank restriction on the conversion of paper into gold] the bank directors have the power of increasing or reducing the circulation in any degree they think proper: a power which should neither be entrusted to the State nor to anybody in it" (Ricardo's works, McCulloch's edition, p. 406). The second text is: "The only use of a standard is to regulate the quantity, and by the quantity the value of the currency and without a standard it would be exposed to all the fluctuations to which the ignorance or the interests of the issuers might subject it."

In other words the use of a standard is to provide safeguards against the dangers of inflation. The best and most effective safeguard is convertibility. All the forms of currency and of bankers' credit ought to be convertible into one another and into gold without let or hindrance. Such convertibility is only guaranteed when the principle of limitation is applied in each case in a way effective according to the circumstances of the case. In some parts of the system the limitation is applied in a very rigid manner, as for example with the token coins. The essence of "Gresham's law" in the case of token coins is that only by limitation can the nominal value be kept up. In the United Kingdom it used to be thought that to support this limitation effectively the legal tender ought also to be limited. Experience (as observed by Prof. Cannan) has shown that the limitation may be secured in other ways. In the case of banknotes, whether issued by the State or by banks with delegated powers, the principle of limitation has been applied in different ways. In the United Kingdom before the war the limitation of the issues of bank-notes was far more stringent than in any other country. The Bank Act of 1844 came to be known as the cast-iron system. The essence of it was that, after a point, no notes could be issued unless in exchange for an equivalent amount of gold. In normal times there was no elasticity. In times of crisis elasticity was provided by the suspension of the Act. Other countries had other methods of regulating the issues of their paper money. When Jevons wrote his book on Money in 1875 he was able to describe in his Chapter XIV. on "Methods of Regulating Paper Currency" no less than 14 different methods, and since that time other important varieties have been introduced. In these different systems the elasticity in normal and in abnormal times varies, but it is only in the case of inconvertible notes that the principle of limitation by reference to the metallic standard is abandoned altogether, and even in that case there is in general some kind of hope deferred that some time or other the link with gold will be restored.

During the World War, in all the belligerent countries except the United States and Japan, the connexion of the notes with gold, that is to say the effective convertibility, was abandoned in practice. No other effective method of limitation was discovered or applied. Instead of limitation there was expansion, in order to make the Government loans effective in monetary purchasing power. The greater the expenditure by the State, so much greater became the volume of the forms of purchasing power, and the issues of notes had to conform to other increases if recurrent banking crises were to be avoided.

Historical Examples. — Before the World War there were three notable outstanding cases of inflation in connexion with issues of inconvertible paper. They throw light on the processes and consequences of the inflation after 1014. The assignats of the French Revolution long formed the classical example in the text-books of the dangers of inconvertible paper. The issues began on what appeared to be, having regard to the circumstance of the time, a reasonable basis. The confiscated lands were more than sufficient in estimated value to meet the deficits of former years and to provide a surplus for the immediate budgets. In Dec. 1789 the Assembly issued assignats of 1,000 livres (£40) each, bearing interest at 5 %, to be accepted from purchasers of the nationalized lands. These notes were part of the floating debt, and were, to begin with, not legal tender. It may be observed that the first notes of the Bank of England (1694) were for high denominations and bore interest. In the course of time the interest on the assignats was abolished, the denomination was lowered, the notes were made legal tender as currency, and any pretence of "representing" lands or any other assets was abandoned. In brief, all effective limitation ceased, and the depreciation both specific and general became excessive. In spite of severe penalties against dealings in specie, culminating at last in the death penalty, in the course of time the notes were refused, and by 1796 had become practically worthless. Attempts had been made to substitute other notes mandats or promises of mandats, but there was no effective withdrawal and no real limitation, and the mandats followed the lead of the assignats. In Feb. 1797 all the paper money was demonetized, the mandats being receivable for taxes or land purchase at 1 % of their face- value.

The refusal of the paper money began in the French provinces and the circulation was most effective and prolonged in Paris. The analogy with Bolshevist Russia is instructive. There the refusal of the paper money began with the peasants. It is indeed remarkable that the leaders of the Russian Revolution took no warning from the example of revolutionary France. In fact, they advanced more rapidly to monetary destruction. And in Russia there do not seem to have been any of the compensating temporary advantages of inflation. "It is worthy of remark," says a recent writer (R. G. Hawtrey), "that so long as the Paris workmen were ordinarily paid in assignats there were no complaints of unemployment; the high prices attributed to the knavery of speculators were the principal grievance." In Russia unemployment increased with the inflation.

The next great example of inconvertible paper and inflation is furnished by the Bank Restriction in England which began in the year in which inconvertible paper was abandoned in France (1797). The contrast with France is remarkable, and, to begin with, confirms on the positive side the effectiveness of the fact of limitation even when the actual practice is not based on any reasoned principle. The notes of the Bank of England, though inconvertible, were not made legal tender until 1812. They were at first simply debts due by the Bank of England which the bank was not allowed to pay in legal currency. But the notes were accepted by the Government in payment of taxes, and also by the bankers and merchants under a formal agreement amongst themselves. In 1811 Lord King demanded payment of his rents in coin (not paper), and an Act was passed forbidding any differentiation between coin and paper that is, making illegal the quotation of two prices. Full legal tender was only granted to the notes the next year (1812).

The specific depreciation of the Bank of England notes began in 1800. At this time (and practically up to 1873) gold and silver were ranked equally as precious metals, and the variations in the ratio of their values never departed widely from 152 to i. From 1797 to 1818 at Hamburg the highest ratio is 16.25 in 1813 and the lowest 15.04 in 1814. The maximum specific depreciation of the notes in 1813 compared with gold was 136.4, and with silver 134.7 (see table in Hawtrey's Currency and Credit, p. 269). By 1816 the specific depreciation relative to the precious metals had practically disappeared. As measured by the exchange on Hamburg the depreciation reached a maximum in 1811 and was about par by 1816.

It is more difficult to estimate the general depreciation as compared with commodities. In 1801 the index number of prices, calculated by Jevons, based on a standard taken as 100 in 1782, had risen from no in 1797 to 153 in 1801, after which there was a fluctuating fall followed by a rise to the maximum of 164 in 1810. It is impossible to say how much of this general rise in prices is to be attributed to the inconvertible paper and how much to causes primarily affecting demand and supply of the commodities taken as the basis of the index numbers. The great argument of Tooke (History of Prices) was intended to show, by examining the actual records of the circulation and of prices, that the influence of the currency was of little importance compared with demand and supply. Tooke's general argument was weakened by the fact that he laid the chief stress on commodities which were largely affected by the course of the seasons. The modern view from Jevons onwards is that the general rise in prices was in part due to the issues of the inconvertible notes. A reference to the figures shows (Hawtrey, p. 269) that there is no exact connexion between the specific depreciation of the paper and its general depreciation as measured by general prices. Two questions arose in this period on which there was a prolonged controversy which has been revived mutatis mutandis by the World War. It was maintained by some that there was no specific depreciation of notes but only an appreciation of gold owing to the exceptional demands for it in connexion with the war. Now, it is argued, there is depreciation of gold. The other allied question was whether the specific depreciation of the notes was the exact measure of the fall in their purchasing power (or general depreciation). Another point of interest in this period was the influence of economic opinion on economic action. The celebrated Report of the Bullion Committee in England (1810) put the case for the resumption of specie payments and a return to convertibility in the strongest way. The principles of the report were due to the influence of Ricardo, although he was not a member of the committee. Later economists have in general approved of the report, both as explaining the facts and as suggesting the only adequate remedy. But the resolutions founded on the report were not only rejected by the House of Commons at the time (1811), but in opposition to them resolutions were carried by Vansittart which it is now agreed were "abundantly foolish." The answers given by the governor and directors of the Bank of England before the committee were described by Bagehot as "almost classical by the nonsense." By some recent economists, however, the policy of the report has been condemned, notably by Prof. Foxwell, in the introduction to the History of the Bank of England by Prof. Andreades. It is also now generally admitted that the questions involved in the report are more complex than the framers of the report considered. It is noteworthy that the principles of the report were eventually adopted and became the foundation of the Bank Act of 1844. It is remarkable that Lord Cunliffe's Committee on Currency and Foreign Exchanges, in their "first interim" report (1918), strongly approved of the practical return to the principles of 1844.

The third great historical example of inflation of inconvertible paper is furnished by the American Civil War. The period (1862-79) used to be called by American economists "the inflationist period." In about a year, owing to the stress of the war, 450,000,000 dollars of "greenbacks" were issued, and in the next two years other 200,000,000 dollars of interest-bearing, legal-tender notes were added. In the last year of the Civil War the paper had suffered a specific depreciation as compared with gold of 50%, and there had also been a great rise in prices, partly at least due to the inflation of the currency. In this case the inflation was primarily an inflation of currency and not of credit. At the close of the war steps were taken to reduce the paper money, and the interest-bearing notes were cancelled. The reduction of the greenbacks, however, was made gradual a monthly maximum of withdrawals being enforced in 1866. From this time onwards to the final restoration of specie payments in. 1879 there was a contest between the inflationists and the supporters of "hard" money. The main argument of the inflationists rested on the hardships that follow on a contraction of the currency and consequent fall in prices. For a time the inflationists were successful, and in 1874 a bill was passed through both Houses of Congress actually increasing the paper issues by about 400,000,000 dollars. This bill was vetoed by President Grant and prepared the way for the Resumption Act of 1875, which provided for the resumption of specie payments in 1879. After this year the advocates of what was called "soft" money turned their attention to the coinage of silver.

The American experience after the Civil War is of special interest as applied to the case of the United Kingdom after the World War. The same arguments were advanced in 1920-1 regards the hardships and the dangers of any deflation and the relative advantages of rising or at least stable prices. The less extreme supporters of inflation, like their American predecessors, thought that there should be no actual contraction, and that trade and production should be allowed to overtake the extra supplies of money and in that way bring about a gradual restoration to the normal. In the United States, after the Civil War, the actual resumption of specie payments was delayed for 14 years. Although the American inflation at that time was, to begin with, specially an inflation (or abnormal increase) of inconvertible paper, after the Civil War credit influences not only in the United States but in other countries had considerable influence on the extent of the depreciation of the paper. In the first months of the peace the gold value of 100 paper dollars was 70. But although the paper was reduced in three years by over 15% the effect on the specific depreciation was insignificant, 100 paper dollars being worth only 71.6 in gold. After 1869 for three years there was a great rise in the gold value of the paper to 89-5 in 1871, in spite of an absence of contraction. After 1871 there was another reaction followed by another and more marked revival. This want of conformity between contraction and appreciation of the paper (in terms of gold) is explained by Mr. Hawtrey (op. cit., p. 309) as due to the variations in the value of gold consequent on credit movements in Europe. In 1866 there was the Overend and Gurney banking crisis in England. In 1871-3 there was the boom in trade following on the Franco-German War. This boom was accompanied in the United States by an excess of imports, due to the advance of European capital for railway construction.

Enough has been said to show that the relation of the quantity of paper money, even when inconvertible, to changes in specific or general depreciation is by no means simple. Nor is such a result opposed to the "quantity theory" of money in its extended modern form. The value of paper money in terms of gold depends partly on causes affecting the paper (not only its quantity but its credit or discredit), and partly on causes affecting the gold itself not only the supply available for monetary purposes but the various elements of demand both for monetary and non-monetary purposes. The premium on gold is accounted for by various causes, and it is not the exact measure of the fall in purchasing power of the paper as regards commodities.

This brief survey of the three notable cases of inflation before 1914 shows very clearly that the inflation of the World War period was due to similar causes acting with varying force. The precise effect of the increase in the quantity of the inconvertible paper cannot be isolated. The main point is the abandonment of the effective working of convertibility through which the gold standard makes operative the principle of limitation. But even when convertibility is maintained apparently and by law in the most effective manner, as for example under the Bank Act of 1844, it is quite possible that for the time being de facto convertibility may be restrained, and there may be an inflation of paper money and of the credit that rests on paper money for cash payments. The old question as to the possibility of the over-issue of convertible notes has been answered in the affirmative by the practical legislators of every country. In other words every country has imposed special restrictions on the issues of notes. But in the course of monetary progress the over-issue of convertible notes has become of relatively small importance as compared with the over-expansion of credit, at all events in highly developed countries. The connexion of credit with the gold standard is not only through the note issues. In the United Kingdom the cheque has for long been the most important form of currency or means of payment. It is possible that even wages might be paid by means of cheques (a beginning has been made by Messrs. Lever), though still forms of legal tender would be necessary for other kinds of cash payments.

Once, however, convertibility has been definitely abandoned as regards the notes, then one of the great restraints on the increase of credit also has been abandoned. It is one thing for banks to provide the gold necessary to meet an internal drain, and quite another to get the notes required in exchange for some form of bankers' credit. It is one thing to keep a free market for gold, and quite another for the government of a country to meet the foreign demands for payment by borrowing abroad instead of sending gold. It is one thing to control the movements of gold by changes in the rate of interest, and quite another to let the movements of gold depend on the governmental regulations regarding import and export.

The World War Period. — In tracing the progress of inflation during the World War, the case of the United Kingdom is the most instructive and important. It is also the most difficult, because the abandonment of the gold standard which opened the way for inflation was not definitely announced or admitted, and was only realized some time after the fact had been accomplished in practice. The first authoritative recognition that the gold standard was no longer operative in the United Kingdom was that made in the first report of the Cunliffe Committee issued Aug. 1918. It begins with an account of the currency system which had been effectively maintained in the United Kingdom before the war, and it points out that "under these arrangements the country was provided with a complete and effective gold standard." But the report goes on to state: "The course of the war has, however, brought influences into play in consequence of which the gold standard has ceased to be effective." The main steps in this practical abandonment are also well stated in the report. On the outbreak of war it was considered necessary by the Government not merely to give permission for a suspension of the Act of 1844, as had been done on some earlier occasions, but also to empower the Treasury to issue its own currency notes for £1 and IOS. as legal tender throughout the United Kingdom. It may be noted that before the war only Bank of England notes were legal tender (not the notes of other banks), and Bank of England notes were not legal tender by the bank itself. In the bank restriction (see above) full legal tender was only conferred on the notes in 1812, i.e. 15 years after the beginning of the restriction.

Under the powers given by the Currency and Bank Notes Act of 1914, the Treasury undertook to issue the new notes through the Bank of England to bankers, as and when required, up to a maximum not exceeding for any bank 20% of its liabilities on current and deposit accounts. The amount of notes issued to each bank was to be treated as an advance bearing interest at the current bank rate. Later on, certificates of larger denominations were issued to banks in lieu of notes, to save trouble, and it became the practice for the banks to pay for the notes in other forms of bankers' credit. In this way the principle of limitation as applied to the notes was practically abandoned. What ought to have been barriers to expansion became elastic bands that yielded at the slightest pressure. The reserves were adjusted to the liabilities and not the liabilities to the real reserves. In place of a limited amount of gold that could only be increased by being attracted from other countries, the real banking reserve was now a mass of notes which could be increased on the demand of the banks themselves. It must be said in justification of these very elastic provisions regarding the notes that it was never anticipated that the demand for internal currency would have necessitated extensive recourse to these provisions. At the beginning of Aug. 1914 an extended bank holiday was sufficient to restore confidence in the currency situation. The danger, as events showed, lay in another direction. The banks were made so secure that they imposed no restraints on the demands of the Government. The inflation was made possible by the issues of the notes but the real inflation began with the expansion of credit. The credits created by the Bank of England in favour of its depositors, under the arrangements by which the bank undertook to discount approved bills of exchange, and other measures taken at the same time for the protection of credit, caused a large increase in the deposits of the bank. At the same time the needs of the Government for funds to finance the war in excess of what was raised by taxation and by real borrowing from the public made it necessary for the bank to create credits in favour of the Government in the shape of Ways and Means advances. The consequence was that the total amount of the deposits of the bank increased from about £56,000,000 in July 1914 to £273,000,000 in July 1915. The balances created by these operations passed, by means of payments to contractors and others, to the Joint Stock banks, and caused an increase in their deposits, which were also expanded by credits created in connexion with the various war loans. The consequence was that the total deposits of the banks of the United Kingdom other than the Bank of England increased from £1,070,681,000 in Dec. 31 1913 to £1,742,902,000 in Dec. 31 1917. This process of credit inflation is correctly described in the Cunliffe report (note, p. 4.): "Before the war these processes if continued compelled the Bank of England to raise its rate of discount, but the unlimited issue of currency notes has now removed this check upon the expansion of credit."

The great increase in bank deposits represented a corresponding increase in purchasing power, which in conjunction with other causes (e.g. war demands, war obstructions, war scarcities, etc.) caused a rise in prices. The rise of prices in its turn brought about a demand for legal-tender currency for cash payments of all kinds (wages, transport, retail trade, etc.). The war contractors and others had to break up their large credits into smaller credits, and these again were transmuted into legal tenders. "The unlimited issue of currency notes in exchange for credits at the Bank of England is at once a consequence and an essential condition of the methods which the Government found necessary to adopt in order to meet this war expenditure." On June 30 1914 the fiduciary issue of the Bank of England was under £19,000,000, but by July 10 1918 there had been added £230,412,000 in Treasury currency notes not covered by gold.

Compared with the mass of purchasing power indicated by the growth of deposits, and still more effectively by the increase in the clearing-house returns, the increase of notes may seem of relatively small importance. The importance of the currency notes lies not in their mass compared with other forms of purchasing power but in their function as taking the place of gold. Before the war the Bank of England, with a smaller gold reserve than those of other great European banks, supported a far greater mass of credit. Under certain conditions the movement of a few millions of gold was sufficient to threaten a crisis. Severe precautionary measures were taken to prevent the depletion of the ultimate metallic reserves. The quantity of gold was small, but it was necessary. Before the war, periodical warnings were given that the gold reserves were inadequate to bear the possible strain. By substituting currency notes for gold (and by amassing credits abroad), the quantity of gold held by the central bank became of relatively little importance.

The currency notes, as explained above, were never definitely made inconvertible. It was even provided that when they were presented at the Bank of England gold could be demanded. But since it was against the law to make any use of gold money except as currency - i.e. it could lawfully be neither melted down nor exported - the presentation of currency notes for conversion in this way at the bank could only lead to unpleasant questions and possibly incriminating answers. The convertibility was, in fact, only nominal or indefinitely suspended.

The legal prohibition of the melting of gold coin, the control both of the exportation and the importation of gold, and the consequent limitation of dealings in gold, severed the link that formerly existed between the values of coined and uncoined gold. Under normal conditions the market price of gold could only differ from the mint price of £3 17S. IO1/2d. by very small amounts, negligible so far as any premium on gold was concerned. Practically, in London before the war, gold coin and gold bullion were convertible to any extent at very short notice. The actual records of the price of gold in London show the stability of the price within these very narrow variations. Since there was never the least hesitation among the public in accepting the currency notes, the gold coins previously in public use were gradually withdrawn from circulation by gentle persuasion and the voluntary action of the banks (not by compulsion). Under these conditions it was not possible to discover if there was in fact any specific depreciation of the notes relatively to gold within the country. Spasmodic cases occurred of sovereigns being bought at a premium in 1916, and both buyers and sellers were prosecuted, but at the time the cases were considered as of no practical importance, and it was generally believed that the notes were not depreciated as regards gold. In a paper read by Prof. Foxwell to the Institute of Actuaries March 26 1917 he stated that he was not aware of any depreciation of this kind in Great Britain, though he had been on the look-out for it incessantly. The police-court cases noted above must have escaped his vigilance, but it is quite clear that there was no recognized depreciation in the sense of a premium on gold in terms of the notes during the war.

A specific depreciation of British currency might have been evidenced by the course of the foreign exchanges, especially with countries such as the United States which had preserved the gold standard effectively. But the course of the foreign exchanges is influenced especially in war-time by other factors, and we cannot at once argue from a fall in the American exchange to a depreciation of British currency. In Sept. 1915 there was a considerable fall in the sterling exchange on New York, but after that time the exchanges were controlled and an artificial stability at 4.76 1/2 dollars to the pound sterling was maintained until the control was taken off after the war (1919). It may be observed that the test which the framers of the Bullion Report (1810) thought of the most importance was not applicable owing to the artificial control. It may be added that this artificial control necessitated the incurring of large indebtedness to the United States by England. After the control of the exchanges was taken off there could be no question that the pound sterling depreciated in terms of the dollar, and this old method of estimating the depreciation was revived.

To the great mass of the people of a country, the specific depreciation of the currency, whether measured by the price of bullion or by the course of the foreign exchanges, is of little interest except in so far as it may be a sign of general depreciation or a fall in the purchasing power of the actual currency. The point was well put in a speech by Mr. Reginald McKenna to the shareholders in the London Joint City and Midland Bank on Jan. 29 1921. In discussing the variations in the meaning of inflation he said that one idea runs through all the meanings, namely that inflation is always associated with rising prices. As already explained, a general rise in prices is not in itself inflation, but it is, as experience shows, always associated with it in the sense of abnormal issues of inconvertible paper.

In considering the effects of the inflation (or abnormal issues) of inconvertible paper on general prices two questions must be carefully distinguished: (i) What is the effect in the country of issue; and (2) what is the effect indirectly on general world prices measured in terms of gold (the old standard).

Under normal conditions, when convertibility of all the forms of currency and credit is effective in the great commercial countries (as before the World War), the level of prices in any one country depends partly on causes operating in that country, e.g. tariffs, demand and supply, and partly on the relation of that country to the rest of the commercial world. When the link between gold and paper is broken in any one country, after a point the local issues become of predominant importance. Russia furnishes an example in an extreme form.

In the United Kingdom during the war there can be little doubt that a rise of prices followed on the issues of the currency notes, as shown by Prof. J. S. Nicholson in a paper to the Royal Statistical Society June 1917 (republished in War Finance). It was not implied that the rise was simply caused by throwing the new paper into circulation (as in the case of issues of notes in countries where credit is relatively little developed), but account had to be taken of the effect of the issues on the abandonment of the restraining influence of the gold standard. In the paper referred to it was shown that every kind of currency and of credit had expanded. There had been, example, a very great increase in the silver and bronze coin put into circulation, and on the other side a great expansion the use of cheques. Within the country the principle of convertibility had been maintained, and the relative amounts legal tenders of the various kinds and of bankers' credits had increased more or less in like proportions (not exactly for reasons given in Nicholson's War Finance, p. 92). As already explained, once the gold standard was abandoned the not took over the function of gold in restraining or not restraining advances of credit. A comparison with the United States shows also that the rise in general prices began sooner and advanced more rapidly in Britain than in America.

In other countries roughly the local rise was proportionate the expansion of the local currencies (and bank credits). The differences are best seen and most exaggerated in Russia and Austria-Hungary, but also in France and Germany.

Broadly speaking during the war (and after the war up to the middle of 1920) general prices in most countries were related to the inflation of their respective currencies and the credits based on them. Prices in particular countries, were determined to a greater extent by local causes on account of the restrictions placed on international trade in consequence of the war. Account must be also taken of the efforts, of governments to maintain control over prices of important commodities, which, though by no means completely successful and in general undertaken too late, had on the whole considerable effect. That is to say, the level would have been higher but for the control. Local prices were also to some extent kept down by the government of the country concerned buying in the foreign markets instead of allowing unfettered competition. This attempt to establish a buyers' monopoly amongst the allied belligerents was applied too late, and was not very effective as against the great trusts which established sellers' monopolies. Still, no doubt, this part of governmental control also affected the price levels of particular countries. The general result was in accordance with former experience namely that governmental control is a feeble remedy against a rise of prices consequent on the abandonment of the standard. The fundamental difficulty is that a government can only attempt control in its own country in so far as in combination with other buyers it may establish some kind of buyers' monopoly. In other words, world prices still govern world markets, and the local prices have to be adjusted to the world levels. This consideration leads up to the effects of inflation (in the sense of abnormal issues of inconvertible paper and the consequential expansion of other representative money) in particular countries on world prices. In dealing with this second question it must be observed that in the past this influence had to be considered in estimating changes in world prices (or the purchasing power of gold).

The substitution of paper for gold (or the precious metals when there was de facto a link between gold and silver) liberates a certain quantity of the gold which can be used for monetary purposes in other countries. In the American Civil War the displacement of metallic money, no doubt, had some influence in raising the general level of prices in European countries. In the World War the vast accumulation of gold in the United States tended, 'no doubt, both directly and indirectly to raise prices in that country and in that way to affect world prices measured in terms of gold. Similar effects were observed in Japan whilst in Sweden precautions were taken against this depreciation of gold. The indirect effect of this influence was far greater in the World War than on any previous occasion owing to the vast area affected by the issues of inconvertible paper and the importance of the countries concerned. It is obvious from the experience of the United States that the mere preservation of convertibility and the effective maintenance of the gold standard are not sufficient to prevent a general rise in prices as'; measured in the gold standard. Gold prices in the sense of "world prices" depend broadly on the quantity of the gold in use for monetary purposes and on the work to be done by it. In the course of the war, paper was largely substituted for gold, and so far as trade was concerned there was less work to be done by the gold. The general effect then of the World was analogous to that of great discoveries of gold. Such a result was not in itself a necessary consequence of the World War and of the issues of inconvertible paper. It was quite possible pointed out by Prof. J. S. Nicholson (in a paper of date Aug. 3 1914 republishcd in War Finance, Part II. ch. 1), that the destruction of credit would more than counterbalance the influences making for a rise in prices. In fact, however, instead of any destruction of credit there was a universal expansion. All governments financed their war needs by loans. The United Kingdom alone of European countries met any considerable part of its war expenses by taxation. In France and Germany the great issues of inconvertible notes directly raised prices, and prices were also raised by the expansion of governmental credits exercised in purchasing power. The nofcs displaced gold, and the gold was used for monetary purposes in other parts of the world, notably the United States and Japan. In other countries the notes took the place of gold as reserves in the banks, and the reserves were much more easily replenished and increased than was possible with gold. In that way, indirectly as well as directly, the issues of the notes tended to raise general prices. All the world over, in spite of the war, indeed in a sense in consequence of the war, there was a great expansion of credit. But this expansion of credit was only made possible by a corresponding expansion of inconvertible notes.

The evils consequent on inflation which had been exemplified in former historical cases were observed in the World War and in the boom that followed up to the end of 1920. Any general rise in prices, from whatever causes arising, brings difficulties of readjustments, and these difficulties are increased when the main causes are connected with paper money. The reason is that the changes consequent on excessive issues of paper, especially if accompanied by excessive expansion of credits, are much more rapid and intense than when the changes are due to increases in the metal or metals used for standard money. A general rise in prices gives at first a relative advantage to traders and employers of labour, as compared with consumers in general and the receivers of wages and salaries. During the World War wages in industries bearing on the war rose far more rapidly than had been the case in former experiences of inflation. At first the idea prevailed in the United Kingdom that the war would be of short duration, and throughout the dangers of defeat were so appalling that monetary considerations seemed relatively of no importance. No effective restraints were put on inflation. The workers soon learned that they had only to ask in order to have. The employers added any rise of wages to the cost, and to the cost as so determined added on again the usual or unusual percentage of profit. In war contracts the general rule seemed to be to calculate the contractors' profit as a percentage of cost, and with rising nominal cost profits rose automatically. When the enormous rise in profits was observed, an attempt was mack to catch the excess above the pre-war normal by the excess profits duty. But under the inflationist conditions that prevailed the imposition of this tax led again in many cases to a further rise in prices. The profit-makers were also imbued with the old belief that any tax that could be evaded ought to be evaded, at any rate by all lawful means. It seemed better business to increase expenses of various kinds (e.g. by provision for bonuses, for depreciation, etc.) rather than increase profits if two-thirds had to be surrendered to the State. The "profiteering" that arose out of the war was not due entirely to inflation, but it was magnified by th(inflation. In many cases, however, the extra profit earned in the war was no more than fair economic remuneration for the services rendered, and in some cases the war profit was low compared with what might have been reasonably expected. In the modern industrial State enterprise cannot be made a matter of routine, and the so-called unearned increment is a necessary and cheap stimulus. In the war the need for speed and quick adjustments was overwhelming. If inflation and excess profits were requisite for the sake of speed, they may indeed be considered as evils but as necessary evils.

It was only after the war when the danger to the national existence had passed away that those who had suffered from the maladjustments of inflation began to complain. Industrial unrest became rampant in every country. The rise in nominal wages in the best of cases had not much exceeded the rise in the cost of living and in some cases it had fallen below. The rise in prices came to be greater in the conventional necessaries of the various classes than in the necessaries commonly so-called. The middle classes suffered far more than the lower wage-earners. A large part of them passed into the ranks of the new poor.. It is the middle classes who provide normally the greater part of the brain power of the country in education and the professions and in the advancement of the arts and sciences. During the war they also had provided the greater part of the brain power for the armies and navies. It was galling to the new poor to observe that in the redistribution consequent on the rise in prices their position had been changed for the worse for the advancement of all kinds of "profiteers." Industrial unrest amongst the manual working classes spread to the brain-working classes. By the beginning of 1921 the new poor had been driven, partly by need and partly by disgust, to rebel against the high prices. There were new poor in all countries. A general crisis arose from the side of demand. The effect on wholesale prices was soon apparent in the fall in the index numbers. But for long there was only a partial readjustment in retail prices. In spite of the buyers' boycott retail prices moved but little. This was mainly due to the absence of bona-fide competition. The absence of competition spells the growth of monopoly.

During the war there was in the United Kingdom a great growth of trusts. The report of the Committee on Trusts tried to show that little of the rise in prices was to be attributed to the trusts, and that from the governmental standpoint in carrying on the war the trusts had been useful. It had been found more easy to bargain with a combine than with a number of separate bodies. This view of the trusts also found favour with people of socialist leanings, who thought that the growth of the trusts would be indirectly favourable to the socialistic ideal. When the trusts came to own the business of the nation, it would be time for the nation to own the trusts. Whether these favourable opinions of the growth of trusts were sound or not during the period of the actual war, the popular belief is that the fall in wholesale prices after 1920 was prevented from spreading down to the ordinary consumers largely by the influence of the great combines. No official information is, indeed, available to test this belief. In all times there has been a natural dislike of monopolies. This dislike, however, is largely founded on the belief that monopolies mean high prices. The growth of the trusts has been accompanied by a considerable dilution of capital and by a great rise in the rate of interest. The boom after the war was marked by excessive issues of new companies which were largely amalgamations. These amalgamations involved the payment of high interest to the constituent companies. New capital was attracted to provide the connective tissue for these constituent companies, and this again could only be attracted by high interest. The post-war boom was marked by a great increase of interest on industrial preferences and debentures. Here again was a reason for keeping up prices.

Deflation. — The question how prices were to fall when interest had to be higher leads to a consideration of deflation. Deflation, as the name implies, is the reverse of inflation. With this meaning it must involve the restoration of the effective working of the gold standard. An essential part of this process in the United Kingdom must be the actual convertibility of the currency notes. With this object in view Lord Cunliffe's Committee in their Final Report (Dec. 1919) recommended in England that the fiduciary issue of one year should not be exceeded in the next. Under this provision, which was accepted by the Government, the maximum fiduciary issue (i.e. the amount of Treasury notes in circulation not covered by gold) for 1920 was fixed at £320,600,000, and that for 1921 at £317,555,200. In the redemption account of the currency notes the amount of gold held remained at £28,500,000 from Dec. 1915 to 1921, but the gold had been supplemented by the addition of £19,450,000 Bank of England notes (up to Dec. 1920), these notes still being regarded as "as good as gold," owing to their being convertible into gold at the bank. The ratio of the gold holding (plus the Bank of England notes) to the currency notes rose from 8.3% in June 1919 to 14.5% in June 1921. In June 1920 the bank rate was raised to 7%, and this high rate was maintained with the view of limiting the expansion of credit. Consequent on the depression that followed the post-war boom the rate was lowered to 6% in June 1921, and to 5 1/2 % in July 1921. The high rate must have had some effect in checking speculation and bringing it to an end sooner than otherwise would have been the case. It had little or no effect, however, on the governmental borrowings, and from June 1920 to June 1921 the floating debt actually increased by some £79,000,000. The root cause of the inflation, as already explained, was the governmental expenditure of borrowed (or artificially created) money. It is plain that a high rate for money is not by itself sufficient to check governmental extravagance. Public resentment at the heavy taxation involved by the waste of public money began to be effective at the same time as the resentment against high prices led to a falling-off in demand.

It must be remembered that in case of need and the Government of the day is the judge of the need governmental borrowing would be resorted to. In case of need also the amount of currency notes requisite for the smooth working of the credit system must be provided. In case of a financial crisis the banks would always expect the restrictions on the fiduciary issues to be abandoned if necessary. Again, the increase of the reserve against the currency notes cannot of itself insure convertibility. The convertibility could only be effective when the foreign exchanges, especially with the United States, had been restored to the normal. It is not only the notes but all the other forms of credit which must be convertible into gold in case of need if the gold standard is to be effectively reestablished.

Just as the consequences of inflation (e.g. the rise in prices and in nominal wages) must be distinguished from the inflation itself, so also with deflation. The great fall in the index numbers of wholesale prices (United Kingdom) after the spring of 1920 cannot be ascribed to deflation, because in fact there was no deflation in the sense of monetary contraction. The Economist index number for March 1920 was 325 (compared with 100 for July 1914), and in Dec. 1920 was 231, whilst from Dec. 1919 to Dec. 1920 the notes in Great Britain had risen from £464,900,000 to £509,859,000. During the same year the bank clearings had risen from £28,000,000,000 to £39,000,000,000. In the same way the bank deposits increased during the year. The banking number of the Economist on May 21 1921 showed that the rate of increase of deposits (other than in the Bank of England) was 5.7% in 1920 as compared with 18 1/2% in 1919 and 16 1/2% in 1918. The actual increase in 1920 over 1919 was £136,000,000 in bank deposits (other than those of Bank of England), £12,000,000 in currency notes and £41,000,000 in Bank of England note circulation. In 1921, however, up to end of April currency notes declined £30,000,000 and Bank of England notes £4,000,000 and the deposits of 9 joint-stock banks declined by about £120,000,000.

The want of correspondence between the index numbers of wholesale prices in the United Kingdom and the amount of money (notes and bankers' money) has been cited by some writers as destructive to the "quantity theory" of money.

The quantity theory,. however, in its modern extended form does not imply that immediately on every increase or decrease of money there must be a proportionate fall in prices. In either case there must be some lag. Even with great gold discoveries it takes time before the effect becomes marked, and similarly as regards a fall in the amount. The opponents of the quantity theory, who assert that the money in use (including notes and bankers' credits) must be adjusted or follow on the movements in prices, are in a worse case. How comes it that when prices have fallen so greatly there has not been a corresponding contraction of "money"? The truth is that the element of time must always be considered. An abnormal increase of money takes time for its full effects to be realized. Similarly any contraction will take time to operate. After a period of inflation when prices begin to fall there will be for a time an apparent abundance of money. An illustration may be taken from what occurred in the great fall in prices from 1873 to 1896. At the depth of the depression of prices there was apparently a superabundance of gold at the great banking centres, and the rates of discount were never so low. Yet the general fall in prices was ascribed to the fall in the production of gold and the greater demand for it for monetary uses consequent on the destandardization of silver.

Not only must time be taken account of, but the survey must be extended to world prices, especially with the restoration of international communications. Prices in the United States after the war had a dominating influence on world prices. In the United States convertibility between the various money forms was maintained during and after the war. The Federal Reserve Act, however, made it possible for a certain amount of gold to support a larger superstructure of credit. At the same time, through the influx of gold from Europe, the gold foundation was also greatly increased. The consequence was that from 1913 to 1919, whilst the physical volume of business (in the United States) increased approximately 9.6%, the monetary circulation increased 71%, and bank deposits 120%. At the same time the percentage of actual cash reserves held against deposits declined from 11.7 in 1913 to 6.6 in 1919. Through the concentration of gold a greater power of expansion was given to the credit within the country, whilst the complete abandonment of the gold standard in Europe took away the restraining effect of a possible foreign drain. In this way, in spite of convertibility being maintained in the United States, the gold standard had not the same limiting effect as before the war. This loosening of the restraints of the gold standard is in fact equivalent to a form of inflation, and American economists (e.g. Prof. Kemmerer) speak of American inflation during the war.

It follows from these considerations that the process of deflation must be slow. It seemed probable in 1921 that for a considerable time the fall in prices would continue in the United Kingdom to precede the process of deflation.

Similar reasoning applies to wages and employment. With the great fall in prices money wages must fall, because in the last resort wages are paid out of the price of the product when there is a definite product, whilst wages that are given for services that perish in the act are proportioned to the corresponding disutilities involved as compared with the work of the product-makers. If the fall in prices in the United Kingdom is not due to deflation in the sense of monetary contraction, the fall in wages cannot be ascribed to that cause. When the fall in wages is not readily adjusted to the fall in prices there must be an increase of unemployment. But this unemployment cannot be ascribed to deflation.

The process of deflation must begin with a stoppage of inflation, and the effective prevention of the outbreak of renewed inflation. The essential condition is the stoppage of governmental expenditure that depends on borrowed money or the creation of artificial credits. In other words, the gold standard must be effectively restored.

The assumption that a fall in prices must of necessity be accompanied by a fall in real wages and in employment is not confirmed by the experience of the last quarter of the 19th century. Real wages increased during the great fall in prices, and complaints began to be made of the fall in real wages when prices began to move upwards. The charts constructed by Mr. Kitchin (Times Financial and Commercial Review, 1921) show that there is no close correspondence between movements in employment and movements in prices under ordinary normal conditions. The great and rapid increase in unemployment in the United Kingdom in 1021 might be partly ascribed to the stoppage of the progress of inflation and the check to speculation.

The fall in prices and in employment may also be partly ascribed to the repudiation of contracts by foreign merchants when they were seen to be unprofitable. This facile repudiation of bargains is symptomatic of the laxity of moral fibre that follows on inflation. This weakening of business moral makes it more difficult for governments to meet the obligations of public indebtedness. There has been a revival of old ideas on lessening the burden of public debts by disguised repudiation. It is said that the debts were incurred in depreciated money and therefore aught to be redeemed in depreciated money. It is proposed to stabilize the present level of purchasing power by changing the unit of value. How far such partial repudiation is necessary or desirable for any particular country (e.g. Germany) must be decided by the particular country. Even before the war the very moderate proposals for international bimetallism were not found to be practicable.

The essential facts of the situation are that the United States and Japan have effectively kept to the gold standard, qua freedom from specific depreciation, and the departure by the United Kingdom as compared with the United States has not been so great as to make the return to the gold standard impracticable. It seems then that world prices will be reckoned on the gold standard, and the national prices of other countries will in the course of time be adjusted to the specific depreciation of their currencies in terms of gold. International trade in the last resort must be carried on in terms of commodities and services. A country cannot for an indefinite period have a stimulus to its export trade simply through the specific depreciation of its currency. So long as the specific depreciation (e.g. of the German mark) is greater than the general depreciation as regards purchasing power of labour and other things within the country itself, so long excess profits are earned on exports. But such a condition is obviously unstable. The general theory was explained by Prof. J. S. Nicholson in a paper (Jan. 1888) on the "Causes of Movements of General Prices," republished in the Money and Monetary Problems. The argument was primarily applied to the case of gold and silver, and the consequences of the great depreciation of silver relatively to gold, but it was shown that, mutatis mutandis, the same reasoning applied to gold and paper. The silver-standard countries found it desirable to adopt a gold or gold-exchange standard, and by analogy the paper-standard countries at present may be expected in time to revert more or less completely to the gold standard.

The gradual return to the gold standard will no doubt be accompanied by a general fall in prices. The fall, which was very rapid in 1920, slackened by the middle of 1921 but seemed likely to be resumed. One obstacle to the continued fall in wholesale prices and the spread of the fall to retail prices was the action of combination in restraint of competition. It is this reliance on combination to keep up prices which is the great obstacle to the policy of ensuring de facto deflation by increasing the amount of goods so as to use the superabundant money. When the world is suffering from the exhaustion of the World War and when production ought to be increased as much as possible to restore the pre-war standards of material comfort, it is paradoxical that limitation of production should be anywhere in favour. It might seem to Labour that limitation of hours or of days is a remedy for unemployment (the "lump of labour" theory), and it is possible that in some cases Labour and Capital could combine to insist on monopoly prices. The great obstacle, however, to the success of any such policy of artificial limitation to keep up prices is the difficulty of making all the combines world-wide in their reach.

LITERATURE.— There is already a large literature dealing with inflation and its consequences during and after the World War. No doubt, as after the Napoleonic period, there will be prolonged controversy on the best methods to be adopted in restoring economic and financial equilibrium. The Report of the Committee on Currency and Exchange, which was unanimously adopted by the delegates of the 39 nations present at the International Financial Conference at Brussels (Oct. 1920), confirmed the opinions expressed in the report of the Cunliffe Committee, which was drawn up with special reference to the United Kingdom. The Brussels report may be divided into four sections. The first deals with the meaning, causes and progress of the inflation in the World War, and points to the necessity of stopping the growth of inflation by the limitation of governmental expenditure to revenue and the limitation of the creation of credit to bona fide economic needs. The second section calls for increased production. In this connexion the abandonment of governmental control is advocated, but no reference is made to the dangers of limitation of production by the great combines. The third section recommends the return to the gold standard, but the opinion is given that it is useless to attempt to fix the ratio of existing fiduciary currencies to their nominal value. In the fourth section it is stated that deflation must be gradual and that no useful purpose could be served by any attempt to establish an international currency or unit of account to impose artificial control on exchange operations. Supplementary volumes give details affecting various countries of the evidence on which the Report is based.

In the Financial and Commercial Review for 1920, issued by the Swiss Banking Corporation, convenient tables are given on p. 5 of the index numbers of the principal countries of wholesale and retail prices (England, France, the United States, Italy, Japan and Germany), and on p. 13 of the gold reserves and paper circulation of 17 principal countries for 1914, 1918, 1919 and 1920.

The following are useful works of reference:.— The Paper Pound of 1797-1821, a reprint of the Bullion Report of 1910 with introduction by Edwin Cannan (1919); J. S. Nicholson, Inflation (1919); R. G. Hawtrey, Currency and Credit (1919); R. W. Kemmerer, High Prices and Deflation (1920); the four Reports of Section F of the British Association on Currency and Credit in the War, edited by Prof. Kirckaldy, 1916-20, have been collated and brought down to the middle of 1921 in one volume entitled British Finance, 1914-1921, by Mr. A. H. Gibson; Irving Fisher, Stabilising the Dollar (1920); J. S. Nicholson, War Finance (2nd. ed. 1918); J. M. Keynes, Economic Consequences of the Peace (1920). The work by Yves-Guyot and A. Raffalovich, Inflation and Deflation (1921), gives in short compass a very valuable account of former periods of inflation beginning with John Law, and also gives in a short form the leading facts of the actual progress of inflation in the various countries in the World War. The writers reassert the classical opinions on the evils of inflation and advocate as rapid deflation as possible. H. S. Foxwell, Papers on Current Finance (1919), criticizes the generally accepted theories of inflation. The Review of Economic Statistics, issued monthly by the Harvard Committee on Economic Research, gives not only a general analysis of business conditions with probable forecasts (somewhat on the analogy of meteorological observations and deductions) but provides in a convenient form the statistics of changes in production and in financial conditions. (J. S. N.)