The Art of Central Banking

Ralph G. Hawtrey

• Publisher: Routledge
• Year: 2012
• Print ISBN: 9781138963856
• eBook ISBN: 9781136232558
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

First Published in 1970. A reprinting of the original collection of essays, from 1932 which begins with two essays describing French Monetary Policy and the Wall Street Speculation and Crisis of 1929. Moving onto an essay on Consumer's Income and Outlay and then the titular essay the art of central banking, looking at how a central bank is entrusted with the regulation of credit and money.

CHAPTER I.

FRENCH MONETARY POLICY.

THE WAR-TIME AND POST-WAR INFLATION.

MY subject here is primarily the French monetary reforms of 1926-28, and the subsequent working of the system then established. But a brief survey of the events leading up to the preceding monetary crisis will be necessary.

In the first place the trouble originated in the distresses and mistakes of the war. France, like the other belligerents, lapsed deplorably from the path of sound finance. No new taxes were imposed for two years, and few then. There was not even a long-term loan issued till November, 1915, fifteen months after the outbreak of war. Up to that date the war had been financed exclusively by the creation of floating debt and by external borrowing, and a considerable part of the floating debt took the form of direct advances from the Bank of France. The Bank of France also had to discount the pre-moratorium bills at the outset.

The result was that inflation got well started and could never be stopped. By the end of 1918 40 milliards had been added to the floating debt (of which 17 milliards were advances from the Bank of France) and 32 milliards had been raised by external debt. First England and then America had assumed the burden of pegging the French exchange at a rate not too far from parity. To counteract the depreciation with which so vast a mass of inflation threatened the currency was a formidable task. The English exchange position was seriously threatened by it in the earlier part of the war, and the United States, after entering the war, actually suspended the gold standard and saw the dollar at a heavy discount. It was with the withdrawal of American and English support for the pegging of the franc in March, 1919, that the French monetary crisis may be said to have begun. The year 1919 was one of drift. The expenditure was enormous. To the heavy military and demobilisation expenses remaining after the signature of peace was added the bewildering miscellany of emergency expenditure which none of the ex-belligerent Governments escaped, and for France a special burden in the beginning of the restoration of the devastated districts. The total expenditure of the year exceeded 50 milliards and the deficit exceeded 40. No loans were issued (except one of 4 milliards by the Crédit National for the devastated districts) and no less than 36 milliards was added to the floating debt.

It was at this period that the collapse of the currency began. Inflationary symptoms were ominous enough at the end of the war. The note issue exceeded 30 milliards, as compared with a pre-war monetary circulation which may be estimated at 11 milliards. But when the pegging of the exchanges was brought to an end in March, 1919, there cannot be said to have been any serious discredit of the currency. The discount on French francs in New York, which had been kept down to 5 per cent. during the last six months of the pegging system, rose to about 20 per cent. in June. But this represented no more than the market’s opinion of the obviously artificial character of the pegged rate. At a time when the wealth value of gold in the world had fallen to half what it had been in 1913, the note circulation of 30 milliards was not very seriously redundant. But the inflationary finance of 1919 brought discredit and collapse. The note issue increased to 37 milliards and the exchange fell more than in proportion. The situation was not peculiar to France. The same thing was happening all over Europe. It took a little time for the foreign exchange markets to understand that the gold parities of the European currencies had no more than a historical significance, and that there was no presumption that anyone who bought or held a currency far below parity was bound to make a gain equal to the difference in the long run.

The gradual discouragement of speculative holders showed itself in growing depreciation, which culminated in an exchange panic in February, 1920. The French franc was one of the more respectable currencies. It was quoted at about 35 per cent. of parity (this at a time when gold itself had no more than 45 per cent. of its pre-war purchasing power).

For most of Europe the panic of February, 1920, was a sudden pressure, quickly followed by some recovery. But in each country the course of events was affected by its own special circumstances. In France (as indeed in most of them) the governing condition was the state of the budget. And the budget was burdened with the gigantic cost of reconstruction of the devastated districts. In the claim made upon Germany in 1921 through the Reparation Commission this item accounted for 129

milliards of francs out of the total of 218 milliards. The actual cost up to the 31st March, 1930, was 92 milliards in francs, equivalent to £1340,000,000 in gold.¹ In the years 1920-23 an annual outlay of 11

to 17

milliards was incurred on reconstruction.

This capital expenditure was met out of a special budget of “expenses recoverable under the Peace Treaty,” along with the current provision for war pensions and the growing interest charge on the debt created from year to year to provide funds for this special budget.

In a sense the special budget of recoverable expenses was the cause of the collapse of the franc. To meet it from revenue would have been an unpatriotic act, an expression of doubt as to the recovery of reparations in full from Germany. It was consecrated as a deficit in principle. The result was not only to involve the country in continuous borrowing which the investment market was at times unable to absorb, but also to tie up the prospects of the French franc with the prospects of the German mark in the minds of the public. Any event which threw doubt on Germany’s capacity to pay reparations immediately had an adverse effect on the franc.

Now a currency unit which has become unstable is subject to speculative influences which tend to exaggerate its instability. An ill-founded speculative movement in a commodity market brings its own corrective, bulls overloaded with redundant supplies, or bears seeking to cover themselves in face of scarcity. But this is not true of the foreign exchange market. A bear movement, a “flight” from the currency, stimulates borrowing from the banks and creates a new supply of the currency ; a bull movement, the restoration of “confidence,” discourages borrowing and creates a currency shortage. In either case the speculation tends to bring about the fulfilment of the speculators’ expectations, and to place the purchasing power of the currency unit on a new level.

By judicious management of credit the central bank can counteract these tendencies. It can stop a speculative depreciation of the currency by raising Bank rate or in the last resort by actually refusing to lend at all. It can stop a speculative appreciation by buying securities or foreign exchange in the open market and so creating an additional supply of currency.

But in the years 1920-26 the Bank of France was not in a position to exercise such management. Its balance-sheet was choked with advances to the Government, which could not be effectively reduced owing to the weakness of the budget position. Against any serious speculative depreciation of the franc the Bank was helpless, unless it was prepared to draw upon its gold reserve.

THE CRISES OF 1924-26.

After the exchange crisis of February, 1920, France participated in the general European recovery, though political complications (the Kapp Putsch and the French occupation of Frankfort) delayed the process for a few months. A real effort was made to place the budget on a sound footing. The Minister of Finance, M. François-Marsal, secured the imposition of drastic new taxation (especially a turnover tax and a greatly increased income tax) which raised the revenue from 11.6 milliards in 1919 to 23.1 milliards in 1921. There still remained deficits of 38 milliards in 1920 and 28 milliards in 1921, but two big loans were issued in 1920, and bonds were also being issued by the Crédit National, the organisation which had been set up to finance reconstruction. Consequently the growth of the floating debt was comparatively slow.

Active measures of deflation were not possible, but for the time being a speculative fall of the franc no longer drove the Government to inflationary borrowing. The monetary circulation was kept down, and speculative depreciation brought its own corrective in an insufficiency of cash for the day-to-day needs of business. The collapse of 1920 had brought the franc down to a gold value of 5.8 cents (as measured by the exchange on New York). In the course of 1921 it rose, subject to some irregularity, and by the spring of 1922, the period of the Genoa Conference, it exceeded 9 cents. (Par was 19.295 cents.)

But meanwhile M. Poincaré had assumed office, and the conciliatory policy of M. Briand towards Germany was thrown to the winds. In July, 1922, the German request for a moratorium of reparation payments was refused, in January, 1923, came a formal accusation of default, in that the delivery of telegraph poles was behindhand, and the Ruhr was occupied. The collapse of the mark proceeded with ever-growing rapidity, and culminated in November, 1923. By that time it had come to be recognised that the Reparation question would have to be the subject of an agreed settlement, and the appointment of the Dawes Committee followed.

Meanwhile the franc had depreciated from 9 cents in May, 1922, to 5 cents in December, 1923. An ominous development was the failure of a loan issued by the Crédit National in January, 1924, which produced only 1636 millions in place of the 3 milliards required. The foreign exchange market became demoralised, and the franc fell in March, 1924, to 3

cents.

In 1923 there had been a budget deficit of 18 milliards, although the capital outlay on reconstruction had been only 11

milliards. Issues of bonds (3 to 10 years) had kept down the floating debt, but if the market would not take the bonds an abyss of inflation would open out. Clearly further taxation was imperative, and M. Poincaré obtained the imposition of a double décime, an addition of 20 per cent. to nearly all the existing taxes.

At the same time he had recourse to external borrowing. In the then existing state of French finances, with the enormous debts to the British and American Governments unsettled, the issue of a Government loan abroad was impossible. But credits were raised in America of

100,000,000 through Morgans, and in England of £4,000,000 through Lazards, by pledging a part of the gold reserve of the Bank of France.

The franc rapidly recovered, exceeding 6

cents in April, 1924, to the great embarrassment of bear speculators particularly in some foreign centres. A rise of 80 per cent. in a few weeks was not by any means what was desired. The equilibrium of markets was upset. But the Bank of France had no power to moderate the rise by buying securities in the open market or by buying gold or foreign exchange at a premium.

The Reparation question had, for the time being, been settled by the Dawes Plan, and M. Poincaré’s double décime promised to wipe out the budget deficit (except for the reconstruction expenditure, now reduced to something under 5 milliards a year), yet the market in francs had become more speculative and nervous than ever.

The trouble that ensued in the period from May, 1924, when M. Poincaré was defeated at the elections and made way for a Radical Government under M. Herriot, till July, 1926, when M. Poincaré returned to power at the head of a Government of National Union, representing both Right and Left, was partly political. In France, as in most democratic countries, the parties of the Left are sometimes distrusted by high finance. The violent oscillations of the franc in the spring of 1924 had disturbed confidence, and fears of confiscatory taxation increased the nervousness.

There was no longer any important deficit on the ordinary budget, but the financial position was nevertheless precarious. The requirements of reconstruction, reduced as they were, were by no means negligible, but the real danger lay in the floati...

Table of contents

• Cover
• Halftitle
• Title
• Copyright
• Preface
• Contents
• Foreword
• Chapter I. French Monetary Policy
• Chapter II. Speculation and Collapse in Wall Street
• Chapter III. Consumers’ Income and Outlay
• Chapter IV. The Art of Central Banking
• Chapter V. Money and Index-Numbers
• Chapter VI. Mr. Keynes’s Treatise on Money
• Chapter VII. International Short-term Investment
• Chapter VIII. Remedies for Unemployment
• Index