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No. 17 "Inflation: Possibilities Involved in Existing and Proposed Legislation," February, 1935. American Liberty League. 400dpi TIFF G4 page images Digital Library Services, University of Kentucky Libraries Lexington, Kentucky Am_Lib_Leag_17 These pages may freely searched and displayed. Permission must be received for subsequent distribution in print or electronically. No. 17 "Inflation: Possibilities Involved in Existing and Proposed Legislation," February, 1935. American Liberty League. American Liberty League. Washington, D.C. 1935. This electronic text file was created by Optical Character Recognition (OCR). No corrections have been made to the OCR-ed text and no editing has been done to the content of the original document. Encoding has been done through an automated process using the recommendations for Level 1 of the TEI in Libraries Guidelines. Digital page images are linked to the text file. Pamphlets Available Copies of the following pamphlets may be obtained upon application to the League's national headquarters: American Liberty League Speech by Jouett Shouse The Tenth Commandment Why, The American Liberty League? Statement of Principles and Purposes Progress vs. Change Speech by Jouett Shouse Recovery, Relief and the Constitution -Speech by Jouett Shouse American Liberty League Its Platform An Analysis of the President's Budget Message N. R. A. Its Past, and Recommendations for the Future Analysis of the $4,880,000,000 Emergency Relief Appropriation Act Economic Security A Study of Proposed Legislation Democracy or Bureaucracy? Speech by Jouett Shouse The Bonus An Analysis of Legislative Proposals The Constitution Still Stands Speech by Jouett Shouse Write to american liberty league NATIONAL PRESS BUILDING WASHINGTON, D. C. INFLATION Possibilities Involved in Existing and Proposed Legislation american liberty league Rational Headquarters NATIONAL PRESS BUILDING WASHINGTON, D. C. Document No. 17 February, 1935 Inflation â˜… Less than a dozen years ago the world was aghast at the ravages of inflation in Germany. The entire mortgage indebtedness of the German people, estimated at about ten billion dollars in 1913, eould have been paid off in November, 1923, with one American cent, but this boon to debtors did not compensate for the wiping out of endowments of hospitals and colleges, pensions and annuities and fixed incomes of the small salaried classes. Today in the United States there are three avenues through which inflation of a devastating character may come. These are: 1. Treasury deficits which unless ended speedily will lead inevitably to unsound financing methods. 2. Printing press currency proposed to be issued to finance specific projects or general expenditures. 3. Credit expansion policies under recent and proposed monetary and banking laws permitting a concentration of political control and offering a foundation for disastrous inflation. Historical Examples The record of history is convincing as to the perils of inflation. The most notable examples in recent times have been in Germany, Russia and France. In each case post-war budgetary difficulties were chiefly responsible. Fiscal needs induced our own country to embark upon its greenback experiment in the Civil War period. In earlier history the French assignats form an outstanding instance of deliberate inflation of the currency. Like some of the present-day schemes it was intended to be controlled inflation. Whether the result of governmental necessities or deliberately planned, the consequences of excessive inflation have been equally ruinous. Comparisons with what has taken place in various countries appear fantastic. Nevertheless, it is impossible to ignore events of history. Assume that ten loaves of bread cost SI in the United States. In the Civil War greenback experience the cost would have mounted to $2.85. Under depreciations similar to the French postwar inflation, the earlier French assignats and the Russian and German post-war inflations, the cost would have become respectively $10, $288, fifty billion dollars and one trillion dollars. The value of a thousand-dollar savings deposit or insurance policy would shrink to $350 in the Civil War greenback situation, to $100 in the French post-war inflation, to $3.47 at the time of the French assignats and to an infinitesimal fraction of one cent in the Russian and j-German post-war inflations. What Inflation Is The term "inflation" ordinarily is used rather loosely to mean an increase in currency or credit tending toward an advance in prices. As defined by most of the authorities, inflation exists when currency or credit increases more rapidly than business transactions in such a way that the general price level rises. The definition given by Dr. Edwin W. Kem-merer of Princeton University in Kemmerer on Money, published in 1934 by the John C. Winston Company, Philadelphia, is as follows: "Inflation exists in a country whenever the supply of money and of bank deposits circulating through checks, so-called deposit currency, increases relatively to the demand for media of exchange in such a way as to bring about a rise in the general price level." Dr. James Harvey Rogers of Yale University in The Process of Inflation in France, published in 1929 by the Columbia University Press, New York, defined inflation for the purpose of that particular study as: "An increase in the general level of prices growing out of an increase in expenditures while goods available for purchase are not correspondingly increased in amount." When inflation first develops it gives an incentive to the conversion of money into commodities because of a fear of depreciation of purchasing power. The speculative instinct enters in. The process tends to stimulate business and market activity and to increase the velocity of currency and bank deposits. This in turn gives an impetus to inflation. The spiral of events accelerates rapidly in momentum. If the inflation is only moderate in character, there may be no injurious effects. The trouble is that once started, it is difficult to control. If it gets out of bounds, there is a loss of confidence in the value of the currency. Beyond this point complete collapse of the monetary system is only a step. 4 Inflation works in a particularly insidious way. Usually it is not until it is too late that there is a general realization that harm has been done. Just as in the case of a drug, the early effects are stimulating. When the dose is repeated too often, the result is demoralizing. The most active inflationists will not admit that they are for inflation as the term is understood in its opprobrious sense. They talk of reflation and propose to carry the process only to the precise point where good ends and evil commences. Granting good intentions, past experience justifies doubt as to their ability to control an inflationary movement, once it gains momentum. Debtors and Creditors The movement for deliberate inflation has gained its greatest support by reason of the plight of agriculture. The purpose has been to restore the price of the farmers' products to the level existing when they contracted their debts. Inasmuch as farmers pay their debts with the return from wheat or corn or other agricultural products, an increase in prices obviously makes it easier to pay fixed obligations for land or implements. The claim is made that inflation would benefit the farmers. That statement is challenged. There are farmers who are creditors as well as farmers who are debtors. Moreover the increased costs which would characterize inflation would fall as heavily on the farmer as on any other class. Who are the debtors of the country? A classification by Evans Clark in his book The Internal Debts of the United States, published in 1933 by the Macmillan Company, New York, is recognized as one of the most authoritative. Mr. Clark estimates that all internal debts in the year 1932, including long-time debts, short-time business debts, personal and household debts and bank debts, totaled $285,000,000,000. Of this sum $134,000,000,000 consist of long-time debts,$126,-800,000,000 of this amount being covered in classified statistics. In the tabulation of items making up the $126,800,000,000 the smallest is farm mortgages, the total being given as $8,500,000,000, or 6.7 per cent. Other items are: owners of real estate in cities, $27,500,000,000, or 21.7 per cent; financial corporations, including life insurance companies (paid-up value of life insurance), investment 5 trusts and loan agencies, $21,900,000,000, or 17.3 per cent; states, counties, cities and municipalities, $18,700,000,000, or 14.7 per cent; railroads, $14,300,000,000, or 11.3 per cent; the Federal Government, $14,200,000,000, or 11.2 per cent; public utility corporations, $11,300,000,000, or 8.9 per cent; and industrial corporations, $10,-400,000,000, or 8.2 per cent. Individual citizens who are taxpayers are the real debtors in the case of the obligations of governmental bodies, while individuals who are stockholders are the real debtors in the case of the various classes of corporations. Many farmers come within these classes. Except in instances such as agriculture where the producer of raw materials benefits very greatly from increased prices, higher prices are apt to increase rather than lessen the burden of debts. The creditor classes include individuals, business concerns and institutions owning bonds, mortgages and notes. Funds of the life insurance companies are invested in bonds and mortgages. These companies have held nearly one-fourth of all outstanding farm mortgages and nearly one-fifth of all outstanding urban mortgages. The banking institutions have invested deposits of the citizens in bonds and mortgages. The building and loan associations are large mortgage holders. The endowed universities, hospitals, libraries and welfare foundations have extensive investments in bonds and mortgages. As the value of the dollar becomes less through inflation, there is a decline in the value of all savings deposits, life insurance policies, annuities and endowments. The cheaper dollar may help one relatively small group of debtors, but all creditor classes are injured. Treasury Deficits The United States today is the fifth year of Treasury deficits. No nation ever has been able to continue an unbalanced budget indefinitely without resorting to currency inflation. The greatest present danger lies in the budget situation. A year ago in his budget message the President expressed the belief that there should be no further increase in the public debt after June 30, 1935. This year he said that we have not yet reached a point at which a complete balance of the budget can be obtained. There is no assurance that the budget will be balanced in 1937 or even in 1938. The aggregate deficit of the six fiscal years from 1931 to 1936, inclusive, will exceed $20,500,000,000, a sum sev- eral billions greater than the entire public debt at the beginning of the depression. The Congress recently has enacted a law under which it will be possible to continue to borrow money until the total debt, which is now more than $28,500,-000,000, mounts to $45,000,000,000 . The Administration deserves commendation for its refusal thus far to utilize the power given in the Thomas Inflation Amendment in May, 1933. Under that Act there is permissive authority to the executive branch of the government to resort to the same type of financing that France, Germany and Russia did when they were unable to meet their obligations by ordinary borrowing. In each of these nations inflation was brought on by governmental borrowing from the central bank. The Thomas Amendment makes possible a greater use of the Federal Reserve banks in governmental financing. The Amendment provides for direct purchases by the Reserve banks from the Treasury of government obligations up to $3,000,000,000 besides giving the President a voice in the initiation of ordinary open market operations in which these banks buy government securities already on the market. Currency issued in connection with the transactions would not be subject to the usual requirements with respect to gold backing. It would be fiat money just as would the $3,000,000,000 of greenbacks which the Treasury may issue under the Thomas Amendment. Thus far, the Treasury has been able to borrow all the money it needs. No one can tell when it may become difficult to do so. If such a point is reached, there will be a temptation to turn to the authority under the Thomas Amendment. Such a course would be highly dangerous. The best policy to pursue is to terminate the period of Treasury deficits at as early a date as possible. Thereafter, there need be no fear of inflation from unsound financing devices. Currency Inflation Throughout the depression there has been agitation for deliberate inflation of the currency by those who believe that commodity prices will be advanced by such action and that such a method of financing is both easy and legitimate. It has been proposed that all sorts of projects, including the four billion dollar work-relief program and the two billion dollar soldiers' bonus payment, be financed by the issuance of currency. Also certain inflationary proposals have 7 been designed to promote a greater circulation of silver with consequent benefit to silver producers. The Administration properly has rejected all currency inflation schemes. The agitation for them nevertheless has continued. The issuance of a government obligation which bears no interest is alluring. The idea of keeping such obligations in circulation, thus avoiding the ultimate reckoning day, makes the plan doubly attractive. The method is given a false coating of soundness by the theory that a larger volume of currency is desirable. Except as it tends to weaken confidence in the monetary system and thus to contribute to the inflationary process, an increase in currency can have little effect upon prices or upon business activity. Currency now in circulation is greater than at the peak of the speculative boom in 1929. Less than 10 per cent of the business of the country is transacted with currency, more than 90 per cent being by bank checks. It is the velocity of turnover of bank deposits which is the factor of greatest importance. The soundness of the currency system is based upon confidence. There is no exact formula to govern the amount of paper money which can be issued per unit of metallic reserves. The people of this country became accustomed to the monetary system as it existed prior to 1933 and grew to have confidence in it. The new monetary laws contain changes which have disturbed some authorities, but there has been as yet no loss of confidence in the currency. It has been the experience of nations over a period of centuries that the issuance of printing press currency is the surest way to break down public confidence. If confidence is undermined, currency will depreciate, a larger quantity of currency will be necessary and inflation will result. Such a depreciation would be different from what has taken place in the devaluation of the dollar. While the dollar has been depreciated by more than 40 per cent from its former level in terms of foreign exchange, domestic prices are only a little higher than in 1931 and not so high as in 1930. All forms of our currency are maintained at a parity with the new gold dollar. The new dollar looks no different from the old to the ordinary citizen. Our monetary system might survive the issuance of a moderate amount of printing press currency, but if the process were commenced, the pressure upon the Congress for additional amounts for other purposes would be irresistible. The only safe course is to avoid anything of the sort. Credit Expansion The administration is pursuing a policy of credit expansion with a view to a stimulation of industry. So long as new credit no more than anticipates a healthy increase in business, the results are beneficial. If there is a wave of speculative activity which leads to an undue use of credit, inflation develops. As an engine of inflation, credit is much more powerful under our banking system than currency. At no time in our history have the potentialities in the way of credit expansion and, therefore, of inflation been so great. The reason may be found in the monetary legislation enacted during the past two years. The pending Banking Act of 1935 broadens the powers of administrative authorities to promote an expansion of credit and by the same token increases the danger of inflation. The Gold Reserve Act, the Silver Purchase Act and the Thomas Inflation Amendment make possible a tremendous credit expansion under the control of the President and the Secretary of the Treasury. Expansion under the Gold Reserve Act and the Silver Purchase Act is brought about through the use of gold and silver certificates. The Thomas Inflation Amendment gives a measurt of control over Federal Reserve credit. The proposed Banking Act of 1935 strengthens the control of the President and the Secretary of the Treasury over Federal Reserve credit by shifting powers now vested in the Federal Reserve banks to the Federal Reserve Board which is made more definitely subject to administration influence. What has been taking place may be realized from a glance at figures in the Daily Treasury Statement and Federal Reserve reports. Gold assets of the Treasury have increased to nearly $8,500,000,000 from a little more than $7,000,-000,000 immediately following the devaluation of the dollar and the accompanying increase in the price of gold. The gold certificates in the hands of the Federal Reserve banks have increased by nearly $1,900,000,000. As a basis for the issuance of currency at the statutory gold minimum of 40 per cent this amount can be increased two and one-half times. The currency or credit can be pyramided in the form of bank credit approximately ten times. Silver assets of the Treasury have increased by about $225,000,-000 and silver certificates in circulation by about the same amount. The silver certificates can be pyramided ten times in the form of bank credit. Excess reserve balances of the member banks with the Reserve banks recently mounted to a new record total of more than $2,300,000,000. This meant that this much credit which has been forced into the banks has remained unused because of a lack of confidence either on the part of the banks or the borrowers. If confidence is restored and if a speculative fever develops, the unused reserves will be quickly drawn upon. With a huge supply of credit at hand the tendency toward inflation will be strong. The excess reserves now existing, if expanded ten times, would mean credit amounting to as much as $23,000,000,000. It would be possible theoretically to expand credit by twice that amount on the basis of gold and silver certificates actually issued during the past year. The total expansion possibilities on the basis of existing law are far in excess of $100,000,000,000. It is to be hoped that the powers over credit which are being concentrated in the hands of government officials will be used only in a way that will aid recovery and will not plunge the nation into uncontrolled inflation. Retention of greater authority in non-political agencies would be reassuring. As matters now stand the menace in the event of a too rapid business boom is very great. Inflation in United States The United States has had various periods of inflation during which there has been an increase in prices by reason of an expansion of currency or bank deposits. Our only experience with depreciated paper money inflation was in connection with the greenbacks during the Civil War. Somewhat earlier in the fifties we had an inflation from an increase in the world's production of gold. At the beginning of the present century there was an inflation from the same cause. During the World War the expansion of bank deposits due to war expenditures was responsible for an inflation. The speculative activity in 1928, causing a substantial speeding up of the velocity of turnover of bank deposits, contributed to the inflationary condition existing prior to the depression. In the summer of 1933 inflation developed by 10 reason of an increase in the velocity of currency and bank deposits due to the influence of developments in Washington. The subsequent collapse of the inflationary boom tended to nullify the beneficial effects of the early stages, just as invariably happens. The Civil War greenbacks, which were first issued in 1862 to aid in financing the Civil War, depreciated to about 70 cents on the dollar during that year. Their value as indicated by prices of gold ranged between 63 and 80 cents during 1863 and in March, 1864, dropped to a low of slightly more than 35 cents on the dollar. In 1865 the greenbacks rose as high as 73 cents, and in the period between 1870 and 1875 their value ranged from 85 to 90 cents. They were restored to par in 1878 when redemption in gold was made possible. On a basis of 100 for the year 1860 wholesale commodity prices reached a maximum of 185 in the year 1865. The depreciation of greenbacks was nothing like that which marked the post-war period in France, Germany and Russia and the time of the French assignats a century and a half ago. French Post-War Inflation The course of inflation in France in the postwar period was checked before it reached a stage of such complete disaster as in Germany and Russia. France was involved in budget difficulties just as the United States is today. Failing to balance its budget when the war was over, France resorted to various expedients to finance continued deficits. After borrowing all it could elsewhere, the government fell back upon loans from the Bank of France. According to Professor Rogers, the most powerful influence in advancing the inflation process in France was the large and long-continued advances by the Bank of France to the government. These advances played a predominant role in the process of inflation despite the fact that they represented only a relatively small proportion of the total borrowings. Inasmuch as the loans from the central bank were additions to purchasing power which were not matched by savings, the use of the currency and credit led to inflation of the most pronounced type. Between the end of the World War and 1927, France more than doubled its internal debt. The United States during the same period was rapidly reducing its war debt. To some extent France had relied on loans from its central bank during the War. The total advances outstanding by the Bank of France to the government at the end of 1918 were 17,150,-000,000 francs. By 1927 the total was 36,000,-000,000 francs. The loans were at interest rates ranging from zero to one-half of one per cent. The advances were reflected in an increase in currency in circulation. The note circulation of the Bank of France, which amounted to 30,250,-000,000 francs in 1918, reached 56,551,000,000 in 1927. The inflationary process caused a rapid advance in the general price level. On the basis of an index number of 100 representing wholesale prices in the year 1913, the French price level multiplied more than three times during the War and by nearly seven times by 1926. The franc, which had a par of 19.3 cents, had been pegged at about 18 cents during the War. Exchange rates fell to less than six cents in 1920, rose to nine cents in 1922, dropped to three and one-half cents in 1924 and to a low of about two cents in July, 1926, rising somewhat thereafter. France was saved from complete disaster when in 1926 under Poincare it finally took steps to balance the budget. Loans from the Bank of France to the government were discontinued. Confidence in the franc returned. The franc was pegged at about 3.9 cents in the latter part of 1927 and stabilization took place at 3.92 cents in the law of June 25, 1928. The final effect of the inflation may be easily comprehended by using a thousand-dollar insurance policy or savings account as an illustration. The stabilization of 1928 was at about 20 per cent of the old par. A thousand dollars received thereafter from an insurance company or bank were found to have shrunk in purchasing power to about two hundred dollars. By stabilizing at the level to which the franc had depreciated, France retained a high price level. The index for wholesale prices stood at 357 in October, 1934, on the basis of 100 for 1913. German Post-War Inflation Like France, Germany was involved in budget difficulties after the War. Its national expenditures had increased five-fold during the War period and its national debt six-fold. The paper money in circulation had increased from less than three billion marks at the beginning of the War to 29 billion at the end of November, 1918. Wholesale prices in Germany slightly more than doubled during the War period. In view of the large expansion of currency, the ad-12 vance in prices up to the time of the Armistice was moderate. The German government borrowed from the Reiclwbank during the War by the process of discounting Treasury bills. This was done to an increased extent as it became necessary to meet deficits in the post-war period. By the time the orgy of inflation reached its height toward the end of 1923, the government Treasury bills which were held by the Reichsbank totaled nearly 200 quintillion marks. What happened during 1922 and 1923 was unlike anything that had ever occurred in the world's history. Paper marks depreciated more rapidly than the Continental currency of the United States in Revolutionary War days or the assignats of France, also in the latter part of the eighteenth century. The expenditures of the German government increased from 145 billion marks for the year ending March 31, 1921, to more than eight trillion marks two years later and to 49 quadrillion marks the next year. It was impossible to keep up with expenditures by levying more taxes. Currency in circulation, which amounted to 252 billion marks in August, 1922, increased to two trillion marks in January, 1923, and to 28 quadrillion marks in September, 1923, and finally reached a total of 497 quintillion marks at the end of 1923. By November 20, 1923, one gold mark was regarded as equal to one billion paper marks. New rentenbank notes which were issued at about that time as an intermediate step toward stabilization were exchanged at the rate of one for one billion paper marks. Subsequently, when the Reichsbank was reorganized in October, 1924, it issued new gold reichsmarks, one of which was equivalent to one trillion old paper marks. During the inflationary period the gold value of the mark as quoted in foreign exchange dropped from an original par of 23.82 cents to about one-half cent in December, 1921, one-one hundredth of a cent in December, 1922, and twenty-three-trillionths of a cent in December, 1923. Russian Post-War Inflation Russia also was plunged into inflation by efforts to finance governmental deficits through the issuance of fiat money. Early in the War the Russian Treasury was allowed to discount its short-term obligations at the State bank to any extent desired, previous restrictions being removed. The currency was on an inconvertible 13 paper basis. As early as 1916 there was only paper money in circulation. The government obtained enormous amounts from the bank. Between January 1, 1917, and January 1, 1923, the quantity of money in circulation increased two hundred thousand times while prices increased ten million times. The depreciation was more rapid than the rate of issuance of currency. A new Soviet State bank issued notes to meet deficits of the Treasury during 1922 and 1923. Finally in 1924 a new ruble was issued in exchange for fifty billion of the old depreciated rubles. French Assignats The French assignats which were issued between 1790 and 1796 form an outstanding instance of deliberate inflation. The French Revolutionary government was confronted with the problem of both raising revenue and overcoming a condition of business depression. Just as has been true of present-day inflation advocates, the radicals of that period thought that the issuance of paper money would stimulate prices and revive trade. In response to the demands of the inflationists, the Constituent Assembly in April, 1790, authorized the issuance of assignats to the amount of four hundred million livres, to be legal tender and to bear interest at three per cent. The currency was to be secured by church lands recently seized. At the beginning the effect was to relieve the Treasury of some of its burdens and to stimulate trade. As soon as the assignats began to circulate, however, they depreciated to the extent of about five per cent. The four hundred millions of paper were soon exhausted, and there was an immediate agitation for the issuance of additional currency. It was even claimed that the first issue had been a success. Mirabeau, a leading inflationist of the day, advocated that currency be issued equal to the amount of the whole national debt and insisted that such action would bring prosperity to the nation. The Assembly in September, 1790, by a vote of 508 to 423 approved the issuance of assignats up to a total of one billion two hundred million livres. This issue bore no interest and was payable to bearer but provided that as fast as the assignats were paid in for land they should be burned. In the latter stages of the issuance of assignats the printing presses were run at the will of the executive authority, blanket authorization being given for the issuance of such amounts as might 14 be needed. Within a year the discount on assignats was from 18 to 20 per cent, and within two years it amounted to 44 per cent. At about that time there was a temporary rise in their value, but in 1795 a rapid depreciation commenced. By February, 1796, it required 288 paper francs to equal one gold franc. Prices of various necessities soared, that of sugar rising 69 _ times and soap 44 times. Finally the populace joined in a public burning of the machinery with which the assignats had been made. Despite the disaster due to the assignats the monetary enthusiasts of the day caused a new form of paper money, designated as mandats, to be issued. The mandats were described as fully secured and as good as gold, but there was little difference between them and the assignats. They promptly depreciated to 35 per cent. Within six months they were down to only three per cent of their face value. The inflation was responsible for a period of bankruptcy which lasted for ten years and which retarded progress in France for many years thereafter. # * * * The experiences of various nations, including our own, provide a yardstick by which to measure what might happen if inflationary experiments get beyond control. In the light of sound monetary policies supported by the evidence offered in history, the Congress should pledge its best efforts toward a balanced budget and against measures which might lead to a ruinous inflation of currency or credit. Advocates of legislative proposals for inflation have sought to find justification in the ruling of the Supreme Court of the United States in the gold clause cases. The impetus thus given to agitation for extreme monetary measures emphasizes the need for caution. While the Court upheld the exercise by the Congress of broad powers under its constitutional authority to coin money and regulate the value thereof, the decision offers no warrant or excuse for resort to schemes heretofore proved dangerous and unwise. 15