Reading notes : Lords of Finance (part 4)

Deflation or Devaluation : A painful way to return to gold standard.

All currency issue must be backed by some liquidate material, such as gold .This was the school of taught that received by all major central bankers after first world war.

After the war, there was universal consensus among bankers that the world must return to the gold standard as quickly as possible.

Every nation involved in war, faced the dilemma. For all had resorted to inflationary finance to a greater or lesser degree. There were essentially two way to restore the past balance between the value of gold reserve and the total money supply.

Deflation : done by contracting the amount of currency in circulation .
Painful, as involved a period of dramatically tight credit and high interest rates, which bound to recession and unemployment.

Good as it save investor and savers, but will ultimately hurt them back when recession .
Taken by UK and US

Devaluation, formally devalue the money. A disguised form of expropriation, which cheat the investors and creditors out of the true value of their savings.

Good as it save business and government out of local debit, but as value of saving decrease, the central bank ruined their reputation and eventually resorted to devaluation which inturn create unstable economy.
Taken by France and German.

The limited of gold supply and the imbalance in gold reserve were deemed to cause unstable in the economic condition.

efore the war, the 4 major economy operate on 5 billion worth of gold.
After war in 1923, the monetary gold around 6 billion dolar.
With 2/3 concentrate on US.
Price in US and Uk still 50 % higher than pre war level, hence the real purchasing power of gold had contracted by almost 25 %.

Norman tried to persuade other central banker to substitute pound as gold. ( as the US did today )
Us remained the only country circulating gold coin after 1923.

The gold standard work in 19 th century as new mining discoveries had fortuitously kept pace with economy growth.
Besides, the commitment that paper money could be converted into something unequivocally tangible like gold is needed.in the pass.

Inflation, a subtle mechanism for transferring wealth between social groups, from savers, creditors, and wage earners to the government , debtors, and businessmen.

For Norman, gold standard is one of the pillar of a free society. Like property rights or habeas corpus, which had evolved in the western liberal world to limit the power of the government . ( Its power to debase money ) .

The monetary policy of Fed changed by Strong :
- to stabilize the price
- fine tune the economy by supply more credit when economy weak and contract credit when economy are strong.
- by buying or selling government securities from its portfolio, the Fed could directly and immediately alter the quantities of money flowing through the banking system.


German in 1923
Tax avenue account for 10 % of government expenditure, the rest filled by the printing of money.

Currencies had to be backed by a highly liquid , easily transferable, international acceptable asset, such as gold.

The Reichsmark became so worthless that the government was able to buy back its many trillion of debit. Valued at 30 billion when first issued, for only 190 million Rentenmark, equivalent to about 45million dollar

Though the Rentenmark was for the moment stable, it was not yet acceptable to foreigners, and hence could not provide the basis for loans to import goods from abroad.

Britain, refusing to inflate its way out of debt or to allow its currency to collapse, had been rewarded with the highest unemployment rate in Europe and a limping economy.

By contrast, France had been invaded during war, suffered the highest ratio of casualties of any country other than Serbia, and seen large tracts of its most productive land leveled and destroyed.
France resorted to inflation to lighten the burden of debit and to a weak franc to steal a march on the british by cheaping their goods.
Exports boomed, number of unemployment low.

Return to gold might be interest of city financiers, but not for the merchant, the manufacture , the workmen, and consumer ---- Winston Churchill

Indication : by tying pound to gold, no way for Britain to devalue its currency to ease local depression pressure, or for its goods to compete internationally.

France

When war broke out and the very survival of the nation was threatened, the Banque, like all other European central banks. Voluntarily subordinated itself to its government, and obligingly printed whatever money was needed to finance the colossal effort. But unlike the Reichsbank, within a few months of the end of the war, it reasserted its independence and refused to go on filling the gap between government spending and tax revenues.

In between 1925 and 1926, fearing of France bankruptcy, the franc exchange rate keep on falling,
The ability of government to finance itself in question , given the overhang of 10 billion in short term debit,
( equivalent to 100% of GDP )

However , it was the psychology of fear-- a generalized loss of nerve --- that seemed to have gripped French investor and was driving the downward spiral of the franc.
Risk was that international speculators, those traditional bugaboos of the left, would create a self-fulfilling meltdown as they shorted the currency in the hope of repurchasing it later at a lower price. Thereby compounding the very downward trend that they were trying to exploit.

At one point during the war, the British had tried to pursuade the Banque de France to ultilize some of its gold for the war effort. What was the point, they asked , of building up a reserve if not to use at times of crisis.

The tough stance adopted by US government, particularly congress, over repayments of war debts had aroused much bitterness in France. Casualties of Frenchmen during the war had been twenty times that of Americans.


July 1926, as franc reversed its fall
Moreau, recognized the choice of the exchange rate ultimately determined how the financial burden of the war was to be shared.
The level of franc is going to be settled, not by speculation or the balance of trade, or even the outcome of the Ruhr adventure, but by the proportion of his earned income in which the French taxpayer will permit to be taken from him to pay the claims of the French renties ---- Maynard Keynes

The higher the Banque de france let the franc rise, the higher would be the value of government debt, the better for the French rentier and the worse for the taxpayer.
Hence, fixing the exchange rate was a matter of balancing “ the sacrifies demanded of the different social classed in the population”.

Every country in Europe to emerge from war had faced the same issues.
Britain had chosen one extreme: to impose most of the burden on taxpayers and to protect its savers.
Germany had chosen the opposite extreme : the way of pathological inflation, which had wiped away its internal debts at the price of annihilating the savings of its middle classes.

Banque de franc start intervened the Franc exchange rate at 25 to one dollar.
French goods were among the most competitive in the world; exports were booming, while prices were stable.
By the middle of 1927, waves of French capital that had fled to London or New York had washed back home, allowing the Banque to accumulate a foreign exchange war chest of 500 million dollars, most of it in pounds.

Moreau’s mistake was to assume that the value of currency of a major economic power, such as France, the fourth largest industrial economy in the world, was a matter of it alone.
Exchange rates, by their very nature, involve more than one side and are therefore a reflection of a multilateral system.
Moreau’s decision to fix the franc at an undervalued rate would eventually help to undermine the stability of the very standard to which he had now hitched his currency.

The Gold standard did offer a traditional safety valve for dealing with shifts in gold holdings. The shrinkage of reserves in the country losing bullion was supposed to lead to an automatic contraction in credit and a rise in interest rate, which would thereby shrink its buying power , while attracting money from abroad. Meanwhile, the country gaining gold would find its credit expanding and its capacity to spend increasing, thus induce inflation , reduce interest rate and encourage import which causing gold to flow out. .