... from Tragedy and Hope, A History of the World in Our Time, by Professor Caroll Quigley p. 54 - 62
Domestic Financial Practices
In each country the supply of money took the form of an inverted pyramid or cone balanced on its point. In the point was a supply of gold and its equivalent certificates; on the intermediate levels was a much larger supply of notes; and at the top with an open and expandable upper surface, was an even greater supply of deposits. Each level used the levels below it as its reserves, and, since these lower levels had smaller quantities of money, they were "sounder." A holder of claims on the middle or upper level could increase his confidence in his claims on wealth by reducing them to a lower level, although, of course, if everyone, or any considerable number of persons tried to do this at the same time the volume of reserves would be totally inadequate. Notes were issued by "banks of emission" or "banks of issue," and were secured by reserves of gold or certificates held in their own coffers or in some central reserve. The fraction of such a note issue held in reserve depended upon custom, banking regulations (including the terms of the bank's charter), or statute law. There were formally many banks of issue, but this function is now generally restricted to a few or even to a single "central bank" in each country. Such banks, even central banks, were private institutions, owned by shareholders who profited by their operations. In the 1914-1939 period, in the United States, Federal Reserve Notes were converted by gold certificates to 40 percent of their value, but this was reduced to 25 percent in 1945. The Bank of England, by an Act of 1928, had its notes uncovered up to £250 million, and covered by gold for 100 percent over that amount. The Bank of France, in the same year, set its note cover at 35 percent. These provisions could always be set aside or changed in an emergency, such as war.
Deposits on the upper level of the pyramid were called by this name, with typical bankers' ambiguity, in spite of the fact that they consisted of two utterly different kinds of relationships: (1) "lodged deposits," which were real claims left by a depositor in a bank, on which the depositor might receive interest, since such deposits were debts owed by the bank to the depositor; and (2) "created deposits," which were claims created by the bank out of nothing as loans from the bank to "depositors" who had to pay interest on them, since these represented debt from them to the bank. In both cases, of course, checks could be drawn against such deposits to make payments to third parties, which is why both were called by the same name. Both form part of the money supply. Lodged deposits as a form of savings are deflationary, while created deposits, being an addition to the money supply, are inflationary. The volume of the latter depends on a number of factors of which the chief are the rate of interest and the demand for such credit. These two play a very significant role in determining the volume of money in the community, since a large portion of that volume, in an advanced economic community, is made up of checks drawn against deposits. The volume of deposits banks can create, like the amount of notes they can issue, depends upon the volume of reserves available to pay whatever fraction of checks are cashed rather than deposited. These matters may be regulated by laws, by bankers' rules, or simply by local customs. In the United States deposits were traditionally limited to ten times reserves of notes and gold. In Britain it was usually nearer twenty times such reserves. In all countries the demand for and volume of such credit was larger in time of a boom and less in time of a depression. This to a considerable extent explains the inflationary aspect of a depression, the combination helping to form the so-called "business cycle."
In the course of the nineteenth century, with the full establishment of the gold standard and of the modern banking system, there grew up around the fluctuating inverted pyramid of the money supply a plethora of financial establishments which came to assume the configurations of a solar system; that is, of a central bank surrounded by satellite financial institutions. In most countries the central bank was surrounded closely by the almost invisible private investment banking firms. These, like the planet Mercury, could hardly be seen in the dazzle emitted by the central bank which they, in fact, often dominated. Yet a close observer could hardly fail to notice the close private associations between these private international bankers and the central bank itself. In France, for example, in 1936 when the Bank of France was reformed, its Board of Regents (directors) was still dominated by the names of the families who had originally set it up in 1800; to these had been added a few more recent names, such as Rothschild (added in 1819); in some cases the name might not be readily recognized because it was that of a son-in-law rather than that of a son. Otherwise in 1914, the names, frequently those of Protestants of Swiss origin (who arrived in the eighteenth century) or of Jews of German origin (who arrived in the nineteenth century), had been much the same for more than a century.
In England a somewhat similar situation existed, so that even in the middle of the twentieth century the Members of the Court of the Bank of England were chiefly associates of the various old "merchant banking" firms such as Baring Brothers, Morgan Grenfell, Lazard Brothers, and others.
In a secondary position, outside the central core, are the commerical banks, called in England the "joint-stock banks," and on the COntinent known as "deposit banks." These include such famous names as Midland Bank, Lloyd's Bank, Barclays Bank in England, the National City Bank of the United States, the Credit Lyonnais in France, and the Darmstadter Bank in Germany.
Outside this secondary ring is a third, more peripheral, assemblage of institutions that have little financial power but do have th every significant function of mobilizing funds from the public. This includes a wide variety of savings banks, insurance firms, and trust companies.
Naturally, these arrangements vary greatly from place to place, especially as the division of banking functions and powers are not the same in all countries. In France and England the private bankers exercised their powers through the central bank and had much more influence on industry, government and on foreign policy and much less influence on industry, because in these two countries, unlike Germany, Italy the United States, or Russia, private savings were sufficient to allow much of industry to finance itself without recourse either to bankers of government. In the United States much industry was financed by investment bankers directly, and the power of these both on industry and on government was very great, while the central bank (the New York Federal Reserve Bank) was established late (1913) and became powerful much later (after financial capitalism was passing from the scene). In Germany industry was financed and controlled by the discount banks, while the central bank was of little power or significance before 1914. In Russia the role of the government was dominant in much of economic life, while in Italy the situation was backward and complicated.
We have said that two of the five factors which determined the value of money (and thus the price level of goods) are the supply and demand for money. The supply of money in a single country was subject to no centralized, responsible control in most countries over recent centuries. Instead, there were a variety of controls of which some could be influenced by bankers, some could be influenced by the government, and some could hardly be influenced by either. Thus, the various parts of the pyramid of money were but loosely related to each other. Moreover, much of this looseness arose from the fact that the controls were compulsive in a deflationary direction and were only permissive in an inflationary direction.
This last point can be seen in the fact that the supply of gold could be decreased but could hardly be increased. If an ounce of gold was added to the point of the pyramid in a system where law and custom allowed 10 percent reserves on each level, it COULD PERMIT an increase in deposits equivalent to $2067 on the uppermost level. If such an ounce of gold were withdrawn from a fully expanded pyramid of money, this WOULD COMPEL a reduction of deposits by at least this amount, probably by a refusal to renew loans.
Throughout modern history the influence of the gold standard has been deflationary, because the natural output of gold each year, except in extraordinary times, has not kept pace with the increase in output of goods. Only new supplies of gold, or the suspension of the gold standard in wartime, or the development of new kinds of money (like notes and checks) which economize the use of gold, have saved our civilization from steady price deflation over the last couple of centuries. As it was, we had two long periods of such deflation from 1818 to 1850 and from 1872 to about 1897. The three surrounding periods of inflation (1790--1817), 1850--1872, 1897--1921) were caused by (1) the wars of the French Revolution and Napoleon when most countries were not on gold; (2) the new gold strikes of California and Alaska in 1849--1850, followed by a series of wars, which included the Crimean War of 1854--1856, the Austrian-French War of 1859, the American Civil War of 1861--1865, the Austro-Prussian and Franco-Prussian wars of 1866 and 1870, and even the Russo Turkish War of 1877; and (3) the Klondike and Transval gold strikes of the late 1890's, supplemented by the new cyanide methods of refining gold (about 1897) and the series of wars from the Spanish--American War of 1898-1899, the Boer War of 1899--1902, and the Russo-Japanese War of 1904--1905, to the almost uninterrupted series of wars in the decade 1911--1921. In each case, the three great periods of war ended with an extreme deflationary crisis (1819, 1873, 1921) as the influential Money Power persuaded governments to reestablish a deflationary monetary unit with a high gold content.
The obsession of the Money Power with deflation was partly a result of their concern with money rather than with goods, but was also founded on other factors, one of which was paradoxical. The paradox arose from the fact that the basic economic conditions of the nineteenth century were deflationary, with a money system based on gold and an industrial system pouring out increasing supplies of goods, but in spite of falling prices (with its increasing value of money) the interest rate tended to fall rather than rise. This occurred because the relative limiting of the supply of money in business was not reflected in the world of finance where excess profits of finance made excess funds available for lending. Moreover, the old traditions of merchant banking continued to prevail in financial capitalism even to its end in 1931. It continued to emphasize bonds rather than equity securities (stocks), to favor government issues rather than private offerings, and to look to foreign rather than domestic investments. Until 1825, government bonds made up almost the whole of securities on the London Stock Exchange. In 1843, such bonds, usually foreign, were 80 percent of the securities registered, and in 1875 they were still 68 percent. The funds available for such loans were so great that there were, in the nineteenth century, sometimes riots by subscribers seeking opportunities to buy security flotations; and offerings from many remote places and obscure activities commanded a ready sale. The excess of savings led to a fall in the price necessary to hire money, so that the interest rate on British government bonds fell from 4.42 percent in 1820 to 3.11 in 1850 to 2.76 in 1900. This tended to drive savings into foreign fields where, on the whole, they continued to seek government issues and fixed interest securities. All this served to strengthen the merchant bankers' obsession both with government influence and with deflation (which would increase value of money and interest rates).
Another paradox of banking practice arose from the fact that bankers, who loved deflation, often acted in an inflationary fashion from their eagerness to lend money at interest. Since they make money out of loans, they are eager to increase the amounts of bank credit on loan. But this is inflationary. The conflicts between the deflationary ideas and inflationary practices of bankers had profound repercussions on business. The bankers made loans to business so that the volume of money increased faster than the increase in goods. The result was inflation. When this became clearly noticeable, the bankers would flee to notes or specie by curtailing credit and raising discount rates. This was beneficial to bankers in the short run (since it allowed them to foreclose on collateral held for loans), but it could be disastrous to them in the long run (by forcing the value of the collateral below the amount of the loans it secured). But such bankers' deflation was destructive to business and industry in the short run as well as the long run.
The resulting fluctuation in the supply of money, chiefly deposits, was a prominent aspect of the "business cycle." The quantity of money could be changed by changing reserve requirements or discount (interest) rates. In the United States, for example, an upper limit has been set on deposits by requiring Federal Reserve member banks to keep a certain percentage of their deposits as reserves with the local Federal Reserve Bank. The percentage (usually from 7 to 26 percent) varies with the locality and the decisions of the Board of Governors of the Federal Reserve System.
Central banks can usually vary the amount of money in circulation by "open market operations" or by influencing the discount rates of lesser banks. In open market operations, a central bank buys and sells government bonds in the open market. If it buys, it releases money into the economic system; if it sells it reduces the amount of money in the community. The change is greater than the price paid for securities. For example, if the Federal Reserve Bank buys government securities in the open market, it pays for these by check which is soon deposited in a bank. It thus increases this bank's reserves with the Federal Reserve Bank. Since banks are permitted to issue loans for several times the value of their reserves with the Federal Reserve Bank, such a transaction permits them to issue loans for a much larger sum.
Central banks can also change the quantity of money by influencing the credit policies of other banks. This can be done by various methods, such as changing the rediscount rate or changing reserve requirements. By changing the rediscount rate we mean the interest rate which central banks charge lesser banks for loans backed by commercial paper or other security which these lesser banks have taken in return for loans. By raising the rediscount rate in order to operate at a profit; such a raise in interest rates tends to reduce the demand for credit and thus the amount of deposits (money). Lowering the rediscount rate permits an opposite result.
Changing the reserve requirements as a method by which central banks can influence the credit policies of other banks is possible only in those places (like the United States) where there is a statutory limit on reserves. Increasing reserve requirements curtails the ability of lesser banks to grant credit, while decreasing it expands that ability.
It is to be noted that the control of the central bank over the credit policies of local banks are permissive in one direction and compulsive in the other. They can compel these local banks to curtail credit and can only permit them to increase credit. This means that they have control powers against inflation and not deflation -- a reflection of the old banking idea that inflation was bad and deflation was good.
The powers of governments over the quantity of money are of various kinds, and include (a) control over a central bank, (b) control over public taxation, and (c) control over public spending. The control of government over central banks varies greatly from one country to another, bu on the whole has been increasing. Since most central banks have been (technically) private institutions, this control is frequently based on custom rather than law. In any case, the control over the supply of money which governments have through central banks is exercised by the regular banking procedures we have discussed. The powers of government over the quantity of money in the community exercised through taxation and public spending are largely independent of banking control. Taxation tends to reduce the amount of money in a community and is usually a deflationary force; government spending tends to increase the amount of money in a community and is usually an inflationary force. The total effects of a government's policy will depend on which item is greater. An unbalanced budget will be inflationary; a budget with a surplus will be deflationary.
A government can also change the amount of money in a community by other, more drastic, methods. By changing the gold content of the monetary unit they can change the amount of money in the community by a much greater amount. If, for example, the gold content of the dollar is cut in half, the amount of notes and deposits reared on this basis will be increased manyfold, depending on the customs of the community in respect to reserve requirements. Moreover, if a government goes off the gold standard completely -- that is, refuses to exchange certificates and notes for specie -- the amount of notes and deposits can be increased indefinitely because these are no longer limited by limited amounts of gold reserves.
In the various actions which increase or decrease the supply of money, governments, bankers, and industrialists have not always seen eye to eye. One the whole, in the period up to 1931, bankers, especially the Money Power controlled by the international investment bankers, were able to dominate both businesses and government. They could dominate business, especially in activities and in areas where industry could not finance its own needs for capital, because investment bankers had the ability to supply or refuse to supply such capital. Thus, Rothschild interests came to dominate many of the railroads of Europe, while Morgan dominated at least 26,000 miles of American railroads. Such bankers went further than this. In return for flotations of securities of industry, they took seats on the board of directors of industrial firms, as they had already done on a commercial banks, savings banks, insurance firms, and finance companies. From these lesser institutions they funneled capital to enterprises which yielded control and away from those who resisted. These firms were controlled through interlocking directorships, holding companies, and lesser banks. They engineered amalgamations and generally reduced competition, until by the early twentieth century many activities were so monopolied that they could raise their noncompetitive prices above costs to obtain sufficient profits to become self-financing and were thus able to eliminate the control of bankers. But before that stage was reached a relatively small number of bankers were in positions of immense influence in European and American economic life. As early as 1909, Walter Rathenau, who was in a position to know (since he had inherited from his father control of the German General Electric Company and held scores of directorships himself), said, "Three hundred men, all of whom know one another, direct the economic destiny of Europe and choose their successors from among themselves."
The power of investment bankers over governments rests on a number of factors, of which the most significant, perhaps, is the need of governments to issue short-term treasury bills as well as long term government bonds. Just as businessmen go to commercial banks for current capital advances to smooth over the discrepancies between their irregular and intermittent incomes and their periodic and persistent outgoes (such as monthly rents, annual mortgage payments, and weekly wages) so a government has to go to merchant bankers (or institutions controlled by them) to tide over the shallow places caused by irregular tax receipts. As experts in government bonds, the international bankers not only handled the necessary advances but provided advice to government officials and, on many occasions, placed their own members in official posts for varied periods to deal with special problems. This is so widely accepted even today that in 1961 a Republican investment banker became Secretary of the Treasury in a Democratic Administration in Washington without significant comment from any direction.
Naturally the influence of bankers over governments during the age of financial capitalism (roughly 1850--1931) was not something about which anyone talked about freely, but it has been admitted frequently enough by those on the inside, especially in England. In 1852 Gladstone, chancellor of the Exchequer, declared, "The hinge of the whole situation was this: the government itself was not to be a substantive power in matters of Finance, but was to leave the Money Power supreme and unquestioned." On September 26, 1921, The Financial Times wrote, "Half a dozen men at the top of the Big Five Banks could upset the whole fabric of government finance by refraining from renewing Treasury Bills." In 1924 Sir Drummond Fraser, vice-president of the Institute of Bankers, stated, "The Governor of the Bank of England must be the autocrat who dictates the terms upon which alone the Government can obtain borrowed money."
In addition to their power over government based on government financing and personal influence, bankers could steer governments in ways they wished them to go by other pressures. Since most government officials felt ignorant of finance, they sought advice from bankers whom they considered to be experts in their field. The history of the last century shows, as we shall see later, that the advice given to governments by bankers, like the advice they gave to industrialists, was consistently good for bankers, but was often disastrous for governments, businessmen, and the people generally. Such advice could be enforced if necessary by manipulation of exchanges, gold flows, discount rates, and even levels of business activity. Thus Morgan dominated Cleveland's second administration by gold withdrawals, and in 1936 -- 1938 French foreign exchange manipulators paralyzed the Popular Front governments. As we shall see, the powers of these international bankers reached their peak in the last decade of their supremacy, 1919 -- 1931, when Montagu Norman and J.P. Morgan dominated not only the financial world but international relations and other matters as well. On November 11, 1927, the Wall Street Journal called Mr. Norman "the currency dictator of Europe." This was admitted by Mr. Norman himself before the Court of the Bank on March 21, 1930, and before the Macmillan Committee of the House of Commons five days later. On one occasion, just before international financial capitalism ran, at full speed, on the rocks which sank it, Mr. Norman is reported to have said, "I hold the hegemony of the world." At the time, some Englishmen spoke of the "second Norman Conquest of England" in reference to the fact that Norman's brother was head of the British Broadcasting Corporation. It might be added that Governor Norman rarely acted in major world problems without consulting with J. P. Morgan's representatives, and as a consequence he was one of the most widely traveled men of his day.
This conflict of interests between bankers and industrialists has resulted in most European countries in the subordination of the former either to the latter or to the government (after 1931). This subordination was accomplished by the adoption of "unorthodox financial policies" -- that is, financial policies not in accordance with the short-run interests of bankers. This shift by which bankers were made subordinate reflected a fundamental development in modern economic history -- a development which can be described as the growth from financial capitalism to monopoly capitalism. This took place in German earlier than in any other country and was well under way in 1926. It came in Britain only after 1931 and in Italy only in 1934. It did not occur in France to a comparable extent at all, and this explains the economic weakness of France in 1938--1940 to a considerable degree.
Domestic Financial Practices
In each country the supply of money took the form of an inverted pyramid or cone balanced on its point. In the point was a supply of gold and its equivalent certificates; on the intermediate levels was a much larger supply of notes; and at the top with an open and expandable upper surface, was an even greater supply of deposits. Each level used the levels below it as its reserves, and, since these lower levels had smaller quantities of money, they were "sounder." A holder of claims on the middle or upper level could increase his confidence in his claims on wealth by reducing them to a lower level, although, of course, if everyone, or any considerable number of persons tried to do this at the same time the volume of reserves would be totally inadequate. Notes were issued by "banks of emission" or "banks of issue," and were secured by reserves of gold or certificates held in their own coffers or in some central reserve. The fraction of such a note issue held in reserve depended upon custom, banking regulations (including the terms of the bank's charter), or statute law. There were formally many banks of issue, but this function is now generally restricted to a few or even to a single "central bank" in each country. Such banks, even central banks, were private institutions, owned by shareholders who profited by their operations. In the 1914-1939 period, in the United States, Federal Reserve Notes were converted by gold certificates to 40 percent of their value, but this was reduced to 25 percent in 1945. The Bank of England, by an Act of 1928, had its notes uncovered up to £250 million, and covered by gold for 100 percent over that amount. The Bank of France, in the same year, set its note cover at 35 percent. These provisions could always be set aside or changed in an emergency, such as war.
Deposits on the upper level of the pyramid were called by this name, with typical bankers' ambiguity, in spite of the fact that they consisted of two utterly different kinds of relationships: (1) "lodged deposits," which were real claims left by a depositor in a bank, on which the depositor might receive interest, since such deposits were debts owed by the bank to the depositor; and (2) "created deposits," which were claims created by the bank out of nothing as loans from the bank to "depositors" who had to pay interest on them, since these represented debt from them to the bank. In both cases, of course, checks could be drawn against such deposits to make payments to third parties, which is why both were called by the same name. Both form part of the money supply. Lodged deposits as a form of savings are deflationary, while created deposits, being an addition to the money supply, are inflationary. The volume of the latter depends on a number of factors of which the chief are the rate of interest and the demand for such credit. These two play a very significant role in determining the volume of money in the community, since a large portion of that volume, in an advanced economic community, is made up of checks drawn against deposits. The volume of deposits banks can create, like the amount of notes they can issue, depends upon the volume of reserves available to pay whatever fraction of checks are cashed rather than deposited. These matters may be regulated by laws, by bankers' rules, or simply by local customs. In the United States deposits were traditionally limited to ten times reserves of notes and gold. In Britain it was usually nearer twenty times such reserves. In all countries the demand for and volume of such credit was larger in time of a boom and less in time of a depression. This to a considerable extent explains the inflationary aspect of a depression, the combination helping to form the so-called "business cycle."
In the course of the nineteenth century, with the full establishment of the gold standard and of the modern banking system, there grew up around the fluctuating inverted pyramid of the money supply a plethora of financial establishments which came to assume the configurations of a solar system; that is, of a central bank surrounded by satellite financial institutions. In most countries the central bank was surrounded closely by the almost invisible private investment banking firms. These, like the planet Mercury, could hardly be seen in the dazzle emitted by the central bank which they, in fact, often dominated. Yet a close observer could hardly fail to notice the close private associations between these private international bankers and the central bank itself. In France, for example, in 1936 when the Bank of France was reformed, its Board of Regents (directors) was still dominated by the names of the families who had originally set it up in 1800; to these had been added a few more recent names, such as Rothschild (added in 1819); in some cases the name might not be readily recognized because it was that of a son-in-law rather than that of a son. Otherwise in 1914, the names, frequently those of Protestants of Swiss origin (who arrived in the eighteenth century) or of Jews of German origin (who arrived in the nineteenth century), had been much the same for more than a century.
In England a somewhat similar situation existed, so that even in the middle of the twentieth century the Members of the Court of the Bank of England were chiefly associates of the various old "merchant banking" firms such as Baring Brothers, Morgan Grenfell, Lazard Brothers, and others.
In a secondary position, outside the central core, are the commerical banks, called in England the "joint-stock banks," and on the COntinent known as "deposit banks." These include such famous names as Midland Bank, Lloyd's Bank, Barclays Bank in England, the National City Bank of the United States, the Credit Lyonnais in France, and the Darmstadter Bank in Germany.
Outside this secondary ring is a third, more peripheral, assemblage of institutions that have little financial power but do have th every significant function of mobilizing funds from the public. This includes a wide variety of savings banks, insurance firms, and trust companies.
Naturally, these arrangements vary greatly from place to place, especially as the division of banking functions and powers are not the same in all countries. In France and England the private bankers exercised their powers through the central bank and had much more influence on industry, government and on foreign policy and much less influence on industry, because in these two countries, unlike Germany, Italy the United States, or Russia, private savings were sufficient to allow much of industry to finance itself without recourse either to bankers of government. In the United States much industry was financed by investment bankers directly, and the power of these both on industry and on government was very great, while the central bank (the New York Federal Reserve Bank) was established late (1913) and became powerful much later (after financial capitalism was passing from the scene). In Germany industry was financed and controlled by the discount banks, while the central bank was of little power or significance before 1914. In Russia the role of the government was dominant in much of economic life, while in Italy the situation was backward and complicated.
We have said that two of the five factors which determined the value of money (and thus the price level of goods) are the supply and demand for money. The supply of money in a single country was subject to no centralized, responsible control in most countries over recent centuries. Instead, there were a variety of controls of which some could be influenced by bankers, some could be influenced by the government, and some could hardly be influenced by either. Thus, the various parts of the pyramid of money were but loosely related to each other. Moreover, much of this looseness arose from the fact that the controls were compulsive in a deflationary direction and were only permissive in an inflationary direction.
This last point can be seen in the fact that the supply of gold could be decreased but could hardly be increased. If an ounce of gold was added to the point of the pyramid in a system where law and custom allowed 10 percent reserves on each level, it COULD PERMIT an increase in deposits equivalent to $2067 on the uppermost level. If such an ounce of gold were withdrawn from a fully expanded pyramid of money, this WOULD COMPEL a reduction of deposits by at least this amount, probably by a refusal to renew loans.
Throughout modern history the influence of the gold standard has been deflationary, because the natural output of gold each year, except in extraordinary times, has not kept pace with the increase in output of goods. Only new supplies of gold, or the suspension of the gold standard in wartime, or the development of new kinds of money (like notes and checks) which economize the use of gold, have saved our civilization from steady price deflation over the last couple of centuries. As it was, we had two long periods of such deflation from 1818 to 1850 and from 1872 to about 1897. The three surrounding periods of inflation (1790--1817), 1850--1872, 1897--1921) were caused by (1) the wars of the French Revolution and Napoleon when most countries were not on gold; (2) the new gold strikes of California and Alaska in 1849--1850, followed by a series of wars, which included the Crimean War of 1854--1856, the Austrian-French War of 1859, the American Civil War of 1861--1865, the Austro-Prussian and Franco-Prussian wars of 1866 and 1870, and even the Russo Turkish War of 1877; and (3) the Klondike and Transval gold strikes of the late 1890's, supplemented by the new cyanide methods of refining gold (about 1897) and the series of wars from the Spanish--American War of 1898-1899, the Boer War of 1899--1902, and the Russo-Japanese War of 1904--1905, to the almost uninterrupted series of wars in the decade 1911--1921. In each case, the three great periods of war ended with an extreme deflationary crisis (1819, 1873, 1921) as the influential Money Power persuaded governments to reestablish a deflationary monetary unit with a high gold content.
The obsession of the Money Power with deflation was partly a result of their concern with money rather than with goods, but was also founded on other factors, one of which was paradoxical. The paradox arose from the fact that the basic economic conditions of the nineteenth century were deflationary, with a money system based on gold and an industrial system pouring out increasing supplies of goods, but in spite of falling prices (with its increasing value of money) the interest rate tended to fall rather than rise. This occurred because the relative limiting of the supply of money in business was not reflected in the world of finance where excess profits of finance made excess funds available for lending. Moreover, the old traditions of merchant banking continued to prevail in financial capitalism even to its end in 1931. It continued to emphasize bonds rather than equity securities (stocks), to favor government issues rather than private offerings, and to look to foreign rather than domestic investments. Until 1825, government bonds made up almost the whole of securities on the London Stock Exchange. In 1843, such bonds, usually foreign, were 80 percent of the securities registered, and in 1875 they were still 68 percent. The funds available for such loans were so great that there were, in the nineteenth century, sometimes riots by subscribers seeking opportunities to buy security flotations; and offerings from many remote places and obscure activities commanded a ready sale. The excess of savings led to a fall in the price necessary to hire money, so that the interest rate on British government bonds fell from 4.42 percent in 1820 to 3.11 in 1850 to 2.76 in 1900. This tended to drive savings into foreign fields where, on the whole, they continued to seek government issues and fixed interest securities. All this served to strengthen the merchant bankers' obsession both with government influence and with deflation (which would increase value of money and interest rates).
Another paradox of banking practice arose from the fact that bankers, who loved deflation, often acted in an inflationary fashion from their eagerness to lend money at interest. Since they make money out of loans, they are eager to increase the amounts of bank credit on loan. But this is inflationary. The conflicts between the deflationary ideas and inflationary practices of bankers had profound repercussions on business. The bankers made loans to business so that the volume of money increased faster than the increase in goods. The result was inflation. When this became clearly noticeable, the bankers would flee to notes or specie by curtailing credit and raising discount rates. This was beneficial to bankers in the short run (since it allowed them to foreclose on collateral held for loans), but it could be disastrous to them in the long run (by forcing the value of the collateral below the amount of the loans it secured). But such bankers' deflation was destructive to business and industry in the short run as well as the long run.
The resulting fluctuation in the supply of money, chiefly deposits, was a prominent aspect of the "business cycle." The quantity of money could be changed by changing reserve requirements or discount (interest) rates. In the United States, for example, an upper limit has been set on deposits by requiring Federal Reserve member banks to keep a certain percentage of their deposits as reserves with the local Federal Reserve Bank. The percentage (usually from 7 to 26 percent) varies with the locality and the decisions of the Board of Governors of the Federal Reserve System.
Central banks can usually vary the amount of money in circulation by "open market operations" or by influencing the discount rates of lesser banks. In open market operations, a central bank buys and sells government bonds in the open market. If it buys, it releases money into the economic system; if it sells it reduces the amount of money in the community. The change is greater than the price paid for securities. For example, if the Federal Reserve Bank buys government securities in the open market, it pays for these by check which is soon deposited in a bank. It thus increases this bank's reserves with the Federal Reserve Bank. Since banks are permitted to issue loans for several times the value of their reserves with the Federal Reserve Bank, such a transaction permits them to issue loans for a much larger sum.
Central banks can also change the quantity of money by influencing the credit policies of other banks. This can be done by various methods, such as changing the rediscount rate or changing reserve requirements. By changing the rediscount rate we mean the interest rate which central banks charge lesser banks for loans backed by commercial paper or other security which these lesser banks have taken in return for loans. By raising the rediscount rate in order to operate at a profit; such a raise in interest rates tends to reduce the demand for credit and thus the amount of deposits (money). Lowering the rediscount rate permits an opposite result.
Changing the reserve requirements as a method by which central banks can influence the credit policies of other banks is possible only in those places (like the United States) where there is a statutory limit on reserves. Increasing reserve requirements curtails the ability of lesser banks to grant credit, while decreasing it expands that ability.
It is to be noted that the control of the central bank over the credit policies of local banks are permissive in one direction and compulsive in the other. They can compel these local banks to curtail credit and can only permit them to increase credit. This means that they have control powers against inflation and not deflation -- a reflection of the old banking idea that inflation was bad and deflation was good.
The powers of governments over the quantity of money are of various kinds, and include (a) control over a central bank, (b) control over public taxation, and (c) control over public spending. The control of government over central banks varies greatly from one country to another, bu on the whole has been increasing. Since most central banks have been (technically) private institutions, this control is frequently based on custom rather than law. In any case, the control over the supply of money which governments have through central banks is exercised by the regular banking procedures we have discussed. The powers of government over the quantity of money in the community exercised through taxation and public spending are largely independent of banking control. Taxation tends to reduce the amount of money in a community and is usually a deflationary force; government spending tends to increase the amount of money in a community and is usually an inflationary force. The total effects of a government's policy will depend on which item is greater. An unbalanced budget will be inflationary; a budget with a surplus will be deflationary.
A government can also change the amount of money in a community by other, more drastic, methods. By changing the gold content of the monetary unit they can change the amount of money in the community by a much greater amount. If, for example, the gold content of the dollar is cut in half, the amount of notes and deposits reared on this basis will be increased manyfold, depending on the customs of the community in respect to reserve requirements. Moreover, if a government goes off the gold standard completely -- that is, refuses to exchange certificates and notes for specie -- the amount of notes and deposits can be increased indefinitely because these are no longer limited by limited amounts of gold reserves.
In the various actions which increase or decrease the supply of money, governments, bankers, and industrialists have not always seen eye to eye. One the whole, in the period up to 1931, bankers, especially the Money Power controlled by the international investment bankers, were able to dominate both businesses and government. They could dominate business, especially in activities and in areas where industry could not finance its own needs for capital, because investment bankers had the ability to supply or refuse to supply such capital. Thus, Rothschild interests came to dominate many of the railroads of Europe, while Morgan dominated at least 26,000 miles of American railroads. Such bankers went further than this. In return for flotations of securities of industry, they took seats on the board of directors of industrial firms, as they had already done on a commercial banks, savings banks, insurance firms, and finance companies. From these lesser institutions they funneled capital to enterprises which yielded control and away from those who resisted. These firms were controlled through interlocking directorships, holding companies, and lesser banks. They engineered amalgamations and generally reduced competition, until by the early twentieth century many activities were so monopolied that they could raise their noncompetitive prices above costs to obtain sufficient profits to become self-financing and were thus able to eliminate the control of bankers. But before that stage was reached a relatively small number of bankers were in positions of immense influence in European and American economic life. As early as 1909, Walter Rathenau, who was in a position to know (since he had inherited from his father control of the German General Electric Company and held scores of directorships himself), said, "Three hundred men, all of whom know one another, direct the economic destiny of Europe and choose their successors from among themselves."
The power of investment bankers over governments rests on a number of factors, of which the most significant, perhaps, is the need of governments to issue short-term treasury bills as well as long term government bonds. Just as businessmen go to commercial banks for current capital advances to smooth over the discrepancies between their irregular and intermittent incomes and their periodic and persistent outgoes (such as monthly rents, annual mortgage payments, and weekly wages) so a government has to go to merchant bankers (or institutions controlled by them) to tide over the shallow places caused by irregular tax receipts. As experts in government bonds, the international bankers not only handled the necessary advances but provided advice to government officials and, on many occasions, placed their own members in official posts for varied periods to deal with special problems. This is so widely accepted even today that in 1961 a Republican investment banker became Secretary of the Treasury in a Democratic Administration in Washington without significant comment from any direction.
Naturally the influence of bankers over governments during the age of financial capitalism (roughly 1850--1931) was not something about which anyone talked about freely, but it has been admitted frequently enough by those on the inside, especially in England. In 1852 Gladstone, chancellor of the Exchequer, declared, "The hinge of the whole situation was this: the government itself was not to be a substantive power in matters of Finance, but was to leave the Money Power supreme and unquestioned." On September 26, 1921, The Financial Times wrote, "Half a dozen men at the top of the Big Five Banks could upset the whole fabric of government finance by refraining from renewing Treasury Bills." In 1924 Sir Drummond Fraser, vice-president of the Institute of Bankers, stated, "The Governor of the Bank of England must be the autocrat who dictates the terms upon which alone the Government can obtain borrowed money."
In addition to their power over government based on government financing and personal influence, bankers could steer governments in ways they wished them to go by other pressures. Since most government officials felt ignorant of finance, they sought advice from bankers whom they considered to be experts in their field. The history of the last century shows, as we shall see later, that the advice given to governments by bankers, like the advice they gave to industrialists, was consistently good for bankers, but was often disastrous for governments, businessmen, and the people generally. Such advice could be enforced if necessary by manipulation of exchanges, gold flows, discount rates, and even levels of business activity. Thus Morgan dominated Cleveland's second administration by gold withdrawals, and in 1936 -- 1938 French foreign exchange manipulators paralyzed the Popular Front governments. As we shall see, the powers of these international bankers reached their peak in the last decade of their supremacy, 1919 -- 1931, when Montagu Norman and J.P. Morgan dominated not only the financial world but international relations and other matters as well. On November 11, 1927, the Wall Street Journal called Mr. Norman "the currency dictator of Europe." This was admitted by Mr. Norman himself before the Court of the Bank on March 21, 1930, and before the Macmillan Committee of the House of Commons five days later. On one occasion, just before international financial capitalism ran, at full speed, on the rocks which sank it, Mr. Norman is reported to have said, "I hold the hegemony of the world." At the time, some Englishmen spoke of the "second Norman Conquest of England" in reference to the fact that Norman's brother was head of the British Broadcasting Corporation. It might be added that Governor Norman rarely acted in major world problems without consulting with J. P. Morgan's representatives, and as a consequence he was one of the most widely traveled men of his day.
This conflict of interests between bankers and industrialists has resulted in most European countries in the subordination of the former either to the latter or to the government (after 1931). This subordination was accomplished by the adoption of "unorthodox financial policies" -- that is, financial policies not in accordance with the short-run interests of bankers. This shift by which bankers were made subordinate reflected a fundamental development in modern economic history -- a development which can be described as the growth from financial capitalism to monopoly capitalism. This took place in German earlier than in any other country and was well under way in 1926. It came in Britain only after 1931 and in Italy only in 1934. It did not occur in France to a comparable extent at all, and this explains the economic weakness of France in 1938--1940 to a considerable degree.
No comments:
Post a Comment