Carroll Quigley - Tragedy and Hope - A History of the World in Our Time

These methods were not mutually exclusive, and in some cases overlapped. It might, for example, be argued that devaluation or use of fiat money were forms of partial repudiation. Nor were all these methods equally practical. For example, the first (increase real wealth) was by far the soundest method to achieve a restabilization, but no one saw how to accomplish it. The fourth (taxation) would have put a burden on the economic system so great as to be self-defeating. In Britain, the public debt could have been paid only by a tax of 25 percent for about three hundred years. Such heavy taxes might have had such a depressing effect on production of real wealth that national income would decline faster than tax rates rose, making payment by taxation impossible. Nor were all these alternative methods of paying the public debt of equal practicality in respect to their effects on the two other financial problems occupying the minds of experts and statesmen. These other two problems were inflation and price parities. These problems were just as urgent as the public debt, and the effects upon them of the different methods for paying the public debt could have been completely different. Efforts to pay the public debt by fiat money would have made the inflation problem and perhaps the price-parity problem worse. Taxation and increasing real wealth, on the other hand, would have reduced the inflation problem at the same time as they reduced the public debt, since both would have increased the value of money (that is, they were deflationary). Their effects on the problem of price parity would differ from case to case.

Finally, these methods of paying the public debt were not of equal value in theory. Orthodox theory rejected repudiation, devaluation, and fiat money as solutions to the problem, and, since it showed no way of increasing the production of real wealth, only taxation was left as a possible method of paying public debts. But the theorists, as we have shown, could call taxation a possible way only if they neglected the economic consequences. These consequences in most countries were so disastrous that taxation, if tried, soon had to be supplemented by other, unorthodox, methods. Great Britain and the United States were the only Great Powers which continued to use taxation as the chief method of paying the public debt.

The second problem which had to be faced before stabilization was possible was the problem of inflation. This was caused by the great increase in claims on wealth (money), and showed itself in a drastic increase in prices. There were three possible solutions: (a) to increase the production of real wealth; (b) to decrease the quantity of money; or (c) to devaluate, or make each unit of money equal to a smaller amount of wealth (specifically gold). The first two would have forced prices back to the lower prewar level but would have done it in entirely different ways, one resulting in prosperity and a great rise in standards of living, the second resulting in depression and a great fall in standards of living. The third method (devaluation) was essentially a recognition and acceptance of the existing situation, and would have left prices at the higher postwar level permanently. This would have involved a permanent reduction in the value of money, and also would have given different parities in foreign exchanges (unless there was international agreement that countries devaluate by the same ratio). But it would have made possible prosperity and a rising standard of living and would have accepted as permanent the redistribution of wealth from creditors to debtors brought about by the wartime inflation.

Since the third method (devaluation) was rejected by orthodox theorists, and no one could see how to get the first (increase of real wealth), only the second (deflation) was left as a possible method for dealing with the problem of inflation. To many people it seemed axiomatic that the cure for inflation was deflation, especially since bankers regarded deflation as a good thing in itself. Moreover, deflation as a method for dealing with the problem of inflation went hand in hand with taxation as a method for dealing with the problem of public debts. Theorists did not stop to think what the effects of both would be on the production of real wealth and on the prosperity of the world.

The third financial problem which had to be solved before stabilization became practical was the problem of price parities. This differed because it was primarily an international question while the other two problems were primarily domestic. By suspending the gold standard and establishing artificial control of foreign exchanges at the outbreak of war, the belligerent countries made it possible for prices to rise at different rates in different countries. This can be seen in the fact that prices in Britain rose 200 percent in seven years (1913-1920), while in the United States they rose only 100 percent. The resulting disequilibrium had to be rectified before the two countries went back on the old gold standard, or the currencies would be valued in law in a ratio quite different from their value in goods. By going back on gold at the old ratios, one ounce of fine gold would, by law, become equal to $20.67 in the United States and about 84 s . 11 1/2d . in Britain. For the $20.67 in the United States you could get in 1920 about half of what you could have bought with it in 1913; for the 84 s . 11 1/2d . in Britain you could get in 1920 only about a third of what it would buy in 1913. The ounce of gold in the United States would be much more valuable than in Britain, so that foreigners (and British) would prefer to buy in the United States rather than in Britain, and gold would tend to flow to the United States from Britain with goods flowing in the opposite direction. In such conditions it would be said that the pound was overvalued and the dollar undervalued. The overvaluation would bring depression to Britain, while the United States would tend to be prosperous. Such disequilibrium of price parities could be adjusted either by a fall of prices in the country whose currency was overvalued or by a rise in prices in the country whose currency was undervalued (or by both). Such an adjustment would be largely automatic, but at the cost of a considerable flow of gold from the country whose currency was overvalued.

Because the problem of price parities would either adjust itself or would require international agreement for its adjustment, no real attention was paid to it when governments turned their attention to the task of stabilization. Instead, they concentrated on the other two problems and, above all, devoted attention to the task of building up sufficient gold reserves to permit them to carry out the methods chosen in respect to these two problems.

Most countries were in a hurry to stabilize their currencies when peace was signed in 1919. The difficulties of the three problems we have mentioned made it necessary to postpone the step for years. The process of stabilization was stretched over more than a decade from 1919 to 1931. Only the United States was able to return to the gold standard at once, and this was the result of a peculiar combination of circumstances which existed only in that country. The United States had a plentiful supply of gold. In addition it had a technological structure quite different from that of any other country, except perhaps Japan. American technology was advancing so rapidly in the period 1922-1928 that even with falling prices there was prosperity, since costs of production fell even faster. This situation was helped by the fact that prices of raw materials and food fell faster than prices of industrial products, so that production of these latter was very profitable. As a result, America achieved to a degree greater than any other country a solution of inflation and public debt which all theorists had recognized as possible, but which none had known how to obtain—the solution to be found in a great increase in real wealth. This increase made it possible simultaneously to pay off the public debt and reduce taxes; it also made it possible to have deflation without depression. A happier solution of the postwar problems could hardly have been found—for a time, at least. In the long run, the situation had its drawbacks, since the fact that costs fell faster than prices and that prices of agricultural products and raw materials fell faster than prices of industrial products meant that in the long run the community would not have sufficient purchasing power to buy the products of the industrial organization. This problem was postponed for a considerable period by the application of easy credit and installment selling to the domestic market and by the extension to foreign countries of huge loans which made it possible for these countries to buy the products of American industry without sending their own goods into the American market in return. Thus, from a most unusual group of circumstances, the United States obtained an unusual boom of prosperity. These circumstances were, however, in many ways a postponement of difficulties rather than a solution of them, as the theoretical understanding of what was going on was still lacking.