Edgar Hardcastle

Inflation and prices (part 3)

Source: Socialist Standard, September 1965.
Transcription: Socialist Party of Great Britain.
HTML Markup: Adam Buick
Copyleft: Creative Commons (Attribute & No Derivatives) 2007 conference "Be it resolved that all material created and published by the Party shall be licensed under the Creative Commons Attribution-NoDerivs copyright licence".

Last month we discussed some aspects of the price of production, and what causes the changes in a commodity's value. We then went on to the influence which the price and the value of gold has upon prices in general. So far we have assumed that the Government fixed the gold sovereign or pound at about one-quarter an ounce of gold and kept it at that amount. But suppose the Government decided to make an alteration in the law and to increase or decrease the weight of gold in the sovereign? If the Government made the sovereign half an ounce weight of gold instead of one-quarter ounce, the effect would be to cut prices of other commodities to one-half. Alternatively, if they decided to reduce the weight of gold in the pound to one-twelfth of an ounce instead of one-quarter ounce, the effect would be to multiply all prices by three. The £4 bicycle (we mentioned in Part One) would then cost £12. This would be a change in the currency unit showing itself as a rise or fall of prices. It would not affect the value relationship between gold and the other commodities—bicycles, suits or clothes and so on. The owner of one ounce of gold which formerly would buy a bicycle would still be able to buy one bicycle, but his ounce of gold would now give £12 instead of £4 and the seller of the bicycle, who formerly could get one. ounce of gold for it, would still get one ounce of gold for it, but would now call one ounce £12 or 12 sovereigns instead of four.

Now this brings us to the inflationary movement that has been going on in Great Britain and in some other countries since about 1940. It may seem to have gone on in a mysterious way, but it is in fact an echo of something which has happened on previous occasions. Inflation took place during the Napoleonic Wars and again during the First World War. But before we can explain the technique of this inflation we have to ask ourselves what determines the amount of currency needed at any time.

This depends partly on the amount of trade that is going on, the amount of buying and selling transactions that are going on at a given moment, but it also depends on the rapidity with which currency itself circulates. The amount of currency needed can change because of expansion and contraction of production and trading, or because the velocity of currency circulation changes, or because the amount needed is reduced by the use of cheques, or certain other reasons. But we can still say that at a given time a given amount of currency is needed. Now when there was currency convertibility, that is to say when you could change gold into Bank of England notes and import and export it freely, the amount of currency regulated itself. Commodities were bought and sold through the medium of gold coins and notes convertible into gold which represented real values, that is to say the value of gold itself. This was a situation in which, if trade declined and less currency was needed, gold coins and notes flowed back into the Bank of England. On the other hand, if trade expanded and more currency was needed, additional amounts of it were forthcoming, but it was always directly linked with the value of gold. At that time, for every additional bank note that went into circulation from the Bank of England, the Bank had to place in its vaults an equivalent amount of gold.

We now come to the question of what happens if this convertibility is destroyed. Suppose the Government suspends convertibility and bank notes can no longer be converted into gold. This does not of itself cause inflation and rising prices. It only causes inflation and rising prices if, as well as suspending convertibility, the Government starts increasing the issue of the unconvertible notes to an excess amount, so that they exceed the amount of gold or silver which would actually circulate if they were not replaced by symbols. We mention silver here as well as gold because some countries used a silver coinage with convertibility instead of a gold coinage with convertibility, and when we refer to symbols we mean paper money—notes.

If the Government destroys convertibility and then issues an excess amount of notes, this causes prices to rise because more money is now circulating in relation to an unchanged amount of goods and trading transactions. This is just the same in effect as the earlier example of what would happen if the Government decided to cut the amount of gold in the pound from one-quarter weight of gold to one-eighth or one-twelfth of an ounce of gold. Prices in those circumstances would double or treble. Marx wrote about this: "If the quantity of paper money issued is double what it ought to be, then £1 would be the money name not of one-quarter ounce, but of one-eighth ounce of gold." The effect would be the same as if an alteration had taken place in the function of gold as the standard of prices; those values which were previously expressed by the price of £1 would now be expressed by the price of £2.

We may be asked how can one tell if inflation has taken place, because it is not alw?ys easy to know whether the amount of paper currency being issued is in conformity with the amount needed. There is in fact always the simple measure of inflation, and that is the price of gold itself in the market. As soon as convertibility ceases and excess notes are issued the price of gold starts to rise. We saw earlier that this had happened during the Napoleonic Wars. The economist Ricardo wrote about this, and what he wrote led to the setting up of what is known as the Bullion Committee, which issued its report in 1810. Ricardo set out to explain, as did the Bullion Committee, why the price of gold in the market had gene up from 77/10½d, an ounce to 92/- an ounce. Ricardo and the Bullion Committee gave their answer; that it was due to the suspension of convertibility and to the issue of excess notes. The remedy was simply to restore convertibility, in which case the excess notes would go out of circulation. The same thing happened again in World War One, and just after that the Cunliffe Committee, which reported in 1919, gave a similar verdict. They told the Government to stop issuing excess notes and the fall of prices which took place in 1921 and 1922 was partly due to the ceiling that the Government placed on the issue of bank notes, and partly due to the fact that a world slump was in being at the time.

We now come to the inflation that has gone on in the last 25 years. Again, we can see the proof of this inflation and the measure of it in the fact that instead of gold selling at about £4 an ounce, it is now selling at 250/- an ounce. The reason is the same as on the other occasions; convertibility has disappeared and an excess note issue has been engineered by the Government. The note issue in Great Britain has increased from about £530 million in 1939 to nearly £2,400 million. The steps by which this 25-year inflation has taken place included the following.

At the original gold weight the pound was equal to 4.86 American dollars. In the 1930's it was the American Government which cut the gold content of the dollar to about half what it was before. A further step in the process was that in 1940 the British Government pegged the British pound to the American dollar, not on the old relationship, but on a new relationship of four dollars to the pound, and in 1949 they reduced it again to 2.8 dollars. The effect of these various changes has been that the amount of gold represented by the English pound is only about one-third of what it was in 1914 and in the 1930's.

This is the main reason why the general price level in this country has more than trebled including, incidentally, the price of that particular commodity labour power—wages. It is true that the process in Great Britain has not been so crude or so drastic as the inflation which took place, for example, in Germany between the wars. On that occasion the German Government was paying its way by printing tens of millions of mark notes every day; in Great Britain now the effect is the same, though in less degree. The British Government prints additional notes and the Bank of England uses them to buy in Government securities. Incidentally, this has the effect of enabling the Government to get what may be called interest-free loans running into an amount of over £2,000 million, but, of course, the effect on the price level is just the same as it would be if the British Government had used the same direct method as was used by the German Government.

One thing it is interesting to notice here is that, being traditionalists, the British Government and the Bank of England continue to issue their accounts just as they used to issue them before 1914, as if the present note issue in this country had some backing. Before 1914 the Bank of England, apart from a certain small amount of notes which was uncovered by gold, had to have a gold reserve fully covering every additional issue of bank notes. At the present time in Great Britain there is in fact no backing at all for the note issue, but in the Bank of England accounts you can see the thing entered in the form that the £2,400 million of notes in circulation are shown on one side of the account in the balance sheet, and on the other side there is shown a similar figure for Government securities, which, of course, in practice means nothing at all.

(To be concluded)