Finance Capital, Hilferding 1910


Credit conditions in the course of the business cycle

At the beginning of a period of prosperity a low rate of interest prevails, which rises only slowly and gradually. Loan capital is plentiful. The expansion of production, and hence of circulation, does indeed increase the demand for loan capital. But the increased demand is easily satisfied, first because the money capital which was lying idle during the depression is available, and second because the onset of a period of prosperity is accompanied by an expansion of circulation credit. Thus, while the commodity capital of industrialists and merchants, which has to be reconverted into money capital, has increased both in volume and in price, the necessary means for circulating it are supplied by the increased amount of credit money. Along with this increase in the amount of credit money its velocity of circulation is also accelerated as a result of the more rapid turnover of commodity capital. The increased supply of loan capital, brought about by the more extensive creation of credit money, is sufficient to meet the increased demand for loan capital without a rise in the interest rate.

In this period the supply of loan capital also grows because the amount of money capital which producers must have available during the turnover period (which depends upon the length of time involved) has diminished as a result of the reduction of turnover time, and the capital thus released comes on to the money market as loan capital.

As prosperity continues, however, these conditions change, and the gradual changes are reflected in the gradual rise in the interest rate. We saw earlier that during a period of prosperity the turnover time of capital is extended, and a disproportion emerges between the various branches of production. The extension of turnover time, that is, the greater sluggishness of sales, also means a slackening of the velocity of circulation of credit money. A bill which falls due in three months cannot be met if the commodity whose money form it represents is only paid for after four months. The bill must either be renewed or settled in cash. Renewal means having recourse to credit, to capital credit provided by the bank, and this involves an increased demand for bank credit. Demand for bank credit will be general because the need to renew bills will not just affect an individual capitalist, but a certain proportion of the whole class of productive capitalists. The increased demand for bank credit, which simply results from the fact that the circulation credit with which the productive capitalists provide each other is no longer adequate, as well as the increased demand for cash, has a direct effect in raising the interest rate.

Increasing disproportionality, which also signifies that sales are slumping, has the same effect. One commodity must be exchanged for another if credit money is to perform its function of replacing cash. If the reciprocal turnover of commodities comes to a halt then cash must take the place of credit money. The bill cannot be met when it falls due because the commodity which it represents has not been sold. If it is, nevertheless, to be redeemed that can only be done by recourse to bank credit which thus takes the place of circulation credit. It is a matter of indifference to the industrialist whether the bill which he has accepted in payment for his commodity is redeemed through circulation credit (which means, in the final analysis, that his commodity is exchanged for another commodity) or through bank credit (in which case his commodity has not as yet been definitively exchanged for another). Of course, he now has to pay a somewhat higher rate of interest, but he does not understand the reason for it, and even if he did understand, this would not change anything and would do him no good. In any case, prices and profits are still high, and he still needs the money capital which he can get for his bill in order to continue production on the same scale. He is quite unaware that the money capital with which he now operates no longer represents the converted form of his own commodity capital, which in reality has not yet been sold at all. Nor is he aware that he is now continuing production with additional money capital made available to him by the banker.

But this is a circumstance of the greatest importance. The incipient disproportionality must show itself in the formation of stocks of commodities. At some point in the circulation process the commodity must come to a halt. This stock of commodities would be bound to affect the market if the commodity had to be sold, in order to continue production with the money realized from its sale. This effect on the market, and the ensuing effect on prices and profits, is avoided by the banks making money capital available to the producers, and in this way credit obscures the incipient disproportionality. Production continues unchanged and is even greatly expanded in some branches where prices are particularly high, because the drawing in of money capital prevents commodities from exerting pressure on the market, thus causing prices to fall. Thus production appears to be in a perfectly healthy condition even though disproportionality between different branches of production has already developed.

The changes in the level of the interest rate, which are primarily determined by changes in the relations of proportionality in the course of the cycle, in turn exert a most powerful influence upon the founding of new enterprises, upon speculation in commodities and securities, and hence upon the whole state of stock exchange business. In the initial stages of prosperity the interest rate is low, and other things being equal this raises the market quotations of fictitious capital. The price of that part of fictitious capital, such as state bonds and bonds issued by public corporations, as well as some types of debentures, which has a fixed and guaranteed return, rises as a direct result of the fall in the rate of interest. In the case of shares a rise in their price following the decline in the interest rate is countered by the reduction of dividends and the greater uncertainty of yields, but prosperity eliminates this counter tendency, and share quotations rise as the rate of interest remains low, because yields increase and become more certain. At the same time speculation increases, with the aim of exploiting the rise in security prices, and the demand for shares grows, with the result that prices are driven still higher. The expansion of production leads to greater activity in the promotion of new companies, while existing ones increase their capital. The banks become very active in issuing shares, and the high level of share prices, together with the low interest rate, bring high profits from such issues. The new shares are quickly taken up on the stock exchange and are easily sold to the public, that is to capitalists who have loan capital available. It is in this period that promotional activity is most vigorous, and the profits made by the banks from their own issues are greatest. Money liquidity favours speculation, which is dependent upon the availability of credit for its operations. Thanks to the low rate of interest, speculation can exploit even small fluctuations in stock exchange prices such as occur during the initial phase of prosperity. The stock exchange is lively and the turnover considerable, and even though price fluctuations are modest, they tend overall to produce a higher level of quotations. This higher level, which results on one side from the increase in the volume of securities and their higher prices, and on the other side from the increased turnover, involves greater recourse to credit for settling balances, which now require larger sums of money. This is even more the case since during such periods 'bullish' predominates over 'bearish' speculation, purchases exceed sales, and -the balances which have finally to be settled are inflated. The increased demand for credit emanating from the stock exchange is not matched by an increased supply, unlike the increased demand of productive capitalists which is immediately met by an expansion of circulation credit. Hence the increased demand has a direct effect in raising the rate of interest, and reinforces those tendencies emerging in the sphere of production which operate in the same direction.

Similar developments occur in the field of commodity speculation, which also tries to take advantage of rising prices and to reinforce the upward trend. On one side, commodities are brought from other markets to a market where the price is particularly high, thus increasing the supply. Since one importer knows nothing about the activities of others, it is all too easy for the supply ultimately to exceed demand, producing a glut on the market. But on the other side speculation in commodities, like speculation on the stock market, strives to maintain, and if possible augment, the rise in prices. Commodities are withheld from the market for as long as possible in order to raise the price; and 'rings' and 'corners' are formed to force up prices by creating artificial shortages. In order to withhold commodities from the market it is again necessary to resort to credit, and this also contributes to the rise in the rate of interest.

Meanwhile, industrial prosperity has become general and has developed into a boom. Prices and profits reach their highest levels. Share prices rise as a result of higher yields. Speculation, which has on the whole shown a profit, has grown enormously. The prospect of speculative gains becomes infectious, and the general public is drawn increasingly into stock exchange dealings, thus providing the professional speculators with opportunity to expand their operations at the expense of the public. Since the interest rate is high the changes in stock exchange prices must be large enough to prevent the higher interest from absorbing speculative gains, if speculation is to be profitable. In fact, these fluctuations now become significant in another way, because the reports from industry are no longer entirely favourable, and although profits continue to rise, there is stagnation here and there, sales are no longer so buoyant, and access to credit begins to be more difficult once the banks begin to consider it hazardous to follow a policy conducive to speculation. This is particularly the case when, with the greater participation of the general public, there is a considerable increase in the number of people who engage in speculation without resources of their own, or with quite inadequate resources. Similar developments occur on the commodity market.

The rising rate of interest tends, however, to depress stock exchange prices, and eventually a point must be reached at which the effort of speculators to force up prices comes to a halt. This point is reached all the more quickly if some of the credit which was previously available is withdrawn from speculation. We have seen that as prosperity advances productive capitalists have to make increasing demands upon the banks, and to the reasons given for that situation we must now add another. The rate of interest is crucial for the level of promoter's profit. The high rate of interest which prevails during a boom reduces promoter's profit and consequently restricts share issues. In addition, at such a time speculation is already satiated and could not absorb further issues at the current high prices. The banks then confront the danger that they will be unable to dispose of the new issue, or will have to do so at relatively low prices.

The needs of industry are now met by the banks themselves. Instead of issuing shares they grant bank credits, on which the productive capitalists must pay the prevailing high rate of interest. But the greater the commitments of the banks to industry the less funds they are able to make available to speculators. Speculation, therefore, has to contract, and this means a decline in the demand for securities and a fall in stock exchange prices. Since the prevailing level of security prices was the basis of the credit made available for speculative purposes, it now becomes necessary to provide additional funds to support the paper which has served as collateral, or in some other way, as a basis of credit; funds which many of the speculators, and particularly their fellow travellers among the public, cannot supply. So there ensue forced sales of pledged shares, a sudden increase in the supply of shares, and a rapid fall in stock exchange prices. This fall in prices is exacerbated by the manoeuvres of the professional speculators who, having recognized the critical state of the market, now rush into 'bearish' operations. The fall in prices leads to a further restriction of credit and new forced sales ; the decline becomes a crash, and a stock exchange crisis and financial panic develops. There is a massive devaluation of paper securities, which fall rapidly below the level corresponding to their real yield at the normal rate of interest. This depreciated paper is then bought up by the large capitalists and banks, in order to be sold later at a higher price when the panic is over and share quotations have risen again. This continues until, in the course of the next cycle, the expropriation of some of the speculators, and the concentration of property in the hands of the money capitalists, again takes place, and the stock exchange performs its function of bringing about a concentration of property through the concentration of fictitious capital.

The immediate cause of a stock exchange crisis, therefore, is the changes which occur in the money market and in the credit situation, and since the advent of such a crisis depends directly upon the level of the interest rate, it can well precede the onset of a general commercial and industrial crisis. None the less, it is only a symptom, an omen, of the latter crisis, since the changes in the money market are indeed determined by the changes in production which lead to a crisis.[1]

Developments similar to those in share speculation also occur in commodity speculation, except that here, in the nature of things, there is a closer connection with the conditions of production. Here too the rise in the rate of interest and the restriction of credit make it more difficult to withhold commodities from the market and so to maintain prices. At the same time the high level of prices encourages maximum production, increased imports, and restraint in consumption, until finally the market collapses. If the commodity is one whose price also affects the price of leading securities on the stock exchange, as is the case with copper, for example, the collapse of commodity speculation may also be the signal for a collapse of stock exchange speculation.

The change in money market conditions also has a decisive influence upon the amount and nature of bank profit. At the beginning of a period of prosperity the interest rate is low and the profits from share issues large. We have seen that in the course of the cycle they move in opposite directions. Moreover, during the whole period of the cycle the bank's profit from its commissions as an intermediary in the provision of circulation credit increases; the profit on money dealing capital also increases because productive capitalists are making more payments; and above all, as the rate of interest rises, bank capital takes an increasing share of the producers' profit at the expense of entrepreneurial gains, and of speculative profit at the expense of marginal gains. The higher the rate of interest, the greater is the share of finance capital in the fruits of prosperity. While prosperity lasts money capital increases its share of the profit made by productive capital.

We have also seen that in the course of the cycle there is an increasing demand for bank credit as soon as the volume of circulation credit has reached its maximum limit. The demand for bank credit develops because the expansion of production entails an increase in circulation, and that in turn requires increased means of circulation. Bank reserves are therefore gradually depleted and this eventually involves resort to the central bank of issue. Lagging sales retard the circulation of bills of exchange, thus reducing the volume of circulation credit and making it necessary for bank credit to fill the gap. But disproportionality, with all its consequences, continues to grow, and its effect upon bank credit is reinforced by the growing demands of speculation. Thus bank credit is gradually strained to the point where the banks are no longer able to expand credit without an excessive reduction in their reserves. When circulation can no longer be expanded through the use of credit there is a demand for cash, and as it flows into circulation in increasing volume reserves are again reduced and the banks are obliged to place further restrictions on the provision of credit. These restrictions mean that industry can no longer correct the dislocations arising from disproportionality, because the required money capital is not available. Commodities must be unloaded on the market in order to obtain means of payment no longer obtainable through credit. As a result prices begin to fall; but since the previous price level was the basis of all credit transactions, this means that bills drawn against these commodities cannot now be met from the proceeds of their sale. A demand for money in order to make payments arises at the very moment when the supply of money is contracting. For circulation credit declines rapidly as the fall in prices devalues bills and reduces the amount of money that can be obtained for them. At the same time, bank credit cannot be expanded because falling prices make it doubtful whether producers will be in a position to repay loans. Thus the very demand for payment leads to the impossibility of satisfying it, and credit stringency reaches a peak. Not only has the interest rate risen to its maximum, but it is impossible to obtain credit at all, for the convulsions in the credit system have as a consequence that all those who have cash available keep it for their own payments. There is only one way to obtain means of payment; namely, by converting commodities into money. Everyone wants to sell, and for the same reasons nobody wants to buy. Prices fall precipitously, but still commodities remain unsaleable. Sales come to a full stop, and circulation credit is annihilated; for no matter how much circulation is reduced the elimination of credit money reduces still more the means of circulation. Cash must take the place of credit and the demand for means of payment becomes a frantic demand for cash.

The consequences of this demand depend upon the specific circumstances; the collapse of commodity prices has a very detrimental effect on the cash position of industrialists, and makes it doubtful whether they will be able to repay their bank loans. If the bank has placed its funds with insolvent industrialists then the bankruptcy of the latter will also involve the bank, and the credit standing which it enjoyed on the basis of its deposits and the acceptance of the notes which it issued, is suddenly destroyed. There is a run on the bank and the repayment of deposits is demanded in cash, whereas only a minimum amount of such deposits has not been used to make loans. The deposits are wiped out and the panic may spread to the other banks, thus forcing them in turn to close their doors. A bank crisis breaks out. The collapse of the credit system, the reversion to a monetary system as Marx calls it, makes cash the only acceptable means of payment. But the quantity of cash available is inadequate for the needs of circulation, more particularly because there is massive hoarding of it as a result of the panic. In consequence a cash premium emerges, the intrinsic value of money disappears (even under a gold standard, as the recent American crisis once again demonstrated), and the value of money is determined by the socially necessary value required in circulation.

A long period of development separates the use of money as a means of circulation and payment from its function as loan capital. Money in the glittering form of gold is the first passionate love of youthful capitalism. The mercantilist theory is its breviary of love. It is a great and all-consuming passion, radiant with the glow of romanticism. For the sake of winning the beloved capitalism performs innumerable feats of heroism, discovers new worlds, fights ever-renewed wars, creates the modern state, and in its romantic ecstasy even destroys the very basis of all romanticism - the Middle Ages. But with advancing years comes wisdom. Classical theory teaches capitalism to despise the romantic façade and to build a solid family establishment in its own home, the capitalist factory. It looks back in horror upon the costly follies of its youth which led it to neglect domestic bliss. Ricardo instructs it in the damage done by its expensive liaison with gold and joins in lamenting the unproductiveness of the 'high price of bullion'. On commercial paper, bank notes, and bills of exchange, capitalism writes its farewell note to the loved one. But it still seeks to retain certain privileges, and the currency school requires from the more modest paper currency that it should conform to the traditions of its more glamorous predecessor. The tastes of ageing capitalism become ever more refined. Having enjoyed its youth to the full, an extravagant and intense passion no longer satisfies it, mystical longings arise, and salvation is sought in faith. John Law proclaims the new gospel. Capitalism, now satiated, abominates the flesh and seeks refuge in the spirit. Once again it experiences a supreme rapture, but suddenly the old desires, long denied, reawaken, the confidence in satisfaction through faith alone evaporates, and there is a frantic desire to make sure that the old virility remains. Credit collapses, and thus suddenly deserted capitalism returns in despair to its first love, to gold. Shaken by the fever of crisis, no sacrifice is too great in order to attain the loved one. Capitalism thought that it had long since liberated itself from the domination of gold, but now it experiences a bitter disillusionment, and shaken by panic recognizes its continuing dependence. But such crises are cathartic. Gradually capitalism comes to understand the nature of what it fears but cannot forsake. The vain effort to abandon gold is given up, and more jealously than ever capitalism endeavours to hold on to it, and especially to restrain its dangerous propensity to travel abroad. Nevertheless, the more capitalism succeeded in establishing its own domination, the less did it allow itself to be bound by this golden chain. The loved one, once so demanding, learns to be more modest and is eventually satisfied with the role of someone in reserve, to whom the incorrigible philanderer may return as a refuge after each fresh disappointment. Her demands may become excessive, and she may occasionally refuse her favours altogether, but these moods do not last long and things soon return to normal. Gold has lost, once and for all, its absolute domination.. .

A monetary crisis is not an absolutely necessary feature of the crisis, and may not always occur. Even during a crisis the turnover of commodities continues, even though on a much reduced scale. Within these limits circulation can be carried on with credit money, all the more so since the crisis does riot affect all branches of production simultaneously or with equal force. Indeed, the slump in sales seems to reach its lowest point only when the situation is complicated by a monetary and banking crisis. If the necessary credit money is made available for circulation the monetary crisis can be averted; and even a single bank whose credit position is unimpaired can do this by advancing credit to industrialists against their collateral. In fact, monetary crises have been avoided whenever such an expansion of the means of circulation was possible, and on the other hand they have always occurred when banks whose credit remained unimpaired were prevented from making credit money available. This was the case in England in 1847 and 1857; an incipient monetary crisis was cut short by suspending the Bank Act which arbitrarily limited the bank note issue (that is, credit money) to the amount of the gold reserve plus £14,000,000. In America, where the law restricts the circulation of credit money in an even more insane way, just when credit is most urgently needed, the monetary crisis of 1907 attained classic proportions.

If one considers the train of events on the national market, then it is evident that the reduction of the cash reserve is due not only to its being drained off into domestic circulation, but also to its flowing out of the country. We have seen that gold functions as world money for the settlement of international payment balances. There is an observable tendency for the balance of payments to deteriorate in a country which has reached the peak of the boom and is close to a crisis. Prices during the boom encourage imports, which rise far above their normal level, whereas exports do not increase to the same extent since the absorptive capacity of the domestic market remains considerable; and in the case of some important export commodities such as ores, coal, etc., there may even be a large absolute decline.

It should also be borne in mind that the principal imports of the advanced capitalist countries are agricultural products, consumer goods, and raw materials, while their exports are mainly manufactured goods. The former, however, are much more subject to speculation, and this alone, aside from other considerations, gives commerce, and market uncertain 'ties, a much more important role here. Hence excessive imports are more likely to occur, and on a larger scale, than excessive exports. The balance of trade, the most important element in the balance of payments, deteriorates and requires a larger quantity of gold for settlement.

Events on the money market take a difference course. In the first place, interest rates are highest in the country where the boom is greatest. Consequently a considerable amount of foreign money is invested there on a long-term or short-term basis. Furthermore, speculation in shares and commodities on the exchanges is in full swing and attracts foreign speculators, with the result that large sums of money flow into the country for the purchase of securities. The particular structure of the balance of payments at any given moment depends upon credit relations in international trade. England, where crises always tend to be preceded by a large outflow of gold, extends relatively large amounts of credit for the payment of its exports, but has little resort to credit to pay for the commodities it imports. This increases the imbalance which, as we have seen, tends to emerge in the balance of trade.

The deterioration of the balance of trade may itself be enough to cause a flight of gold, and any reduction in the gold reserve occurring at a time when credit is already strained generates alarm, drives the interest rate still higher, undermines confidence, and above all restricts speculation. Thus it may give the initial impetus to a stock exchange crisis. The effects of a deteriorating balance of trade may be reinforced by fluctuations in the balance of payments. The boom is an international phenomenon, although it may vary in its intensity and timing from one country to another. Let us assume that the boom began in the United States and has reached its peak there while England is only approaching the peak. The higher interest rates and vigorous speculation have attracted a large amount of English capital to America. Now, however, increasingly insistent demands are being made on the money market in England too and the interest rate as well as the volume of speculation rise to a high level. As a result, money previously invested on the American money market is withdrawn and invested in England just at the time when the American balance of trade has deteriorated. This accelerates the outflow of gold from America, leading to a contraction of credit there, and the outbreak of a stock exchange crisis which itself, as the forerunner of a general business crisis, worsens further the balance of payments situation. Foreign funds which had been invested in speculation are promptly withdrawn. This applies, of course, to funds invested in collateral and contango operations, which can be withdrawn, not to funds tied up in securities. At the beginning of the crisis foreign speculators also try to dispose of their declining securities, and these sales are augmented by the forced sales of those whose 'bullish' speculation now collapses. To the extent that foreign countries are involved the sale of securities has an adverse effect on the balance of payments.

At the same time, however, other factors may come into play which may change the course of events. The stock exchange crisis, and the banking crisis which may be associated with it, produce a violent convulsion in the credit system. The interest rate rises to an extremely high level and encourages the investment of foreign money capital. The depreciation of securities makes them attractive to foreign capitalists, and the substantial export of securities then improves the balance of payments. At the same time the balance of trade improves, the credit upheaval puts an end to speculation in commodities, and it soon becomes apparent that the domestic market is overstocked. Prices fall, a commercial crisis begins, and imports stagnate, while exports - as long as the situation in foreign markets, where the crisis has not yet begun, permits - are pushed in order to obtain means of payment.[2] Bankruptcies begin to occur, but in so far as they affect those who have to pay foreign industrialists for imported goods, the bankruptcies cancel out such payments and to that extent improve the national balance of payments.[3] Thus the export of gold is sooner or later brought to an end, depending upon the specific circumstances, before the onset of the crisis, and is replaced by an influx of gold during and after the crisis. The alternation between exports and imports of gold during a period of crisis represents changes in the areas in which the main incidence of the crisis is experienced.

A more pronounced outflow of gold always affects the interest rate at a time when, as a result of the emerging disproportionalities, circulation credit can no longer be expanded sufficiently to meet the requirements of circulation; but its specific effect is strongly influenced by banking legislation. The essence of mistaken banking legislation is that it severely restricts the expansion of circulation credit and prevents it from reaching those limits which would be reasonable from the standpoint of economic laws. It does so by establishing some arbitrary relation between circulation credit and a sum of values with which in reality it has absolutely no connection in terms of its own economic character. As we know, the bank note is simply another form of the draft, or bill of exchange, and this in turn is only a monetary form of the value of commodities. If the volume of banknotes is not related to the amount of bills and drafts - that is, in the final analysis, to the value of commodities in circulation, as happens in a strictly enforced system of so-called bank coverage for notes issued - but is related instead to a metallic reserve, as in England, or to government bonds, as in the United States, where this kind of insanity has reached a peak and debts are regarded as the best collateral for the amount of credit issued (such insanity being explicable by the insane character of fictitious capital), then an artificial limit is placed upon the supply of loan capital which must obviously have a direct effect upon the rate of interest. In England, where the volume of notes is fixed by law and the needs of circulation can be met only by metallic money (since every note issued in excess of £14,000,000[4] simply represents gold in the coffers of the bank and is actually gold, therefore, in an economic sense) every considerable increase in the outflow of gold must pose a direct threat to circulation. Hence, even if business conditions are perfectly healthy, and credit has not been impaired, the bank cannot convert the same quantity of bills into its own notes to offset an outflow of gold, which may have resulted, for example, from increased imports of wheat following -a poor harvest in England. Consequently, whenever there is an outflow of gold, even if one can be sure that it will be temporary, the bank is obliged at once to raise the interest rate in order to protect its gold reserve, thus making credit more expensive; a measure, incidentally, which increases the profit of loan capital, including its own capital, at the expense of entrepreneurial profit. Moreover, the limitation makes it doubtful whether bills can be converted into bank notes, that is into legal tender, or at any rate into generally accepted means of payment. Thus the circulation of credit money required by increased circulation is arbitrarily restricted, although the state of production gives no grounds for this ; and it creates artificially, under these circumstances, a total interruption of the circulation of credit money, with its consequences in a monetary and banking crisis, all for the sake of a false theory, the practical application of which, however, brings loan capital advantages which are by no means purely theoretical.

Even more senseless is the situation in America, where the circulation of notes can only be increased if the banks purchase more government bonds. Since the supply of such bonds is limited, the increased demand leads immediately to an exceptional rise in their price, so that despite the high rate of interest the banks find it unprofitable to issue bank notes. If the banks refrain from purchasing bonds and hence from increasing the notes in circulation, there is an exorbitant rise in the interest rate, which not only ensures unusually large profits for the banks and banking capitalists, but makes them masters of the money market and establishes their dictatorship not only over speculation and the stock exchange, but also over production, through their role in share issues and the provision of credit. This is also one of the reasons why the American stock exchanges have acquired such immense importance in the process of concentrating property ownership in the hands of a few money capitalists. If the present banking legislation were to remain in force the redemption of the national debt (in the United States) would play havoc with the note circulation; a kind of madness which has method in it, for it is an excellent way of making money for loan capital and hence successfully resists all attempts at reform.

The restrictions imposed by banking legislation have only been tolerable, up to a point, because - partly as a result of the legislation - in such countries as England and America, where they are most stringent and harmful, the circulation of notes is supplemented by other types of credit money which make the legal regulations considerably less onerous. The development of clearing house arrangements and the use of cheques come under this heading. The clearing house effects a direct settlement of bills, and to the extent that bills cancel out they perform their function as money and do not need to be converted into bank notes. The same is true of cheques. A cheque is drawn upon the drawer's deposit, even though this deposit does not really exist because the bank has loaned it out. When I pay with a cheque drawn upon this non-existing deposit it is the same as if I paid with a bank note, which also has no metallic backing, but is backed, just like the deposits which have been loaned out, only by the bank's own securities. From an economic point of view the substance is the same even if the forms (and fortunately this is all that banking legislators pay attention to) differ. In addition to these various means of economizing on the circulation of notes (and the fact that one type of credit money can be substituted for another demonstrates their essential equivalence) there is also, in England, the further assurance that the splendid Bank Act would be suspended immediately any danger arose that it might be effectively applied.

The effects of bank note legislation may also weaken, or under certain conditions even completely eliminate, the tendencies which are expressed in changes in the balance of payments during a crisis. We saw earlier that changes in the balance of payments always occur as a result of the state of the balance of trade. The latter itself depends in the first place upon the natural conditions of production, and second, upon the level and stage of economic development. A country which has undergone a long period of economic development, is highly developed industrially, has a large export trade in means of production and a low level of raw material production, will have an adverse balance of trade. Thus England, the first country in which advanced capitalist production became established, was only able to promote its exports of means of production so vigorously by supplying them not only as commodities but as capital; that is to say, not by selling means of production abroad but by sending them abroad as capital investments. Thus, for example, when England made a railway loan to South America it was used to buy machines, locomotives, etc., from England. Such exports, which are at the same time exports of capital, cease to depend upon the simultaneous import of commodities. If it were simply a case of commodity exports, South America, for instance, could only import means of production from England over the long term if it could pay for them with commodities of its own, since it has not accumulated enough money to pay for so large a quantity of means of production out of its stock of metal. In fact, a large part of international trade involves this kind of exchange of commodities, which more or less balances out. But if commodities are exported as capital, the volume of exports becomes independent of commodity production in a country which is still undeveloped, and is limited only by its potentialities for capitalist development on one side, and by the accumulation of capital, the existence of a surplus of productive capital, in the advanced country on the other side. This is precisely the reason for the rapidity of capitalist expansion. It enables the most advanced capitalist countries to increase their industrial production and their exports far beyond their imports from the undeveloped countries. Hence the adverse balance of trade is matched by a favourable balance of payments, since the industrial countries receive regular payments in the shape of profits from the exported capital.

The precise influence of the tendencies which determine the import and export of gold depends upon the particular quantitative structure of the balance of trade and the balance of payments. If there is not such a regular outflow of gold from the United States as was the case in England in earlier crises, two distinct factors account for this. The first is the obstacles to the development of circulation credit arising from the legislation governing the issue of bank notes. This raises the interest rate in America above the European level, because the restricted volume of circulation credit is inadequate, and regularly attracts European money capital. It depends upon the pressure on credit in Europe whether it is possible, in a boom period, to draw this money capital back to Europe, thus producing an outflow of gold from America.

The structure of America's balance of trade may also bring about modifications. America is a country which exports predominantly raw materials. Assuming good harvests it is precisely in boom periods that the American balance of trade will improve greatly, since the prices of cotton, copper, and possibly also wheat will rise, and this improvement in the balance of trade may weaken, eliminate, or postpone those tendencies which lead to an outflow of gold, and hence also postpone the onset of a crisis, for which, however, the outflow of gold is by no means a conditio sine qua non.

In this connection it should be emphasized that the power of national banks to protect themselves against an outflow of gold varies considerably according to the reasons for which gold is required for export. For example, if the bank discount is 5 per cent in Berlin and only 3 per cent in Paris, French banks will have a motive for transferring funds from France to Germany to take advantage of the higher interest rate. The same thing may happen if there is lively speculative activity in Berlin in which French banks want to participate. Such transfers of gold do not arise from any compelling economic necessity, but are largely arbitrary movements of money capital. For this capital could just as well remain in France if capitalists were content with a lower interest rate or smaller stock market gains. These gold movements can therefore be prevented by appropriate banking policies. The simplest way of keeping these funds at home is to assure them of higher interest by raising the bank discount rate. At the same time this equalizes interest rates in the two countries. But the bank can also prevent such transfers of gold directly, if it is able to refuse to convert bank notes into gold. The Austro-Hungarian bank, which has suspended cash payments, has a legal right to do this; and the Bank of France, which can also make payments in silver, can therefore refuse to pay in gold, ultimately by exercising its right to charge a gold premium,[5] and by thus raising the price, eliminate the advantage to be gained from the difference in interest and so remove the motive for exporting gold. The Bank of England and the German Reichsbank do not have such direct means at their disposal; but the latter attempts at least, by indirect pressure upon gold exporters, to restrict the export of gold when the money market is tight, a policy which, when confined to this particular case, is thoroughly rational from the point of view of the national economy. At the same time, this factual restriction of the mobility of money capital, or in other words, of the export of gold, is one of the factors which obstructs the equalization of national interest rates.

The situation is quite different, however, if there arises, for example, a demand for gold from the German Reichsbank because Germans have to pay for commodities or securities in England. They will initially buy sterling drafts on the Berlin exchange, but if the exchange rate rises above parity they will prefer to pay in gold. If the Reichsbank then refuses to provide gold, the German debtors, who are obliged either to pay or to be declared bankrupt, would once more have to obtain sterling drafts. Their demand would raise the price of bills above parity, involving a depreciation of German currency which it is the primary task of banking policy to prevent.

Hence an outflow of gold which results simply from financial transactions can be prevented by stopping the financial transactions themselves. Conversely, it is impossible to prevent an outflow of gold which is necessary in order to meet obligations already contracted in the course of trade in commodities and securities without devaluing the currency.


[1]I am considering the stock exchange crisis here, of course, only as a factor in the general commercial crisis. Stock exchange and speculative crises can also

occur as isolated phenomena, and a stock exchange crisis often emerges during the initial phase of industrial prosperity if speculators exploit the nascent upswing prematurely. This was the case in Vienna in 1895.

[2]Thus, during the last American monetary crisis cotton and wheat exports to Europe were vigorously promoted in order to obtain gold in return.

[3]This is, of course, an old experience. An anonymous 'Continental Merchant' said as much to the members of the famous Bullion Committee in 1810. 'In fact, I only know of two means to liquidate an unfavourable balance of trade. It is either by bullion or bankruptcy.' Report of Committee on the High Price of Bullion, reprinted in J. R. McCulloch, Scarce and Valuable Tracts on Paper Currency and Banking, p. 422.

[4]This refers to the time of Peel; today, the volume of notes not backed by gold can amount to some £18,500,000.

[5]'The Bank of France often charges a premium when money is withdrawn, and if there is a strong demand from abroad this may amount to 8 per cent or even 10 per cent. Since foreign buyers only want gold, the discounter is obliged to add this premium to the domestic discount rate. In general, one can be sure that the gold premium will be used whenever discount rates abroad are high, and those in Paris significantly lower. It increases the interest on a three-month 5 per cent bill by about 2 per cent a year.' Sartorius, Das volksuirtschaftliche System . ..,p. 263.