5. Credit Expansion
It has been pointed out that it would be an error to look upon credit expansion exclusively
as a mode of government interference with the market. The fiduciary media did not come
into existence as instruments of government policies deliberately aiming at high prices
and high nominal wage rates, at lowering the market rate of interest and at debt abatement.
They evolved out of the regular business of banking.
When the bankers, whose receipts for call money deposited were dealt with by the public
as money substitutes, began to lend a part of the funds deposited with them, they had
nothing else in view than their own business.
They considered it harmless not to keep the whole equivalent of the receipts issued as
a cash reserve in their vaults.
They were confident that they would always be in a position to comply with their obligations
and, without delay, redeem the notes issued, even if they were to lend a part of the deposits.
Bank notes became fiduciary media within the operation of the unhampered market economy.
The begetter of credit expansion was the banker, not the authority.
But today credit expansion is an exclusive prerogative of government.
As far as private banks and bankers are instrumental in issuing fiduciary media, their role is
merely ancillary and concerns only technicalities.
The governments alone direct the course of affairs.
They have attained full supremacy in all matters concerning the size of circulation credit.
While the size of the credit expansion that private banks and bankers are able to engineer
on an unhampered market is strictly limited, the governments aim at the greatest possible
amount of credit expansion.
Credit expansion is the government's foremost tool in their struggle against the market
economy.
In their hands, it is the magic wand designed to conjure away the scarcity of capital goods,
to lower the rate of interest or to abolish it altogether, to finance lavish government
spending, to expropriate the capitalists, to contrive everlasting booms, and to make
everybody prosperous.
The inescapable consequences of credit expansion are shown by the theory of the trade cycle.
Even those economists who still refuse to acknowledge the correctness of the monetary or circulation
and Credit Theory of the Cyclical Fluctuations of Business have never dared to question the
conclusiveness and irrefutability of what this theory asserts with regard to the necessary
effects of credit expansion.
These economists, too, must admit, and do admit, that the upswing is invariably conditioned
by Credit Expansion, that it could not come into being and continue without credit expansion,
and that it turns into depression when the further progress of credit expansion stops.
Their explanation of the trade cycle, in fact, boils down to the assertion that what first
generates the upswing is not credit expansion, but other factors.
The credit expansion, which, even in their opinion, is an indispensable requisite of the general boom, is, they say, not the outcome of a policy deliberately aiming at low interest rates and at encouraging additional investment for which the capital goods needed are lacking.
It is something which, without active interference on the part of the authorities, in a miraculous
way always appears whenever these other factors begin their operation.
It is obvious that these economists contradict themselves in opposing plans to eliminate
the fluctuations of business by abstention from credit expansion.
The naive supporters of the inflationist view of history are consistent when they infer
It is clear from their, of course, utterly fallacious and contradictory tenets that credit
expansion is the economic panacea.
But those who do not deny that credit expansion is an indispensable condition of the boom
disagree with their own doctrine in fighting the proposals to curb credit expansion.
Both the spokesmen of the governments and the powerful pressure groups and the champions
Those of the dogmatic unorthodoxy that dominates the university departments of economics agree
that one should try to avert the recurrence of depressions, and that the realization of
this end requires the prevention of booms.
They cannot advance tenable arguments against the proposals to abstain from policies encouraging
credit expansion.
But they stubbornly refuse to listen to any such idea.
They passionately disparage the plans to prevent credit expansion as devices which would perpetuate
depressions.
This attitude clearly demonstrates the correctness of the statement that the trade cycle is the
product of policies intentionally aimed at lowering the rate of interest and engendering
artificial booms.
It is a fact that today measures aimed at lowering the rate of interest are generally
be considered highly desirable, and that credit expansion is viewed as the efficacious means
for the attainment of this end.
It is this prepossession that impels all governments to fight the gold standard.
Expansionism is the great slogan of our day.
All political parties and all pressure groups are firmly committed to an easy money policy.
If a bank does not expand circulation credit by issuing additional fiduciary media, either
in the form of banknotes or in the form of deposit currency, it cannot generate a boom
even if it lowers the amount of interest charged below the rate of the unhampered market.
It merely makes a gift to the debtors.
The inference to be drawn from the monetary cycle theory by those who want to prevent
The Recurrence of Booms and of the Subsequent Depressions is not that the banks should not
lower the rate of interest, but that they should abstain from credit expansion.
The objective of credit expansion is to favor the interests of some groups of the population
at the expense of others.
This is, of course, the best that interventionism can attain when it does not hurt the interests
of All Groups.
But while making the whole community poorer, it may still enrich some strata.
Which groups belong to the latter class depends on the special data of each case.
The idea which generated what is called qualitative credit control is to channel the additional
credit in such a way as to concentrate the alleged blessings of credit expansion upon
in certain groups, and to withhold them from other groups.
The credits should not go to the stock exchange, it is argued, and should not make stock prices
soar.
They should rather benefit the legitimate productive activity of the processing industries,
of mining, of legitimate commerce, and, first of all, of farming.
Other advocates of qualitative credit control want to prevent the additional credits from
are being used for investment in fixed capital and thus immobilized.
They are to be used instead for the production of liquid goods.
According to these plans, the authorities give the banks concrete directions concerning
the types of loans they should grant or are forbidden to grant.
However, all such schemes are vain.
Expansion in lending is no substitute for checks placed on credit expansion, the only
means that could really prevent a rise in stock exchange quotations and an expansion
of investment in fixed capital.
The mode in which the additional amount of credit finds its way into the loan market
is only of secondary importance.
What matters is that there is an inflow of newly created credit.
If the banks grant more credits to the farmers, the farmers are in a position to repay loans
received from other sources and to pay cash for their purchases.
If they grant more credits to business as circulating capital, they free funds which
were previously tied up for this use.
In any case, they create an abundance of disposable money for which its owners try to find the
most profitable investment.
Very promptly, these funds find outlets in the stock exchange or in fixed investment.
The notion that it is possible to pursue a credit expansion without making stock prices
rise and fixed investment expand is absurd.
The typical course of events under credit expansion was, until a few years ago, determined
by two facts.
that it was credit expansion under the gold standard and that it was not the outcome of
concerted action on the part of the various national governments and the central banks
whose conduct these governments directed.
The first of these facts meant that governments were not prepared to abandon the convertibility
of their country's banknotes according to the rigidly fixed parity.
The second fact resulted in a lack of quantitative uniformity in the size of credit expansion.
Some countries got ahead of other countries and their banks were faced with the danger
of a serious external drain upon their reserves in gold and foreign exchange.
In order to preserve their own solvency, these banks were forced to take recourse to drastic
credit restriction.
Thus they created the panic and inaugurated the depression on the domestic market.
The panic very soon spread to other countries.
Businessmen in these other countries became frightened and increased their borrowing in
order to strengthen their liquid funds for all possible events.
It was precisely this increased demand for new credits which impelled the monetary authorities
The policy of devaluation has to some extent altered this typical sequence of events.
Menaced by an external drain, the monetary authorities do not resort to credit restriction
and to raising the rate of interest charged by the central banking system.
They devalue.
Yet devaluation does not solve the problem.
If the government does not care how far foreign exchange rates may rise, it can, for some
time, continue to cling to credit expansion.
But one day the crack-up boom will annihilate its monetary system.
On the other hand, if the authority wants to avoid the necessity of devaluing again
and again at an accelerated pace, it must arrange its domestic credit policy in such
a way as not to outrun in credit expansion the other countries against which it wants
to keep its domestic currency at par.
Many economists take it for granted that the attempts of the authorities to expand credit
will always bring about the same almost regular alternation between periods of booming trade
and of subsequent depression.
They assume that the effects of credit expansion will, in the future, not differ from those
that have been observed since the end of the 18th century in Great Britain, and since the
middle of the 19th century in Western and Central Europe and in North America.
But we may wonder whether conditions have not changed.
The teachings of the monetary theory of the trade cycle are today so well known, even
outside of the circle of economists, that the naive optimism which inspired the entrepreneurs
in the boom periods of the past has given way to a certain skepticism.
It may be that businessmen will in the future react to credit expansion in a manner other
The Chimera of Contra-Cyclical Policies
An essential element of the unorthodox doctrines advanced both by all socialists and by all
interventionists is that the recurrence of depressions is a phenomenon inherent in the
very operation of the market economy.
But while the socialists contend that only the substitution of socialism for capitalism
can eradicate the evil, the interventionists ascribe to the government the power to correct
the operation of the market economy in such a way as to bring about what they call economic
stability.
These interventionists would be right if their anti-depression plans were to aim at a radical
abandonment of credit expansion policies.
However, they reject this idea in advance.
What they want is to expand credit more and more, and to prevent depressions by the adoption
of Special Contra-Cyclical Measures.
In the context of these plans, the government appears as a deity that stands and works outside
the orbit of human affairs, that is independent of the actions of its subjects, and has the
power to interfere with these actions from without.
It has at its disposal means and funds that are not provided by the people, and can be
are only freely used for whatever purposes the rulers are prepared to employ them for.
What is needed to make the most beneficent use of this power is merely to follow the
advice given by the experts.
The most advertised among these suggested remedies is contra-cyclical timing of public
works and expenditure on public enterprises.
The idea is not so new as its champions would have us believe.
When depression came in the past, public opinion always asked the government to embark upon
public works in order to create jobs and to stop the drop in prices.
But the problem is how to finance these public works.
If the government taxes the citizens or borrows from them, it does not add anything to what
the Keynesians call the aggregate amount of spending.
restricts the private citizen's power to consume or to invest to the same extent that it increases
its own.
If, however, the government resorts to the cherished inflationary methods of financing,
it makes things worse, not better.
It may thus delay for a short time the outbreak of the slump, but when the unavoidable payoff
does come, the crisis is the heavier, the longer the government has postponed it.
The interventionist experts are at a loss to grasp the real problems involved.
As they see it, the main thing is to plan public capital expenditure well in advance
and to accumulate a shelf of fully worked out capital projects which can be put into
operation at short notice.
This, they say, is the right policy, and one which we recommend all countries should adopt.
However, the problem is not to elaborate projects, but to provide the material means for their execution.
The interventionists believe that this could be easily achieved by holding back government expenditure in the boom
and increasing it when the depression comes.
Now, restriction of government expenditure may certainly be a good thing, but it does
not provide the funds a government needs for a later expansion of its expenditure.
An individual may conduct his affairs in this way, he may accumulate savings when his income
is high and spend them later when his income drops.
But it is different with a nation or all nations together.
The Treasury may hoard a considerable part of the lavish revenue from taxes, which flows
into the public exchequer as a result of the boom.
As far and as long as it withholds these funds from circulation, its policy is really deflationary
and contracyclical, and may, to this extent, weaken the boom created by credit expansion.
But when these funds are spent again, they alter the money relation and create a cash-induced
tendency toward a drop in the monetary unit's purchasing power.
By no means can these funds provide the capital goods required for the execution of the shelved
public works.
The fundamental error of the interventionists consists in the fact that they ignore the
shortage of capital goods.
In their eyes, the depression is merely caused by a mysterious lack of the people's propensity
both to consume and to invest.
While the only real problem is to produce more and to consume less in order to increase
the stock of capital goods available, the interventionists want to increase both consumption
and investment.
They want the government to embark upon projects which are unprofitable precisely because the
factors of production needed for their execution must be withdrawn from other lines of employment
in which they would fulfill once the satisfaction of which the consumers consider more urgent.
They do not realize that such public works must considerably intensify the real evil,
The Shortage of Capital Goods
One could, of course, think of another mode for the employment of the savings the government
makes in the boom period.
The Treasury could invest its surplus in buying large stocks of all those materials which
it will, later, when the Depression comes, need for the execution of the public works
planned, and of the consumers' goods which those occupied in these public works will
ask for.
But if the authorities were to act in this way, they would considerably intensify the
boom, accelerate the outbreak of the crisis, and make its consequences more serious.
In dealing with the contra-cyclical policies, the interventionists always refer to the alleged
success of these policies in Sweden.
It is true that public capital expenditure in Sweden was actually doubled between 1932
and 1939, but this was not the cause but an effect of Sweden's prosperity in the 30s.
This prosperity was entirely due to the rearmament of Germany.
The Nazi policy increased the German demand for Swedish products on the one hand and restricted
and, on the other hand, German competition on the world market for those products which
Sweden could supply.
Thus, Swedish exports increased from 1932 to 1938 in thousands of tons, iron ore from
from 2219 to 12,485, pig iron from 31,047 to 92,980, ferro alloys from 15,453 to 28,605,
Other kinds of iron and steel from 134,237 to 256,146, machinery from 46,230 to 70,605.
The number of unemployed applying for relief was 114,000 in 1932 and 165,000 in 1933.
It dropped as soon as German rearmament came into full swing to 115,000 in 1934 to 62,000
in 1935 and was 16,000 in 1938.
The author of this miracle was not Keynes, but Hitler.
All this talk about contra-cyclical government activities aims at one goal only, namely to
to divert the public's attention from cognizance of the real cause of the cyclical fluctuations
of business.
All governments are firmly committed to the policy of low interest rates, credit expansion
and inflation.
When the unavoidable aftermath of these short-term policies appears, they know only of one remedy
to go on in inflationary ventures.
6. Foreign Exchange Control and Bilateral Exchange Agreements
If a government fixes the parity of its domestic credit or fiat money against gold or foreign
exchange at a higher point than the market, that is, if it fixes maximum prices for gold
and foreign exchange below the potential market price, the effects appear which Gresham's
as law describes. A state of affairs results which, very inadequately, is called a scarcity
of foreign exchange. It is the characteristic mark of an economic good that the supply available
is not so plentiful as to make any intended utilization of it possible. An object that
is not in short supply is not an economic good. No prices are asked for it or paid for
for it.
As money must necessarily be an economic good, the notion of a money that would not be scarce
is absurd.
What those governments who complain about a scarcity of foreign exchange have in mind
is however something different.
It is the unavoidable outcome of their policy of price fixing.
It means that at the price arbitrarily fixed by the government, demand exceeds supply.
If the government, having by means of inflation, reduced the purchasing power of the domestic
monetary unit against gold, foreign exchange, and commodities and services, abstains from
any attempt at controlling foreign exchange rates, there cannot be any question of a scarcity
in the sense in which the government uses this term. He who is ready to pay the market
price would be in a position to buy as much foreign exchange as he wants. But the government
is resolved not to tolerate any rise in foreign exchange rates in terms of the inflated domestic
currency. Relying upon its magistrates and constables, it prohibits any dealings in foreign
Foreign Exchange on terms different from the ordained maximum price.
As the government and its satellites see it, the rise in foreign exchange rates was caused
by an unfavorable balance of payments and by the purchases of speculators.
In order to remove the evil, the government resorts to measures restricting the demand
for foreign exchange.
Only those people should henceforth have the right to buy foreign exchange who need it
for transactions of which the government approves.
Commodities, the importation of which is superfluous in the opinion of the government, should no
longer be imported.
Payment of interest and principle on debts due to foreigners is prohibited.
Citizens must no longer travel abroad.
The government does not realize that such measures can never improve the balance of payments,
if imports drop, exports drop concomitantly.
The citizens who are prevented from buying foreign goods, from paying back foreign debts
and from traveling abroad, will not keep the amount of domestic money thus left to them
in their cash holdings.
They will increase their buying, either of consumers or of producers' goods, and thus
bring about a further tendency for domestic prices to rise.
But the more prices rise, the more will exports be checked.
Now the government goes a step further.
It nationalizes foreign exchange transactions.
Every citizen who acquires, through exporting, for example, an amount of foreign exchange,
is bound to sell it at the official rate to the Office of Foreign Exchange Control.
If this provision, which is tantamount to an export duty, were to be effectively enforced,
export trade would shrink greatly or cease altogether.
The government certainly does not like this result, but neither does it want to admit
that its interference has utterly failed to achieve the ends sought, and has produced
a State of Affairs which is, from the government's own point of view, much worse even than the previous State of Affairs.
So the government resorts to a makeshift. It subsidizes the export trade to such an extent that the losses which its policy inflicts upon the exporters are compensated.
On the other hand, the Government Bureau of Foreign Exchange Control, stubbornly clinging to the fiction that foreign exchange rates have not really risen, and that the official rate is an effective rate, sells foreign exchange to importers at this official rate.
If this policy were to be really followed, it would be equivalent to paying bonuses to the merchants concerned.
They would reap windfall profits in selling the imported commodity on the
domestic market. Thus the authority resorts to further makeshifts. It either
raises import duties or levies special taxes on the importers or burdens
their purchases of foreign exchange in some other way. Then of course foreign
exchange control works. But it works only because it virtually acknowledges
What is the market rate of foreign exchange?
The exporter gets for his proceeds in foreign exchange the official rate plus the subsidy,
which together equal the market rate.
The importer pays for foreign exchange the official rate plus a special premium, tax
or duty, which together equal the market rate.
The only people who are too dull to grasp what is really going on and let themselves
be fooled by the bureaucratic terminology are the authors of books and articles on new
methods of monetary management and on new monetary experience.
The monopolization of buying and selling of foreign exchange by the government vests the
control of foreign trade in the authorities.
It does not affect the determination of foreign exchange rates.
It does not matter whether or not the government makes it illegal for the press to publish
the real and effective rates of foreign exchange.
As far as foreign trade is still carried on, only these real and effective rates are in
force.
In order to conceal better the true state of affairs, governments are intent upon eliminating
all reference to the real foreign exchange rate.
Foreign trade, they think, should no longer be transacted by the intermediary of money.
It should be barter.
They enter into barter and clearing agreements with foreign governments.
Each of the two contracting countries should sell to the other country a quantity of goods
and services and receive in exchange a quantity of other goods and services.
In the text of these treaties, any reference to the real market rates of foreign exchange
is carefully avoided.
However, both parties calculate their sales and their purchases in terms of the world
market prices expressed in gold.
These clearing and barter agreements substitute bilateral trade between two countries for
the triangular or multilateral trade of the liberal age.
But they in no way affect the fact that a country's national currency has lost a part
of its purchasing power against gold, foreign exchange and commodities.
As a policy of foreign trade nationalization, foreign exchange control is a step on the
way toward a substitution of socialism for the market economy.
From any other point of view, it is abortive.
That can certainly neither in the short run nor in the long run affect the determination
of the rate of foreign exchange.
Remarks about the Nazi barter agreements
The barter and clearing agreements which the Nazi government of the Reich concluded with
various foreign countries have been misinterpreted by the vast literature on the subject.
As these misinterpretations are the basis of many current errors concerning monetary problems,
it seems expedient to devote a few remarks to them.
The considerations which motivated foreign governments to enter into such agreements
with the Reich were not uniform.
Neither were the political and economic consequences of these agreements homogeneous.
We may deal with the problems involved by discussing, first, the case of the agreement
with Switzerland and then those with the countries of the European Southeast.
The Swiss banks had, before Hitler seized power, lent comparatively enormous sums to
German business.
Moreover, one of Switzerland's main industries, tourism, depended to a great extent on German
patrons.
The German foreign exchange control laws gave the German authorities the power to prohibit
all payments to Swiss banks, and to prevent Germans from visiting the country.
The clearing agreement was the only means for the Swiss to salvage at least a part of
their German assets, and to induce the Reich to permit a limited number of Germans to spend
a holiday in the Swiss hotels.
The case of the Balkan agreements is even more interesting, as their meaning was still
more distorted by misinterpretation.
Let us look at an example.
The Reich and one of the southeastern countries of Europe, we may call it Balkania, concluded
an agreement concerning the mutual exchange of commodities which could be bought or sold
on the world market for $20 million.
Balkania had to give a world market value of $10 million in food and raw materials.
Germany had to give a world market value of $10 million in manufactured goods.
The peculiar feature of the bargain was that these commodities bought and sold were in
the terms of the contract not valued according to their world market price, but at a higher
rate, let us say 10% above the prices of the world market.
For the goods Germany had to buy, Balkania was charged 11 million instead of 10. But,
on the other hand, Balkania was credited for the goods it sold with 11 million instead
of 10. This overvaluation was totally, or at least to a great extent, concealed in the
rate of exchange between the Reichsmark and the Balkan, the monetary unit of Balkania's
Let us assume that the dollar was actually worth 10 Balkans on the world market.
By virtue of the barter agreement, Balkania sold to Germany food and raw materials for
which English businessmen offered 100 million Balkans for 110 million, and bought manufactured
Goods, which she could buy from English or American exporters for 100 million Balkans
for 110 million.
In order to understand the meaning of this strange procedure, we have to realize that
the loss and the gain from these overvaluations compensated each other only for the whole
nations, but not for the individual citizens.
For Socialist Germany, where under Hitler all business was nationalized, this made no difference
at all.
But in Balkania, domestic production and domestic trade were still based on private ownership.
Only the foreign trade of Balkania was controlled by the government.
There it was of great consequence that those burdened by the overvaluation of the imported
Goods and those favored by the overvaluation of the exported goods were not the same people.
The terms of the Barter Agreement resulted therefore in a shift of income from some groups
of citizens, of course the black sheep of the government, to other groups of citizens,
of course the government's pet children.
The government of Balkania distributed the boon of the transaction in this way.
1. Higher prices paid to the producers of the exported food and raw materials, 5 million.
2. Gains, legal and illegal, of the government agency entrusted with the execution of the Barter Agreement
and of the friends of the government managing it, 1 million.
3. Gains retained by the Treasury, 4 million.
The losses of the transaction, on the other hand, were distributed in this way.
1.
Higher prices of imported commodities paid by those who were favored by the higher prices
of the exported goods.
1 million.
2.
Higher prices of imported goods paid by other citizens.
5 million.
3.
Fair Prices of Imported Goods Paid by the Government, for example for arms, railroad
equipment, etc., 4 million.
It is obvious that the friends of the government and the peasants producing food and raw materials
realized gains of 5 million, whereas the non-agricultural sections of the population were burdened with
5 million additional expenditure.
Such an effect was in line with Balkania's whole economic policy.
Like many other contemporary governments, the rulers of Balkania made every effort to
favor the agricultural section of the population at the expense of the non-agricultural section.
The political consequences of these agreements were twofold.
As government became dependent on the Reich, but its power at home increased.
The government now disposed of a fund which could be used for the benefit of its friends,
who were on the payroll of the company or government agency entrusted with the execution
of the Barter Agreement.
Moreover, the government had the power to discriminate against those groups of the peasantry
who did not support the government or who were members of a linguistic or religious minority.
The products which had to be exported to Germany were purchased only from the sympathetic producers.
The non-sympathizers were barred from the enjoyment of the benefits of the treaty.
They had to sell their entire crop at the lower prices corresponding to the world market
prices.
In Yugoslavia, for instance, the Catholic Croat peasants complained that the government
purchased only from Serbs.
It is impossible to discover whether this complaint was really well founded.
In any case, the Croats did not blame the Nazis, they blamed the Yugoslavian government.
The Barter Agreements gave Germany a kind of monopoly of the trade with the countries
from the Nazi point of view, this practice meant a skillful use of the domestic economic antagonisms within these countries for the achievement of their own political ends to the governments of the Balkan states, these barter agreements offered an opportunity of initiating a policy favoring the farming class at the expense of the non-agricultural class.
Classes.
What the industrial countries of Western and Central Europe achieved by tariffs and other
measures discriminating against the products of foreign agriculture, and what the United
States achieved by some of the agricultural measures of the New Deal, was in Romania,
Hungary, Bulgaria and Yugoslavia achieved by the Barter Treaties with Germany.
Faced with the problem of this German economic offensive in the Balkans, Great Britain was
helpless.
It had to withdraw from markets where it could buy only at prices higher than those in other
countries.
Consequently, the governments of the Balkan countries concerned declared that there were
no pounds available for the payment of imports from Great Britain and refused to grant import
licenses.
Commerce between Great Britain and these countries was severely restricted.
The same was no less true with regard to all other countries of Western Europe and of America.
Such was the true nature of these much talked about clearing agreements,
which were hailed by many authors as the dawn of a new age of monetary management.