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WAR FINANCE AND INFLATION




BY

A. C. MILLER
Member? Federal Reserve Board

Publication No. 1104
Reprinted from FINANCING THE WAB
Vol. LXXV of THE ANNALS of the
AMERICAN ACADEMY OF POLITICAL AND SOCIAL SCIENCE

Philadelphia, January, 1918

Reprinted from The Annals of the American Academy of Political and Social
Science, Philadelphia, January, 1918.
Publication No. 1164.

WAR FINANCE AND INFLATION
B Y A. C.

MILLER,

Member, Federal Preserve Board.
The beginning of wisdom in the financing of our war is the lull
appreciation of the fact that the ultimate term in our war finance must
be not money, not the dollar—but what the dollar will buy. Every
day that the war goes on makes it clearer and clearer that the war
is a contest in economic organization and resources, and that victory
will lie with the nations which show themselves best able to organize
their resources and to resist the processes of economic waste and
disintegration. Indeed, it looks as though the war would not end
until all the economic power of America is developed to its highest
pitch of efficiency and then delivered as gun-power on the far flung
battle fronts of Europe. We are all rapidly coming to understand
that great belligerent nations must be organized from the fighting
line back to the field, factory and foundry, as great fighting machines, as great organizations for converting the productive-power,
the saving-power and the will-power of the people at home into
fighting-power at the front. We are also coming to understand
that the winning of the war presents a problem of economic stategy
as well as of military strategy: the two together constituting t h e
essential elements of an adequate war strategy. Our economicstrategy must work hand in hand with our military strategy if we
are to make ourselves most effective in coordinating our own activities, and those of the other nations forming the grand alliance, into
one great whole so as to bring the war to an early and victorious;
conclusion. Many are the contributions which time and circumstance will show America must make toward the successful completion of the war, but there is none perhaps that in the end will
prove more important than that of developing and supplying leadership and mastery in coordinating the activities of herself and her
associates along the larger lines of economic and military strategy.
The financial problem in its larger aspects, as I conceive it, i»
largely one of developing a plan under which the instrumentalities
of finance may be so employed as to enforces sound, and in the end,,
a triumphant economic strategy.




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T H E ANNALS OF THE AMERICAN ACADEMY

Some such thought as this, I believe, was in the mind of the
President when he made the momentous observations on war
economy and finance contained in his message of April 2. Properly
understood, they are more than observations: they are the basic
principles of national finance for our guidance in this great crisis.
The President, calling upon Congress and the country to "exert
all its power and employ all its resources to bring the government
of the German Empire to terms and end the w a r / ' states what this
will involve in the way of economic and financial preparation in
these propositions:
It will involve the organization and mobilization of all the material resources
of the country to supply the materials of war and serve the incidental needs of the
nation in the most abundant and yet the most economical and efficient way
possible.
It will involve, also, of course, the granting of adequate credits to the government, sustained, I hope, so far as they can equitably be sustained by the present generation, by well-conceived taxation.
I say sustained so far as may be equitable by taxation, because it seems to
me that it would be most unwise to base the credits, which will now be necessary,
entirely on money borrowed. It is our duty, I most respectfully urge, to protect
our people, so far as we may, against the very serious hardships and evils which
would be likely to arise out of the inflation which would be produced by vast
loans.

Supplementing these statements in his Proclamation on War
Economies, which was issued less than two weeks after the war
message was delivered to Congress, the President concludes one of
the most trenchant economic surveys that has ever come from the
pen of statesman or scholar with these pregnant words:
This is the time for America to correct her unpardonable fault of wastefulness
and extravagance. Let every man and every woman assume the duty of careful,
provident use and expenditure as a public duty, as a dictate of patriotism which
no one can now expect ever to be excused or forgiven for ignoring.

Briefly summarizing the economic and financial principles
laid down by the President, I would state them as follows:
(1) Organization and mobilization of all the country's material
resources;
(2) Strict economy through saving;
(3) Well-conceived taxation;
(4) Avoidance of inflation.




W A R FINANCE AND INFLATION

3

The rule of finance they suggest to my mind for the conduct of
the war, I venture to formulate as follows: Taxation should be carried
to the point where the remainder of the needed income of the government
can safely be provided out of the proceeds of loans—that is, be provided
without producing inflation of credit and prices. The clear inference
I draw is that sound finance will require that the limits of taxation
should be extended as borrowing reaches the point of inflation.
Hardly less clear to my mind and certainly not less cogent is the
inference that finance alone will not achieve the needed results:
consumption will have to be controlled and production will have
to be directed on some adequate basis, in order that any plan of
finance we may adopt shall be certainly equal to the task of providing the government with the vast masses of goods and services
it will require for the war.
II
The present war differs from preceding wars in many ways but
in none more than in the prodigious quantities of material supplies
of many sorts which are required. It is this circumstance which
gives to its financial problems their peculiar difficulty and urgency.
No satisfactory progress can be made toward a solution of those
problems if close calculation is not made at every point of what is
involved in the way of surrender for war purposes of the customary
consumption and income of the country. I venture, therefore,
some statements—not on my own authority, but on the authority of
men who have given much thought to the matter—touching some
of the underlying facts bearing upon the economic costs of the war
in terms of the man-power it will require.
We are setting out to provide, equip and maintain an army of
a million men. Competent judgment has estimated that it will
take the labor of four men, working in munition factories, clothing
factories, on the farm and the transportation systems of the country,
to maintain one soldier at the front according to modern standards
of military efficiency. This means that an American army of one
million men will require the output of four million men working in
factory, field and foundry. If the war should go on into a second
year and we undertake to organize and maintain at the front an
army of two million men, the ratio will still hold good: we shall
require an industrial army of eight million men working at home to




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T H E ANNALS OF THE AMERICAN ACADEMY

maintain, provision and equip those fighting at the front. But our
part in the war, it is well known, is not only to maintain our own
quota of the necessary fighting forces, but also to help the great
nations with which we are associated to maintain their quotas and,
in addition, supply their civilian populations with a large part of
their necessary maintenance. Europe is now on rations and an
important part of our work in furthering the war is to supply the
nations, with which we are allied, with the primary necessities to the
utmost extent we can. There is competent authority for the statement that the munitions, provisions and other maintenance which
the armies and civilian populations of our allies should have from
us will require the output of more than ten million laborers working in their behalf in this country.
If these estimates are approximately accurate and we can
make our predications on the assumption that we are to maintain
an army of but one million men, requiring as has been pointed out
the labor force of four million men at home, and bearing in mind
that the million men composing the army are themselves withdrawn
for the most part from productive industry, it is clear that the
undertaking involves the devotion to war purposes, directly or
indirectly, of the services and product of approximately fifteen
million men here in America on the farm, in the shipyard or in the
factory. If we accept as approximately accurate the estimate of
our present available labor supply as amounting to thirty million
workers, the magnitude of the economic problem with which we are
confronted, is suggested by the statement that not less than onehalf of our existing labor supply, during the period of the war, must
be devoted to the producing of materials and supplies to be consumed by our own army and the armies of our allies and the civilian
populations of the nations in Europe which are dependent on us
for a part of their necessary keep. This means that the civilian
population of our own country will have to rearrange its mode of
living so as to be able to get along with the product of the remaining
labor power of the country—that is, about one-half of what has
been customary—unless happily the labor forces of the country can
be effectively recruited and augmented by the introduction of men
andjwomen into industry who are not now to be reckoned among
the productive classes of the community. We can do this if we
will, and it is doubtful whether we can win the war, or at any rate




W A R FINANCE AND INFLATION

5

win it as quickly and decisively as we all desire, unless we raise our
will-power to the point where we will do it.
This, in sum and in its simplest terms, is the economic problem
to which we must address ourselves. The financial problem is the
problem of getting control of the products needed by the government by the methods which are least wasteful, least obstructive
and least subversive.
Ill
On its financial side, the magnitude of the obligation we have
assumed is indicated by the nineteen billions of dollars which Congress has authorized to be used for the general purposes of the war
for the fiscal year ending June 1918, including in this total the credits
granted to the Allies. Never has any nation, either in the present
or any other war, undertaken so vast a pecuniary obligation for
the same period of time. We are undertaking to apply to the support of the war in a single year almost as much as the German Empire has spent since the beginning of the war.
Can we provide for the vast expenditure we have undertaken?
What have we, as a nation, got in the way of the requisite financial
resources to offset the nineteen billions Congress has voted?
It must be clear to any one who gives any serious attention to
the financing of the war that the expenditures of the government
must, except for a negligible proportion, be defrayed out of the
income of the community. The limits, moreover, within which any
part of the burden of our war costs can be shifted to posterity are
so narrow, especially for a country in our position with no outside
markets left from which to borrow, that we must regard the burden
as one that has got to be shouldered and paid for as we go along out
of the product of our current national industry—or, putting it in
the more familiar financial term, out of the people's current income.
Unfortunately no official or authoritative estimate of the
current annual income of the people of the nation has been made, so
far as I am aware. Some widely used estimates made at the time
of our entry into the war placed the annual money income of the
nation at forty billions of dollars or thereabouts. Such information
and data as I have been able to obtain and such investigation as I
have been able to make, lead me, however, to believe that this is a
very considerable under-statement of our actual situation. Using




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T H E ANNALS OF THE AMERICAN ACADEMY

the term "income" as substantially identical with the money value
of the gross annual product of the country's industrial and business
activities, I believe there is warrant for the opinion that the industrial and business income of the people of the United States for the
year 1917 may come close to fifty billions of dollars: the following
estimate in summary form containing the data on which this opinion
is based:
.SUMMARY ESTIMATE OF THE TOTAL V A L U E O P T H E NATIONAL PRODUCT AND
PRODUCTIVE SERVICES FOR THE Y E A R S

1909-1910, 1914 AND 1916-1917 I N

BILLIONS OF DOLLARS 1

Agriculture
Manufactures
Mineral
Fishing
Transportation
Commercial and professional
Total

1909-1910
5.5
8.5
2.0
0.05
2.8
9.0

1914
6.1
9.9
2.1
0.1
3.0
10.0

27.85

31.2

1916-1917
14.3
14.8
3.5
0.1
3.5
13.5
49.7

The figure of fifty billions for the income of the nation in 1917
refers, of course, to gross income. What proportion of these fifty
billions may properly be regarded as surplus or clear income—that
is to say, income over and above what the people of the country
must consume in order to keep themselves in a state of health and
1
I n estimating gross values of national industry b y principal branches, production figures of the Census Bureau, t h e Department of Agriculture, t h e Geological Survey and other federal agencies were used. Figures for 1916-1917 are
more conjectural than those for 1909-1910 and 1914 for the reason t h a t the value
of manufactures, or t h e total " Value added b y manufactures" h a d t o be estimated largely from incomplete output data of certain basic industries and wholesale prices prevailing during the year. I n this connection use was also made of
the index number of wholesale prices published by our Bureau of Labor Statistics.
Figures of income of t h e commerical and professional classes, including persons
in the public service, are rough approximations, based, in part, upon census d a t a
of occupations.
The large increases in t h e 1917 values of agricultural products a r e d u e
largely to the higher price level and, to a much smaller extent, to larger yields.
In mining and even more so in manufactures, t h e higher values are due b o t h
to higher prices and to larger output, as m a y be seen from t h e following




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W A R FINANCE AND INFLATION

strength and that cheer which has got to be maintained even in wartime if we are to deliver our most telling blows, and to provide for
the necessary upkeep of the industrial equipment of the country—
is a matter upon which opinions and estimates will differ widely.
Approximations, however rough, must nevertheless be attempted.
The annual savings or investment fund of the American people
at the beginning of the European war was variously estimated at
from three to five billions of dollars. That meant that out of the
gross income of the country at that time, three to five billion
dollars' worth of goods were not consumed by the recipients or
owners of the income, but were invested in extensions of industry
and business, or in other words, converted into additions to the
financial and industrial capital of the country.
How much this actual savings fund of from three to five billions
of dollars may, as a matter of fact, have been increased during the
past three years, or even how much the potential savings fund of the
country may have been increased by reason mainly of the vast
tables showing yearly crop and output figures for certain leading agricultural
and mineral products:
QUANTITIES OF PRINCIPAL AGRICULTURAL PRODUCTS FOR THE Y E A R S

NAMED

BELOW

Wheat, 000' bushels
Corn, 000' bushels
Oats, 000' bushels
Cotton, bales
Tobacco, 000' pounds
Hay, 000' tons

1909
683,379
2,552,190
1,007,143
10,649,000
1,055,765
97,454

QUANTITIES OF PRINCIPAL M I N E R A L PRODUCTS

1914
891,017
2,672,804
1,141,060
16,135,000
1,034,679
70,071

FOR THE Y E A R S

1917
659,797
3,210,795
1,580,714
12,047,000
1,185,478
91,715
NAMED

BELOW

Coal, Bituminous, 000' short tons
Iron, pig, 000' long tons
Copper, 000' pounds
Petroleum, 000' bbls. of 42 gal
Zinc, short tons
Cement, 000' bbls. of 380 lbs




1910
417,111
26,674
1,080,160
209,557
252,479
77,785

1914
422,704
22,263
1,150,137
265,763
343,418
87,258

1916
502,520
39,126
1,927,851
300,767
563,451
95,394

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T H E ANNALS OF THE AMERICAN ACADEMY

accessions to the pecuniary prosperity of the country, which have
occurred in this same period of time, offers an engaging problem
both for statistical enterprise and for economic inference and conjecture. My inference is that the largest part of this increase in
the money income of the country may rightly be rated as an addition to the potential savings fund. The indications above given
are that the money income of the country may have grown by an
amount as much as eighteen billions of dollars in the past three
years, due partly to increased production, partly to intensified
demands for many of our staple products, but mainly to the rapid
and general advance of prices. If we allow a deduction of onethird or six billions from the estimated increase of eighteen billions
in order to offset increased living, or other costs (and, also, to account for variations in values computed because of steadily changing
price levels during the year), we have left the sum of twelve billions
of dollars as the apparent amount by which the potential savings
fund of the country has been enlarged during the past three years.
These twelve billions added to the actual savings fund of the country, which was estimated at from three to five billions of dollars
at the beginning of the European war, would seem to indicate that
the present total savings or investment power of the country, taking the actual and potential funds together, might amount to as
much as fifteen billions of dollars or more for the year 1917.
The war taxes, which were imposed by Congress at its recent
session, contemplate the raising of some two and a half billions of
tax revenue, though there appears to be some reason for believing
that the yield of the new taxes may considerably outrun the estimates. Obviously the government cannot also borrow that which
it takes by taxation. Current income is the source out of which both
our tax revenue and our loan revenue will be derived. If some three
billions of tax revenue are taken out of the annual surplus income
of the country, which I have stated my reason for believing might
amount to as much as fifteen billions of dollars, then it would appear
that twelve billions of dollars represents about all that could safely
be raised by loans.
The authorized expenditures and advances for the fiscal year
1918, however, run close to twenty billions of dollars and leave us,
therefore, with the problem of how the additional four or five bil-




W A R FINANCE AND INFLATION

9

lions in excess of the estimated actual and potential savings fund of
the nation are to be obtained. Looking at the problem purely as
a matter of dollars and cents, it must be admitted that the financing
of the war on the projected scale of expenditure is far from a simple
problem, even with such reassuring indications of our possible income
and savings fund as I have ventured to give for the year 1917. It
raises at once two extremely important questions:
(1) Can the vast sums, which it is proposed to raise from loans,
be raised without causing a serious inflation of credit and prices?
(2) Is it at all possible that the war can be carried as an " extra "
—that is to say, that business and living can be as usual during the
period of the war?
IV
No one who looks beneath the surface appearances to the hard
and inexorable realities, can for a moment maintain the position
that the war can be carried as an "extra." We cannot carry the
war as an " e x t r a " and business cannot be as usual during the period
of the war, if we mean to win.
I cannot believe that those who are sponsoring the doctrine of
"business as usual" can appreciate the economic significance of
the doctrine. This war, as the President with rare prevision told
Congress and the people, will involve the " organization and mobilization of all the material resources of the country to supply the
materials of war." The man who knowingly preaches the doctrine
of "business as usual" at this time is, therefore, proposing that
private advantage should be set against or ahead of public necessity.
At this crisis in the nation's life, every business, no matter what its
nature, is affected with a public interest and the public has the right,
indeed owes it to itself, to determine within what limits that business
shall be circumscribed in the interest of the war, or to what extent
it shall be helped and fostered in the same interest. The American
business system is on trial in this war. No one doubts its technical
proficiency and it should not allow anyone in its ranks to raise a
doubt regarding its competency to exercise vision and imagination
in seeing clearly what must be done by the nation in the way of
changes in our business and economic organization during the war.
If it fails to rise to the occasion through weakness or selfishness, or
if selfishness is allowed to hamper and hinder the development of a




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T H E ANNALS OF THE AMERICAN ACADEMY

rational program of economic finance, the American business system
will have gone a long way toward sounding its death-knell and surrendering to other agencies the right of leadership in the great
processes of economic reconstruction which must take place at the
close of the war.
The truth is that nothing can be as usual while the war is on—
neither business nor living can be as usual. We are in this war to
win it and our children will never forgive us if we fail to do any of
the things necessary to win it. The sooner we take this truth to
heart and reshape our lives accordingly, each one in accordance
with his circumstances, the sooner the war will be won and over. The
only powers on earth that can defeat us are weakness and selfishness—selfishness in the shape of profiteering, if business is as usual,
and weakness in the shape of waste and indulgence, if living is as
usual. We need not doubt our ability to overthrow the enemy
without, if we can control the enemies within: that is, the temptations to make money as usual and to live and enjoy as usual. Indeed, the doctrine of "business as usual'' is not only vicious in its
necessary economic implications for a nation in the throes of a great
crisis, but is equally mischievous in its financial implications. For
the twin-sister of the doctrine that business can be as usual is that
other mischievous doctrine that the war cannot be financed without
inflation.
V
Inflation in connection with government war financing may
arise from many different causes but there are two which are of
particular interest in our present situation: (1) Inflation of prices
is apt to result when the government undertakes to spend money,
however obtained, faster than the goods it seeks to buy are being
produced. (2) Inflation, both of banking credit and of commodity
prices, results when the government undertakes to borrow faster
than the people are able or willing to save. In the last named case,
which is the one I mean to discuss, the loans of the government, by
one device or another, will be forced upon the banks. The banks
will pay for the loans by an extension of banking credit and currency. The inevitable effect on commodity prices of an expansion
of banking credit and currency is to raise them. It would seem to
need no extended argument in this day in America to demonstrate




W A R FINANCE AND INFLATION

11

that banking credit in any of its typical forms is purchasing power,,
exerting the same effect on prices when used in payment for goods
or purchases, as any other forms of purchasing media. When
purchasing media are produced faster than goods are produced—in
brief, when the supply of currency and credit in its increase outruns
the increase of the supply of purchasable goods—the prices of goods
must rise. Whether such a condition is best described by the word
" inflation," the fact remains that the rise of prices of purchasable
goods in such a situation is closely connected with the increased
supply of purchasing media. Moreover, when the increase of
purchasing media, occasioned by the expansion of banking credit,
follows upon the investment of banking credit in government loans,
the conclusion is irresistible that the expansion of credit and its
resulting consequences in increased commodity prices are being
induced by bank lendings to the government.
The process by which government loans produce inflation is
disclosed in the financial history of all the great European belligerents. All of these governments, notably Germany, have made
extensive use of banking credit in the flotation of their loans. Not
only the great central banks, but the banks generally in the several
European countries, have been put under pressure to invest their
credit extensively in the purchase or carrying of government securities. The London Economist has repeatedly characterized the
situation thus produced as "bad finance forced on the banks by the
government." An examination of the changes of condition of the
banks of Great Britain, exclusive of the Bank of England, shows
what the process has been. Their deposit liabilities, that is to say
their checking accounts, have increased between the end of 1913 and
the end of 1916 about four hundred and eight million pounds sterling,
an increase of close to 40 per cent. Their bills discounted on the
other side of the statement show only a negligible increase, an increase of some seven million pounds sterling. Their investments,
on the other hand, show an increase from two hundred and eleven
million pounds sterling to four hundred and thirty-seven million
pounds sterling, an increase of over two hundred and twenty-five
million pounds sterling, or 107 per cent: in view of all the circumstances and known facts, it may be said that this increase is made
up chiefly, if not almost entirely, of government obligations, such
as treasury bills, exchequer bonds, etc. In brief, the expansion of




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T H E ANNALS OF THE AMERICAN ACADEMY

banking credit in England seems clearly disclosed by these figures
to have been occasioned for the most part by the expansion of bank
investment, directly or indirectly, in government obligations.
A similar process has been at work in the other countries of
Europe. The expansion of banking credit in France and Germany
however, has been more largely in the form of bank notes than of
bank deposits. The bank note circulation of France increased
from twelve hundred and eighty-nine million dollars in August,
1914, to forty-one hundred and seventy millions in October, 1917,
an increase for the period of over 223 per cent. The circulation of
the Reichsbank of Germany has risen from six hundred ninety-three
million dollars in August, 1914, to twenty-two hundred and eightyfive millions in October, 1917, an increase of 230 per cent in the
course of a little more than three years. This increase in the note
circulation of the great central banks of France and Germany has
been occasioned largely by investments of their credit in the obligations of their respective governments, and seems definitely to
indicate that government borrowing has been a leading factor in
the expansion of their note circulation. Doubtless other causes
have contributed to the vast expansion of banking liabilities in
Europe, but no one cause has probably been a greater factor than
the investment by the banks of their credit in taking or carrying
government loans.
Whether a similar result is to be expected here in connection
with our greater government borrowings, and if so how soon, will
largely depend upon whether all the people who have income enough
to save will save, or whether they can be or will be made to save,
enough out of their incomes to absorb such loans of the government
as may be put out in excess of the ordinary or usual savings fund of
the nation—that is, absorb them as savings loans, not as credit
loans.
The obligations of a government, such as the United States,
when considered purely from the investment point of view, are
unquestionably to be regarded as the most eligible sort of investment. Commercial banks, however, in a country like ours, which
makes daily use of a large body of mobile banking credits, are not
to be likened to investment institutions in the ordinary sense of the
word. A bank's capital is but a small part of its investment power.
A bank is a bank only as it invests its credit. But the safe in-




W A R FINANCE AND INFLATION

13

vestment of its credit, as the history of banking experience has
repeatedly demonstrated, necessarily restricts a bank in its choice
of securities to those which possess the necessary liquid character.
The objection to considerable investment by banks of their credit
in investment securities, such as government bonds, arises, not out
of any question as to the solidity of such securities, when well
selected, but rather because of their lack of liquidity. The history
of modern banking has shown conclusively that distinction must
be made between "security" and "liquidity," or " v a l u e " and
"availability" in determining the kind of investments which are
best fitted for banks which deal in their credit. There are many
forms of investment paper which from the point of view of security
leave nothing to be desired, but yet which are unsuitable as the
basis for the creation of a great body of currency or of active banking
credit.
The doctrine set forth in the famous English Bullion Report,
which came in the midst of the controversies growing out of the
management of the Bank of England's circulation during the Napoleonic Wars, whose truth has since been attested by the experience
of every modern nation, is that two things are necessary to protect a
system of banking currency and credit against the danger of undue
expansion. One of these is the maintenance of adequate reserves;
the other is the maintenance of adequate liquidity of investments.
By liquid investments is meant bank paper which liquidates itself
in short periods of time out of the proceeds of the transactions which
have given rise to the paper. That is to say, paper which grows
out of transactions in trade and industry connected with the production or distribution of goods, which—as the goods are produced
and sold in the normal movements of trade and industry—-will supply the funds out of which the borrowings of bank credit can and will
be repaid. Self-liquidating paper being, therefore, paper which is
connected with productive operations in industry, that is to say,
operations which result in an increase in the supply of usable and
salable goods, it follows that the same banking transaction, which
gives rise to an increase in the supply of purchasing media through
the expansion of banking credit, also gives rise to an increase in the
supply of purchasable goods through the assistance rendered the
producer.
But when a bank invests its credit in the purchase of govern-




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T H E ANNALS OF THE AMERICAN ACADEMY

ment bonds which are issued for the purposes of war—in brief, for
operations that result, not in the production, but in the consumption and destruction of goods—we have an altogether different
situation. The situation is one in which there has taken place an
addition to the volume of outstanding banking credit and purchasing media with little additional in the way of goods to offset it on
the shelves of the shop-keeper, or the warehouse of the manufacturer.
In brief, credit transactions of this sort, so far from being immediately connected with operations resulting in the increased production of aggregate goods, are rather to be described as connected with
operations resulting in the diminution of the community's supply
of purchasable goods. In war times, governments borrow, not for
the purpose of producing goods, but for the purpose of getting possession of goods already produced, or being produced, goods whose
production is otherwise financed. The credit created and extended
by the banks to the government in the process of taking up government bonds is to be regarded as an addition to the total volume of
banking credit, not called out by the needs of productive industry,
but occasioned by the necessities of the public treasury—in brief,
what is being financed by such a creation of credit is not the production of goods, but the acquisition of goods by a non-productive
borrower.
It may be asked, in fact has been asked, how the credit created
and extended by a bank in order to enable its customers or itself
to take up and pay for subscriptions to government loans, can inflate
commodity prices, since, it is said, credit acts on commodity prices
only when offered in exchange for, or payment of, " commodities.'
The process of price inflation in the case in question, that is
where the issuance of government loans is the admitted cause of
bank-credit expansion, is perhaps slightly obscured by this fact,
but in its essentials does not differ from the familiar and typical
case of credit expansion, if sight is not lost of the fact that the
credit extended by the bank in payment for bonds is merely the
beginning and not the end, or the whole, of the process. The credit
received by the government in payment of its bonds is not held
idle in the Treasury, but is used to pay for supplies bought or contracts in process of execution and soon filters into the stream of
circulating bank credit, becoming part of the aggregate supply of
purchasing media afloat in the community. For when the govern-




W A R FINANCE AND INFLATION

15

ment takes payment in credit, it follows that it will make payment
by credit, transferring the credit that it has on the books of the
banks in the same way as a merchant or manufacturer would, who
had been granted a credit accommodation by his bank. Moreover
the credit created in first instance by the bank's subscribing to
government loans and set in motion by being used by the government in payment of purchases made, keeps on moving and changing
hands, passing from the hands of the government to the munitions
manufacturers, from them to the steel manufacturers, and so on—
in other words, lives on as a part of the general body of mobile and
active banking credit until it is extinguished by some one, who,
having payment to make to a bank, uses it for that purpose or until
some one who wishes to buy a bond from a bank, makes payment
therefor in banking credit. When that time is reached, there will
be a simultaneous reduction on both the liabilities' and the resources'
sides of the bank's statement. Till that time is reached, both the
liabilities' and the resources' sides of the accounts will be swollen
by reason of the initial transaction in government finance, which
occasioned the extension of bank credit for the purpose of making
the investment in government bonds.
There is much misconception with regard to the meaning of
"bank resources" and the significance of increases of banking
resources. From the point of view of the lending bank, the obligation of a solvent debtor is a "resource"; from the economic point of
view, however, only that is a resource which in its existing state,
either is or is in process of becoming a usable good. When, therefore, banks are investing their credit extensively in government
securities, there may be a very great increase in the banking resources
of the country, without any increase in the country's actual economic
resources. But since prices—that is to say commodity prices—
depend upon the ratio existing between the supply of purchasing
power in terms of money, and the supply of purchasable resources
in the shape of consumable goods, it follows that an increase of bank
resources not offset somewhere in the economic process by an increase of economic resources in the shape of consumable goods,
must and will lead to a rise of prices.
It can hardly be doubted in view of the known facts of the case
that the great increase of prices which has been experienced throughout the belligerent countries of Europe is, in large measure, due to




16

T H E ANNALS OF THE AMERICAN ACADEMY

the multiplication of the means of purchase and payment by their
banking systems, more rapidly than the multiplication of the goods
available for purchase by their industrial systems. Nor can it be
doubted that a considerable part of the rise of prices, which we have
experienced in our own country since the beginning of the European
war in 1914, has been induced by the great body of new banking
credit created, which has outrun in its expansion the growth in the
productive output of the country. The rise, moreover, has continued since our entry into the war. The index figures compiled
by the Bureau of Labor Statistics show that while wholesale prices
in April 1917 were 74 per cent higher than in July 1914, they were
89 per cent higher in July 1917. It seems likely that if later figures
were available, they would show the forward march of prices to be
continuous. The rise of prices experienced in this country, though
much less than that which has taken place in the leading countries
of Europe (the price index compiled by the London Economist
showing an increase between July 1914 and September 1917 of 120
per cent) is yet sufficient to awaken serious concern, for causes not
dissimilar in their general character and incidence have been operating to produce the rise of prices in both England and the United
States, most notable among them, as already indicated, being the
expansion of banking credit.
How rapid the expansion of banking operations in the United
States has been during the past three years is definitely indicated in
the striking figures for the items "total deposits" and "loans and
investments" which have been assembled in the sub-joined tables,
based upon the data compiled in the office of the Comptroller of the
Currency.
TOTAL D E P O S I T S OF A L L BANKS I N THE U N I T E D STATES EXCLUDING SAVINGS
BANKS AND PRIVATE

National banks
State banks
Trust companies
Total
2

BANKS

(Bank, individual and government)
(In millions of dollars)
June 30,
June 23,
1914
1915
8,543
8,819
3,407
3,460
4,283
4,603
16,233

Report of national banks as of June 20, 1917.




16,882

June 30, June 30*
1916
1917
10,856
12,767
4,518
5,672
5,728
6,413
21,102

24,852

17

W A R FINANCE AND INFLATION

LOANS AND INVESTMENTS OF A L L BANKS I N THE U N I T E D STATES EXCLUDING
SAVINGS B A N K S AND PKIVATE B A N K S

National banks
State banks
Trust companies

Total

(In millions of dollars)
June 30, June 23, June 30, June 30*
1915
1916
1914
1917
8,728
10,127
8,345
11,936
3,304
3,268
4,073
5,003
4,395
5,307
4,163
6,102
15,776

16,427

19,507

23,041

It appears from these figures that both deposits and loans and
investments have grown in the United States at a very rapid rate
since the beginning of the European War in 1914. The growth of
bank deposits between the end of June, 1914 and the end of June,
1917 was eight billions six hundred millions of dollars, a gain of 53.1
per cent. The increase of loans and investments between the same
dates was seven billions two hundred sixty-five millions of dollars,
a gain of 46.1 per cent. Adequate data are not available for estimating with accuracy the trend of development since the end of June
last. The abstract of the Comptroller of the Currency for September 11, 1917, however, shows a gain of four hundred sixty-one
millions of dollars in deposits of the national banks between the
dates of June 20 and September 11, and of three hundred fortyfive millions of dollars in the loan and investment account for the
same period. Much more striking is the trend latterly disclosed by
the reports of the clearing house banks of New York City, covering
the period which has elapsed since the date of the last call of the
Comptroller: between the dates of September 8 and November 3,
1917, the loans, discounts and investments of the clearing house
banks increased from $3,850,652,000 to $4,510,385,000, a gain for a
period of eight weeks of $659,733,000 or 17.1 per cent. Demand
deposits for the same period increased from $3,675,490,000 to
$4,136,335,000, a gain of $460,865,000 or 12.5 per cent. The trend
of development in such a highly sensitive center as New York—the
most important banking center of the country—is not of itself, of
course, to be taken as measuring the banking trend in the country
at large but it may be taken as indicating the general direction in
which banking operations are moving. Taken with other—minor
* Report of national banks as of June 20, 1917.




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T H E ANNALS OF THE AMERICAN ACADEMY

and less significant—indications which need not here be detailed,
it seems not improbable that, if adequate data were available, they
would show an increase of some 10 per cent, or from two to three
billions of dollars, in both the deposit account and the loan and investment account of the banks of the country since our entry into
the war.
It can hardly be doubted, I think, in view of the facts and
probabilities thus outlined that the expansion of banking credit,
wThich has been in progress in the United States since shortly after
the opening of the year 1915, has already produced a condition of
serious price inflation. The evidence seems unmistakable that
inflation of credit and prices is already at work and that, in the
matter of inflation, we are confronted, not by a theory, but by a
condition—a condition which there is reason for believing will be
aggravated if undue reliance is put by the country on banking credit
as a competent economic method for financing the loan requirements
of the government.
If we examine the movements of the federal reserve banks in
recent months, we get some light upon one of the factors which have
helped to sustain the most recent phase of the expansion of banking
credit which is under review. Between the dates of April 6 and
November 2, federal reserve banks increased their holdings of bills
discounted and purchased from $100,663,000 to $689,977,000, an
increase of $589,314,000 or 585.4 per cent. Federal reserve notes
in circulation increased for the same dates from $376,510,000 to
$881,001,000, an increase of $504,491,000 or 133.9 per cent.
When it is recalled that the reserve banks are bankers' banks and
that investments made by reserve banks of their credit in discounted or purchased bills, appear on the books of the borrowing
or selling banks either as cash balances or as additions to (or replenishments of) their cash holdings,4 it is evident that an increase of
five hundred eighty-nine millions of dollars in reserve bank investments was quite sufficient, so far at least as amount is concerned,
to sustain an increase of from two to three billions of dollars in
the operations (loans and deposits) of the banks of the country.
Whether any such direct and definite connection between the operations of the banks of the country and the operations of the federal
4

In other words, as the customary and necessary provision of cash or cash
credit, which, in the accepted nomenclature of banking science, is called " reserve."




WAR FINANCE AND INFLATION

19

reserve banks can, as a matter of fact, as yet be said to exist, is of
course very doubtful. But the connection between the operations
of the federal reserve banks and the growth of their member banks'
operations will probably have to be regarded as close enough to
justify the view that the recent rise in the volume of reserve bank
operations has been a factor of consequence in sustaining the most
recent phase of the expansion of banking credit which has been
noted.
If this rise continues, it is not unreasonable to expect that in
time such use of the rediscount facilities of the reserve system might
convert it into a great engine of banking inflation. The situation is
therefore one which suggests the advisability of careful attention
being given to the character and growth of the operations of the
federal reserve banks in these critical times, lest they be made to
bear an undue share of the burden incident to the borrowing operations of the government.
The credit potentialities of the federal reserve system are vast.
The twelve banks composing the federal reserve system have an
aggregate capacity of credit expansion of about two billions of
dollars. If we assume that one dollar of reserve bank credit increases by not more than sevenfold when transmuted into the credit
extended by a member bank to its customers, it is clear as a proposition of banking arithmetic that the federal reserve banks and
member banks of the federal reserve system, taken together, have
an additional credit capacity of some fourteen billions of dollars.
The question which I believe, in view of this situation, the
country must soon face, is whether it will be the part of financial
prudence for us to attempt to finance our government loans by an
expansion of banking credit with accompanying inflation of prices,
or whether it will be better, however drastic the steps necessary to
accomplish this result may be, to pursue the course of converting
the potential savings fund of the nation into an actual savings fund
of sufficient magnitude to absorb the loans of the government as
savings loans.
VI
It does not fall within my province in this article to discuss the
different steps which are likely in the end to recommend themselves
to the mature judgment of the nation, if the people are to be pro-




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T H E ANNALS OF THE AMERICAN ACADEMY

tected, again to quote the President's language, " against the very
serious hardships and evils which would be likely to arise out of
the inflation which would be produced by vast loans."
One or two general observations may, however, not be out of
order. It will be the part of prudence for us, I believe, to look into
the future as clearly as we can and try to estimate how far we shall
have to reshape or supplement our traditional financial and economic
methods in order to adapt them to the unusual character and unprecedented dimensions of the financial .and economic situation,
which the war is presenting: Whatever will have to be done in the end
would better be done as soon as public opinion can be brought to accept
it.
The traditional methods of finance are everywhere showing
themselves inadequate, unless accompanied and reinforced by thorough-going changes in the general organization of industry from a
peace basis to a war basis. The weakness and defect of much of the
current discussion of war finance is, as I view it, that it does not
seem to comprehend the way in which the whole problem of financing the present war has been utterly transformed by the stupendous
magnitude of its financial requirements. Current discussions run
too frequently in terms of the traditional finance. There is too
much discussion as to whether loans or taxation should be our main
reliance in financing the war, and too little discussion of the changes
which have got to be made in our whole economic organization in
order that any financial system we may devise will prove effective
in putting the government quickly and continuously in possession
of the vast streams of supplies of all sorts required for the war.
The financial problem, at best, is only partly a financial or money
problem—a problem of getting the wherewithal to buy and pay.
Chiefly it is a problem of getting the goods and services to buy.
Obvious and important, therefore, as a system, of well-distributed taxation is, as an alternative to inflation as an expedient of
war finance, it can never be more than a partial solution of our
difficult financial problem. When the system of war taxation, the
foundations of which were laid by Congress at its last session, is
carried to its farthest practicable limits, there will still remain a very,
very wide margin of war expenditure—perhaps the largest part—
which will have to be taken care of out of the proceeds of loans.
Our major financial resource is bound to be the loan and one of our




W A R FINANCE AND INFLATION

21

major financial problems, therefore, to prevent the loan from deteriorating into an inflation. Specifically and positively the problem
is as to how we may best proceed in putting and keeping the loan
on a basis of financial safety—that is on a solid foundation of industry and thrift. The way to this result was pointed out by the President in words which have already been quoted and which can not
too often be repeated:
(1) by "every man and every woman" assuming "the duty of
careful, provident use and expenditure as a public duty" and;
(2) by "the organization and mobilization of all the material
resources of the country"—
the organization, be it observed, not of a part, not of so much as
can be conveniently spared, but the organization of all the material
resources of the country " t o supply the materials of war and serve
the incidental needs of the nation in the most abundant and yet
the most economical and efficient way possible." And all that
this or any financial conference can do; all that any executive department of the government can do; all that Congress can do is to work
out in suitable legislative and administrative detail the terms of the
President's equations.
In sum, we must, as a nation, produce more and consume less.-This, in its simplest terms, must be our national formula of finance.
We must produce more of the things which the nation at war requires and, in order to set free the nation's productive forces to
accomplish this result, we must consume less of the things which
the nation in war-time does not require, even though it has been
our national habit in peace-time to consume such things in unstinted measure.
Whether the various agencies of governmental administration
which have thus far been set up for adjusting the economic life and
activities of the nation to a war basis, will prove adequate to accomplish the result, may be doubted. Much has already been accomplished, but much remains to be accomplished and time is of the
essence of success. I t may well be expected, should the war run
on into a second year, that a more authoritative status will have to
be given to these special agencies if they are to be made fully competent to give effect to the war-will of our people on its economic
side, and that they will not be able to achieve the necessary results




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T H E ANNALS OF THE AMERICAN ACADEMY

until they are clothed with the power to say what shall, and what
may not, be done in the field of industry, or to define the limits
within which this thing or that thing will be permitted.
I believe that the people of the country, when the issue is put
before them intelligently and squarely, will not hesitate to accept
whatever may be involved in a sound financial program with the
same conviction and courage as they accepted the war. No nation
ever went into a righteous war more deliberately than did the
United States. The people, in assuming the obligation of war, I
believe, also understood that they were assuming the responsibility
of properly providing for its conduct and I am inclined to think
that the great body of plain living and plain thinking people in this
country are capable of comprehending what this means in the way
of a sound financial program. Whether it may mean taxation
carried to the farthest limits, compulsory saving, industrial conscription, priority of industry or priority of credits, the response
will be made by the people if the call is authoritatively made upon
them. It is my belief that beyond what is ordinarily appreciated,
the country is ready for whatever may be involved in the thoroughgoing and effective prosecution of the war, for the country is realizing that this is a war of blood and iron, and that until we have
effectively mobilized our iron, we shall not be in a position to bring
the war to a conclusion which will "make the world safe for
democracy."





Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102