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The Interest of Bankers and Business Men in Stable Money ^a ^ An Address by Irving Fisher,- Professor of Economics, Yale University, at the Annual Election and Dinner of the Bankers’ & Bank Clerks’ Mutual Benefit Association at Pitts burgh, Pa., Nov. 8, 1926. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis The President of a very successful busi ness recently told me, , with great earnest ness, that the future great benefactors of mankind would be not the preachers, nor the teachers, nor even the physicians, but the big business men, I have come to believe that there is much truth in this idea, although I was brought up on the hard-boiled doctrine that business and philanthropy could never be mixed. But today business is realizing, as never before, that it has responsibilities to the public. In particular, the banker is realizing that it is his function not merely to strive for private profit, but as well to render a specialized public service. For a new condition has thrust upon him a new responsibility. For several generations the Bank of Eng land, though nominally a private bank, has been increasingly regarded by the public and by itself as existing for the good of English business in general. Its own profits are the last thing its directors think of. The same may be said of our own Fed eral Reserve System. In fact it seems as if it were destined to become, if indeed it has not already become, the greatest public serv ice organization in the world. Among its other important public services, it is begin ning to perform the invaluable service of stabilizing the value of gold. Federal Reserve Stabilizing Gold It is not generally realized that on the policy and conduct of the Federal Reserve System, and the thousands of banks asso ciated with it, now largely depend the sta bility of the American gold dollar, the sta bility of the value of gold money through out the world, and the stability of world business and industry. In times past, the banker might pursue his private profit freely without being troubled by any thought of the effect of his trans actions on the purchasing power of the dol lar, the price level, and general business con ditions. But today he cannot escape some thought of such effects; for today everv banking transaction, as it affects the volume of credit in use, tends to affect the value of gold, the general level of prices and general business conditions. While this is true of all banks, it is particularly true of Central banks such as our Federal Reserve banks, and the Bank of England. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 2 There are three special reasons for this changed situation, and the present import ance of our Federal Reserve System in the new order. One of these is the growth in the last century of the use of bank credit; another is the recent increase in our gold reserve; and the third is the growth of a new ideal in monetary science. First as to bank credit: The contrast be tween present and former conditions is start ling. Originally, of course, a gold dollar derived its worth as money from its worth if melted into gold bullion, available for use in jewelry, gilding, or dentistry. Every dol lar of bank credit was supposed to derive its value from the fact that it was redeemable in gold. In those days, banking was too small a factor to affect appreciably the value of gold. Bank credit, that is deposits and checks against them, was a small tail to a large bullion dog. That is, the value of the gold dollar, or sovereign, was determined almost entirely by the use of gold in the arts. But today the tail is wagging the dog. Today, in Anglo-Saxon countries, bank credit and currency perform from eighty to ninety per cent of the money function in our com mercial system, and this makes the credit factor correspondingly more important than the goldsmith’s market in determining. the value of gold. ' Today, therefore, it is the volume of credit in use that determines the value of gold bullion rather than vice versa. Turning now to the second factor, our present overgrown gold reserve, we note that during the last few years the gold reserve ratio of our Federal Reserve System has been about double the minimum required by law and by conservative banking tradition. The danger of the reserve approaching or falling below these minimum requirements, therefore, has not been present and the ratio between gold reserves and liabilities has ceased to be the guide by which the credit extensions of the Federal Reserve System have been de termined. The old guide of Central banking policy, the gold reserve ratio, is gone—for the present, at least. If the Federal Reserve banks now choose to follow the old rule of conduct and policy they would extend credit enough to take up the slack and so to re duce the reserve ratio to nearly forty per cent. But if they did this they would in flate prices to double the present level, and we would have a repetition of the disastrous joy ride of 1919 and 1920. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 3 A New Criterion Rather than permit such a run-a-way in flation, the Federal Reserve System has felt it wise to ignore the reserve ratio as a guide and virtually to substitute a new criterion, that of stability—“to accommodate business.” Under this new policy the Federal Reserve System considers what is going to be the effect, not upon the reserve ratio, but upon business conditions, of (1) its open market purchases and sales, (2) the changing of its rediscount rate, (3) of its practice as to put ting gold certificates into circulation in place of Federal Reserve notes or vice versa, and (4) of its advice and moral influence with the thousands of member banks. The twelve Reserve banks have foregone the profit they might have made by encour aging rediscounts and by buying securities and acceptances to the limit; they have, in effect, kept one-half of their gold idle; and all this in an effort to prevent undue infla tion or deflation, and so to stabilize general business conditions. In my opinion this in telligent and public spirited policy and the surprising success with which it has been carried out are largely the cause of our pres ent prosperity, our large production and consumption, our small degree of unemploy ment. For four years we have had a “man aged currency;” we have had a roughly sta bilized dollar. This is the new ideal of monetary science. This stabilization work of the Federal Re serve System has only just begun. It is not yet fully self-conscious; the technique is not yet perfect. Although the recent testimony of Governor Strong of the New York Fed eral Reserve Bank, before the Committee on Currency and Banking of- the House of Representatives on the Stabilization Bill of Congressman Strong, has put the matter very clearly, it is not yet understood by the rank and file of bankers, much less by the business men whose interests are being even more largely served. The reason the banker and the business man have not studied and mastered this sub ject, is because they do not understand that our dollar, even our Gold Dollar, has nor, in times past, been stable in purchasing power, that it has not been a satisfactory standard or measure of value, and that great evils have resulted from the fluctuations which have occurred in its purchasing power. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 4 The Money Illusion The cause for this lack of understanding lies in what I like to call the “money illu sion.” Every country is subject to this “money illusion” in respect to its own money. Consequently we find the curious anomaly that we see the variability of other people’s money better than we do that of our own. We see the evils caused by fluc tuations in the purchasing power of other people’s money when we fail to see the evils caused by our own unstable unit of value. I suppose there were few people in the United States who did not know that the mark had fallen in value, but when, five years ago, I made a visit to Europe to study the fall of the mark and the franc and the other monetary units, I found that, wherever I went, in that particular country there was almost no notion that its money had changed, but the knowledge was common that the moneys of other countries had changed. Sometimes this change was given a queer interpretation in people’s minds, as, for example, when they thought of the dol lar as having risen. Germans, for instance, wanted to know why we charged so much for our dollar! That was the way in which they interpreted the great alteration in the exchange on New York—the great deprecia tion of the mark. I talked, with Lord D’Abernon, the Ambas sador from England to Germany, when I met him in London, before I went to Ger many. He said I would find scarcely anyone in Germany who realized that anything had happened to the value of the mark. I said that seemed incredible. He said I would find it so; and I did. Of course, the German professors of economics understand the sub ject perfectly; but of twenty-four German business people, whom I interrogated,—a random selection, a cross section of people that I met in the hotels, on the streets, in the shops;—I found that, out of those twentyfour, just one person had any glimmer of an. idea that the' mark had changed. That per son was an accountant. All the other twen ty-three had the notion firmly established that “a mark is a mark” and, consequently, was stable in value, just as in America some of us have the nation that “a dollar is a dollar,” and, hence, stable in value. Both notions are equally false. Some Victims Of The Money Illusion I remember spending an hour in a shop, speaking with the intelligent woman who https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 3 kept it. She explained that “prices were rising” and that it would cost her as much to replace ihe shirt which she was selling me as she was getting for it. “But,” she said, “I am making a profit on that shirt, for it cost me less than you are paying for it.” A little figuring would have shown her that she was greatly mistaken. It was true that, in terms of German marks, it cost her less than I paid; her books showed a profit; but, in terms of actual purchasing power, she had suffered a loss. She was selling me the shirt for less real value than she had paid for it. She had been victimized by the unstable mark for eight years but because of the “money illusion”, did not know it! Another instance: In Austria a bank ac quired the ownership of some paper mills. Conducting these paper mills in a routine way, the bank added to the cost of the wood pulp, in Austrian crowns, a certain percent age for each stage of manufacture and based its prices for paper on the sum of these several additions. How the bank had de ceived itself by using this system became evident when one of the mills burned and the stock of wood-pulp on hand was sold at its market value. This, in Austrian crowns, was so much more than the cost price that the bank seemed to have made more from the burned mill, by selling the wood-pulp at the advanced market price, than it had made by making into paper the wood-pulp in the mills which did not burn. The truth was, of course, that the manage ment was losing money in all cases—that is, losing purchasing power—though less on the pulp in the mill which burned than on that which was turned into paper. Had they translated Austrian crowns at each stage into purchasing power in commodities they would have been led to charge enough so that they would have made some real money! But they, too, had this “money illusion”. I may illustrate further by an experience of my own, how this “money illusion” oper ates. Before the war one of my books was translated into German. I heard nothing from the publisher during the war because there was no communication with the enemy. Afterward I received a report and was told that the royalties were payable, that there had been a good sale for that type of book —which, by the way, was on the subject of the purchasing power of money—and that a certain amount was due me. As I happened to be on my way to Europe at that time, I wrote that I would collect it when I came https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 6 over. I was gravely handed in Berlin a check for the stipulated sum in marks, but translated into American dollars, and taking into account changes in purchasing power, I found it was about one per cent of what, under normal conditions, would have been justly due me. However, I could not per sonify the responsibility and accuse the pub lisher of wrong-doing. I looked him in the eye, but I found he did not even think it funny. It was the established custom to reckon in terms of marks and he had fol lowed the custom. One of the most interesting cases of this “money illusion” which has come to my at tention is that of a wealthy American wom an who, before the war, had acquired some German real estate on which was a mortgage of 28,000 marks, equivalent then to $7,000. She always thought of her debt in terms of dollars and, after the war, visited Germany and asked her banker there to attend to pay ing the “seven thousand dollars.” He called her attention to the fact that her debt was not in dollars but marks and that the 28,000 marks was no longer equivalent to $7,000; it was now equal to less than $100. Yet she insisted on paying her debt “in full”, as she had always thought of it, and indig nantly refused to “take advantage” of the “fall of the mark”. Your first impulse will be to contrast the attitude of this woman with that of the German publisher who paid me in depreciated marks, to the disparagement of the publisher, but the fact is that each was true to the same principle. Each was keeping a money obligation in terms of the money of his or her own country. Even the American wom an was not repaying the original purchasing power which had been lent to her. To do that would have required, not $7,000, but over $10,000, because the dollar itself had, mean while, fallen in value as I am going to ex plain later. Seeing Changes In Other Moneys To show how each country can see changes in the other country’s money, I may men tion an incident cited in Sir David Barbour’s book on “The Standard of Value”. He is one of the few Englishmen who has made a thorough-going study of this subject, a banker, and, with Mr. Lindsay, the man who was responsible more than any other for the establishment of the gold-exchange standard for India in 1893, one of the great milestones in progress toward stabilization. He rec- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 7 ords the fact that an Englishman and a Hindu were speaking of business conditions, back in the 80’s of the last century, during which time the exchange on India was rapid ly falling. The Englishman mentioned the fall of the rupee. The Hindu looked puz zled, and said, “Fall of the rupee! Fall of the rupee! I wonder what you mean. I have my agents all over India, and they never once reported to me any such thing.” Then he said, “OhL I think I know what you mean. They have spoken of the rise of the pound sterling. I think that is what you mean.” The Englishman, when the rupee changed relatively to the pound sterling, attributed it all to the rupee. The Hindu thought sim ply of the rise of the pound sterling. As a matter of fact, they were both partly right, because, during that period, in terms of com modities, the rupee had fallen in purchasing power about half as much as it seemed to the Englishman to have fallen, and the pound sterling had risen about half as much as it seemed to the Hindu to have risen. Both had the “money illusion”, each as io his own money. America Also Deluded We in America are as truly subject to the “money illusion” as were the Britisher and Hindu just mentioned, and unless we want co humbug ourselves, we must not think of the dollar as being of constant value. We must translate it into purchasing power before we can properly compare figures of any two dates. Otherwise we are victims of this “money illusion”. . An American is usually quite lost when he tries to think of the dollar as . changing in value or purchasing power. “In terms of what can it possibly be measured?” he asks: “Are we not on a gold standard? Is not gold stable?” I was talking with an American business man, a few years ago, about the necessity of stabilizing our dollar. He looked at me in amazement, arid said he had never heard of any instability in the dollar, that he had been on boards of directors in all kinds of business enterprises where they had dis cussed business conditions and never once had he heard any complaint about our un stable dollar. And yet, precisely the same principles apply to dollars as to marks and sovereigns. The only difference has been the extent of the fluctuations. During the post-war period of inflation, in 1919, a lumber merchant in central New https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 Vork, not wishing to be called a profiteer, tried at first to charge for his lumber on the basis of arbitrary percentages, just as the Austrian bank charged for the product of its paper mills. He suddenly woke up to the absurdity of the situation when he found that he was unwittingly selling his lumber, not to the public, which he was trying to save from profiteering, but to the dealers of whom he had originally bought it! They found they could buy lumber of him more cheaply than they could get it from the mills, because prices had risen so fast; that is, be cause the dollar had fallen so fast. After his enlightenment, this man became so much interested in the problems of un stable money, and so anxious to help stab ilize the dollar that he called a group of the business men of his town together and had me address them. While I was speaking I noticed that one present, a leading banker, was busily scribbling with his lead pencil. When I was through he said, “I have been bragging that my bank’s deposits had dou bled since the war began. But now I find, when I translate my present deposits into pre-war dollars, that there has been prac tically no real increase at all!” Must Compare Equal Dollars Every business man ought, when con sidering his problems, to watch the pur chasing power of the dollar and, if it is fluctuating very much, he ought, in order to get fair comparisons, to translate his chief dollar items into dollars of one and the same purchasing power, such as, let us say the pre-war dollars of 1913. All that one needs to do to make such comparisons is to multiply every dollar fig ure of his current operations by what the dollar is then worth in pre-war cents. My own Weekly Index Number of the dollar’s purchasing power can be used for that pur pose, as can any other good Index Num ber, such as that of the United States Bureau of Labor Statistics, if it is first cast into the form of purchasing power. As an instance of how we may be de ceived, unless we take this precaution, let us imagine a company with a capital of $100,000,000 which paid dividends . of four per cent in 1913, and is now paying five per cent. On the face of it one is' apt to think that the dividend today is twenty-five per cent higher than formerly. But the truth is the dividend is smaller in terms of real purchasing power. For, if we translate the present $5,000,000 of dividends into 1913 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 9 dollars by multiplying 5,000,000 by 65 cents, which is the value of the dollar at present, in terms of 1913 cents, we find that the dividends today are only equivalent to $3,250,000 in terms of 1913 dollars or only 3% per cent, as against the four per cent dividends of 1913—a reduction of about twenty per cent. This example makes it plain why these fluctuations are of great practical import ance to investors in long term securities and to “investment counsel” and investment bankers. This aspect of the matter is cov ered in the recent books by Edgar L. Smith on “Common Stocks as Long Term Invest ments”, and Kenneth Van Strum on “In vesting in Purchasing Power”, which I com mend to your reading. Mr. James H. Rand, Jr., President of the Rand Kardex Bureau, Inc., and Secretary Mellon have both shown understanding of this matter, for they recently pointed out that the stock market was not always as high, as it seemed when the reduced pur chasing power of the dollar was considered. How Do We Know How do we know that the dollar today is worth only what 65 cents were worth :n 1913? How do we measure the dollar? It is a natural question! The answer is: By Index Numbers. An Index Number is an average percentage fig ure which shows the average rise or fall of prices. If, for instance, sugar this last week has gone up four per cent, and wheat, ten per cent, then on the average sugar and wheat together have gone up seven per cent, seven being half way between four and ten. We then say the index number is 107 as compared with 100 last week as the base for comparison. If sugar is regarded as twice as important as wheat, then we give twice the weight 'o it, count it as two commodities instead of one, and take our average of four, four and ten, or eighteen divided by three. The re sult is six and our index, number is 106. Or if it is the other way around, and wheat is twice as important as sugar, we count that twice, and take an average of four, ten and ten. This average is eight and our index number is 108. Evidently we do not get very different results by changing our system of weights. . The index number in those three cases works out as 107, 106, 108. When we take two hundred or more com modities, the differences are even smaller. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 10 One of the surprising things in the study of index numbers is that, usually, we get approximately the same result whether we use the weighted or the unweighted system. Take cotton, for instance; in my index num ber it has a weight of 7 per cent of the total, so that if cotton decreases in price by 50 per cent it will reduce the total figure by only about 3^ per cent! So that thus averaging the changes in the prices of a large number of commodities we can find whether and how far prices in general have gone up from one week to another or from one year to another. The United States Bureau of Labor Sta tistics publishes every month an index num ber of the average price movements of 404 commodities. ' I myself publish every week such an index number for 205 commodities. There are many other index numbers in this country and abroad. By means of these index numbers it is possible to tell what is happening to the purchasing power of the dollar. For, to say that the general level of prices has doubled is the same thing as to say the dollar has been cut in two, i. e., if it takes two dollars to buy what one used to buy, one dollar will buy half as much as it did. European Prices The biggest changes in the purchasing power of money have occurred in Europe. German prices went up to three trillion times their former level between 1913 and the adoption of the Dawes’ stabilization plan. In Russia, prices went up five billion fold. In Poland, and many of the other countries subject to tremendous inflation, prices multiplied over a million-fold. _ In Austria, before the currency was stabilized, prices multiplied 15,000 times, which means that the Austrian crown had gone down in purchasing power to 1/15,000 part of what it had been worth. In Italy, in France, even in England—in all of the countries of the world—we find that the general level of prices rose, which means that moneys fell in purchasing power. And America is no exception. While America has long had, so far as I can find, the least unstable money in the world, yet that does not mean that it has been really stable. It has fluctuated in very large per centages. American Dollar Unstable Let us look at the figures for this coun try. Back in 1860, before the Civil War, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 we find the purchasing power about the same as in 1913, before the World War. We may call the level of 1860 or 1913 “the pre-war level”, and think of it, for conveni ence, as a normal for reference, one hun dred per cent. The dollar then was a dol lar, so to speak. In terms of this pre-war dollar, we can measure the dollar at any other time by comparing what it would buy on the two dates. We find, as we pass into the Civil War, from 1860 to 1865, that it became worth on'y forty pre-war cents. That is, in 1865 it was worth only forty per cent of. what it was worth in 1860. From that time on it began to appreciate, at first very rapidly, and then more slowly, until it reached its maximum in 1896, when it was worth 150 pre-war (or 1860) cents,—about four times as much as at the start of that toboggan slide of prices. From 1896 to 1913 the dollar feil from 150 pre-war cents to one hundred again, or “normal”. From 1913 it continued to fall until it got down to forty, again in May, 1920. That was 27 per cent of its 1896 value. Then there came deflation, and a rise in the value of the dollar, or a fall in general prices. So the dollar changed again from forty until it reached seventy-two pre-war cents in January, 1922. Since that time it has been more stable than it had been for many years; and yet it has danced about week by week. My own Index Num ber shows that the dollar was worth in early November 65 pre-war cents, and that it increased in value over 7 per cent in the first seven months of this year. Let us next pass to the causes of these fluctuations in the purchasing power of money. After discussing the causes we shall consider the evil consequences and the pos sible remedies. Our next question, then, is, “What causes the instability of the dollar?” The answer is: The chief cause of rising prices (or falling money) is inflation and the chief cause of falling prices (or rising money) is deflation. In theory, the quantity of money and credit, the velocity with which they circulate from hand to hand, and the volume of trade all have an influence upon the price level. In practice, however, the velocities may usually be overlooked; so we may say rough ly that prices rise when the volume of money and credit outruns the volume of trade, and prices fall when the volume of https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 12 trade outruns the quantity of money and credit. There are several lines of statistical proof of this statement: . (1) If we compare all gold standard countries we find their price levels rise and fall nearly in unison. Similarly the fluctua tions in silver standard countries show a family resemblance. In short, countries with like monetary standards have unlike price movements. (2) Countries with unlike monetary stand ards have unlike price movements. Thus gold and silver standard countries differ in their price movements. (3) The divergence between the price movements of any two countries with unlike monetary standards corresponds roughly to the divergence between these standards. Thus, when between 1873 and 1893 prices fell in gold standard countries and rose in silver standard countries, the divergence was roughly the same as the fall of silver in terms of gold or rise of gold in terms of silver. . (4) Where we can check up by statistics of money, credit, trade and velocities of circulation, we find strong confirmation that the master keys are inflation and deflation. Such confirmation has been given to some extent by Cassel of Sweden, Keynes of Eng land and Carl Snyder and Holbrook Work ing in the United States. At least one great good has come out of the war, the wonderful statistical data furn ished by the various countries as to what happens to the purchasing power of money when you manipulate its volume. Inflation and deflation both during and after the war made of Europe a vast experimental labor atory from which economists have drawn the final convincing evidence needed to convict these two enemies of society. • So much for the causes. We now come to consider the evil consequences of inflation and deflation or, in other words, of the instability of money. The Evil Consequences These are very similar to the evils in volved when any other measure is unstable. We have a sealer of weights and measures to protect the people against the fraud of wrongly made yard-sticks or bushel baskets or inaccurate scales, because we recognize the fact that all these things ought to be standardized. If we are going to have honest dealings with our grocer and our dry goods mer- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 13 chant, we must have honest measures of weight and of length. And so, for the same reason, in dealing with money matters we must have an honest dollar. It is important that we should have a stable yard—certainly, —but the yard, as a unit of measure, enters into only those contracts involving length, as for cloth, ribbon, wire or land; and so also for the pound weight; it enters into contracts for coal, sugar and so forth; but the dollar enters into every sales contract. It is on one side of the counter in every transaction. The importance of stabilizing the dollar, therefore, is equal to the aggre gate of the importance of standardizing every other unit of commerce. And more than that! The dollar is the only unit in countless contracts where no other unit enters, where dollars are exchanged for dollars, present dollars for future dollars; contracts running for long periods of time; so the fluctuations are that much more serious. Every bank deposit is such a contract; so is every, bond issue, every loan, every lease, every insur ance policy, every pension fund, every fran chise. Some of these contracts run over a hundred years or more. In every one of these cases variations of the purchasing power of the dollar produce harm and hard ship to one or the other party to them. If I contract to pay you a thousand dol lars ten years from now, it makes a trem endous difference whether the dollar in which I pay has shrunk ninety-nine per cent or whether it has increased two or three fold during the ten years. In one case , you are cheated, and I have gained; in the other case, I am cheated, and you have gained. In either case there is grave social injustice. Of course, you cannot personify it. I cannot hold you responsible and bring you into court, if I am the loser; or you cannot bring me into court, if you are the loser. But this should not blind our eyes to the fact that gain and loss are there, and the evil is an evil of social injustice. Finally, a variable dollar is worse than a variable yard, pound, bushel etc., because of the “money illusion”. Any variation in the yard would be recognized at once. But changes in the purchasing power of the dol lar are insidious. They occur in so silent and innocent a fashion that they are un observed and the blame is thrown on other things or on individuals. You may be inclined to say: “But these losses even themselves up. What some peo ple lose, others gain. Isn’t society on the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 14 average just as well off?” You might just as well argue that when your house or your bank-vault has been burglarized no harm has been done because what you have lost the burglar has gained! Clearly a great ethical harm has been done. Something has been taken away from its rightful owner. It is a robbery and the culprit is the “robber dollar”. The Robber Dollar Let me illustrate how the robber dollar operates. Consider a working man who put one hundred dollars in the savings bank in 1896 when the dollar was worth 150 pre war cents. Suppose he took that money out in May, 1920, when the dollar was worth forty pre-war cents. That one hundred dol lars would have grown by accretions of interest so that in May, 1920, the depositor would find it was not one hundred dollars but three hundred dollars. At first he would congratulate himself: “See the reward of thrift. I have three times as much as I put in, thanks to the interest.” But when he turned around and tried to spend this $300, he would find that it wouldn’t buy is much as $100 would have bought in 1896. The hundred dollars of 1896 were worth 150 pre-war dollars while the $300 of 1920 were worth only 300x40 cents, or 120 pre war dollars. The victim was cheated out of his interest and $30 (pre-war dollars) of principal as well; not by the banker—you cannot personify it, it was not his fault— but by our robber dollar. It is a fraud just the same, and all the more a fraud because the victim does not understand it. What happened amounted to the abolition of interest. The truth is that, on the aver age, there was no such thing as interest in the United States between 1896 and 1920. Many of you are bond-holders. You will be surprised at that thought. You will say, “Surely I received interest.” Let me illus trate by another case—an actual occurrance. In 1892, close to the time when the dollar had its greatest purchasing power and was worth nearly 150 pre-war cents, a friend of mine, a woman, was left a small fortune of $50,000. This was put in trust, and the in terest was paid to her, about $2500.00 or $3000.00 a year. In 1920, when the dollar was worth 40 pre-war cents, I went with her to see the trustee who had been managing her property all these years. The trustee showed us how ' carefully he had invested this fund,—only in “safe” bonds, hot in un safe stock, he said. He said he was sorry https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 15 that in one case the bonds had deteriorated so that the principal was no longer $50,000 but $48,000. I said, “I claim there has been an impairment of seventy per cent or more.” He said, “Nothing of the sort. You can look at my books.” I said, “I haven’t any doubt of your personal honesty.” Then I explained to him what I have explained here. I said, “This lady has not been re ceiving any income except as she has been living on her capital. Her father put In your custody $50,000, which represented, at that time, a certain purchasing power,—so much bread and butter and clothes and house-rent. If you had kept custody of that sum as real value in terms of human living, not merely as dollars, you would have the equivalent of it today, and the equivalent of it today would be over three times as many dollars. You haven't it. You have only $48,000. If you had really conserved that fortune in actual purchasing power, you would not have paid her that $2,500 every year. You would have re-invested out of that a sinking fund against the sinking value of the principal, so as to keep up the value of the principal to where it was when it was put in your hands. But you would have had to invest all of that $2,500 every year. And even that would not have compensated for the sinking dollar. Therefore, I claim she has not been receiving any income from a real unimpaired capital. The alleged in come has all been falsely kept on your books—not through your fault, but because you have been keeping it by false weight and measure—just as falsely as if in Ger many a fortune of 50,000 marks in 1920 had been called as large as 50,000 marks in 1892.” He said, “It is not my fault”. I said, “No, but for heaven’s sake,—you people who are keeping fortunes of widows, orphans, col leges, hospitals, and churches,—can’t you be interested in something more than whether it is your fault or not? Can’t you be interested in the great need of somehow preventing these widows and orphans and hospitals and colleges from being robbed?” Steady Income A Delusion Just as this woman’s income and principal was only one-third (in value) of what it was when this trust began, so we find that every bondholder’s “steady income” is a de lusion and a snare, so long as we have an unstable dollar. Our period of inflation ruined numerous colleges, hospitals, founda tions, and other institutions, as well as widows and orphans through the fall of the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 16 dollar, just as the fall of the mark swept away the savings of the German bond holders. The difference was merely one of degree. Our bondholders have lost, some times through long periods of rising prices, two-thirds of their real value, while the German bondholders lost over 99 per cent. That is the only difference. When unstable money picks one set of pockets it slips most of the loot into an other set of pockets. To show this, let us assume a company with $100,000,000 of stock and $100,000,000 of bonds, each yielding five per cent, in 1913. That is, $5,000,000 in dividends to the stockholders and $5,000,000 in interest to the bondholders, or $10,000,000 altogether, equally divided between stock holders and bondholders. Now let us sup pose prices double. Let’s see what has hap pened to this company. If it is a typical company, the doubling of prices, because the dollar has been cut in two, will double the amount it receives as income and the amount it pays out as expenses. Therefore, the difference, or profits, in terms of dollars will be doubled. Consequently, the net profits will be no longer ^iv,UU0,000, as for merly, but $20,000,000 although, of course, this $20,000,000 now will have the same pur chasing power as the $10,000,000 before. Therefore, there is no change in the total to all the investors. Let us see how the two classes of investors fare. Will the bond holders get half as before, and the stock holders half? Obviously not, because a bond is a contract to pay a specific number of dollars, and the bondholders are tied down by that contract to five per cent. Therefore, they will get just $5,000,000. The stock holders will rake in all that is left out of the $20,000,000, that is $15,000,000. What, then, has happened to the bondholders? Nomin ally they have the same income as before, $5,000,000. Actually, in purchasing power, they have half as much as before. How about the stockholders? Nominally they have .three times as much, fifteen million in stead of five. But, since the dollar has been cut in two, they have only one and one-half times as much. In short, the bondholders have lost fifty per cent of what they used to have, and the stockholders have gained fifty per cent. Our - unstable dollar has picked the pockets of the bondholders and slipped the loot into ■ the pockets of the stockholders. Next suppose " the opposite movement. Suppose, after the 'fifty-fifty division of the https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 17 $10,000,000 a year, prices drop to half their previous level. Then the company with the same physical volume of trade will find its money receipts cut in two and its expenses also cut in two. Therefore, their difference, or profit, will be cut in two. That is, in stead of $10,000,000 there will be $5,000,000 to divide between stockholders and bondholders. This $5,000,000 will be worth as much as the original $10,000,000, but it will no longer be divided between stockholders and bond holders on a fifty-fifty basis. The bond holders under their bond contract are en titled to -five per cent, which means the en tire $5,000,000. There will be nothing left for the stockholders and the company will be on the verge of bankruptcy. The blame would fall on the management but it would be the robber dollar that did the stealing. Nor is this a merely imaginary situation. It is going on every day to some degree. In fact, the extent of this subtle robbing is prodigious. Professor W. I. King, one of the best statisticians I know, when appear ing in favor of a bill in Congress on this subject, sometime ago, said that, as nearly as he could reckon it, there had been a sort of picking of the pockets of one class for the advantage of another to the tune id forty billions of dollars in the United States during a period of half a dozen years. Sup posing there should be a forty million dollar bank robbery; it would be on the front page of every newspaper. Yet this forty billion dollar robbery—one thousand times as great —was so subtly accomplished that it was not generally recognized as robbery; and the fact that you cannot localize and personify the fault, because it is due to instability in our monetary system, makes it even more serious. We cannot even take comfort in the thought that the robber dollar which robs Peter pays Paul. Not only does Paul de serve nothing but he never gets as much as Peter loses. There is a large net loss to society from this see-saw dollar. It is the chief cause of the so-called “business cycle”. Inflation and deflation produce booms, crises and depressions which upset the proper ad justment of society and cause a net loss all the time. For instance, falling prices reduce profits. Reduced profits close factories; closed fac tories mean less wealth produced. These relations of the unstable dollar -u the so-called “business cycle” are very reai and can be shown statistically. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 18 On this point I would refer you foi further details to my articles in the Journal of the American Statistical Association for December, 1923, and June, 1925. I have shown in those articles that there is (1) a 90 per cent correlation between the rate of change in the purchasing power of money and the degree of employment and (2) a 94 per cent correlation between the rate of change in purchasing power and the volume of trade. Unemployment A Result That falling prices, that is, a rising dollar, or a rising mark, or a rising franc, produce unemployment, and “soup-kitchens”, statis tics clearly show. In the United States in 1920, in England, in Czechoslovakia, in Nor way and other places this has been observed. Mussolini is said to contemplate drastic de flation in Italy. Does he realize that it means unemployment? This is the inevitable effect and in Italy it may mean revolution as well. The drama is now unfolding. For those who are interested in following up the unemployment phase of this matter I refer to an article in the International Labour Review for August, 1926. There the Chief of the Unemployment Service of the International Labour Office has produced statistics from numerous countries to prove that falling prices mean unemployment and that stable prices mean steady production. He has also linked the general price level with Central Bank policy, as I have done in my introductory remarks, and has shown how the three things are inseparably joined together, viz., Central Bank policy, the gen eral price level, and the condition of em ployment. The clear lessons to be learned from these studies and the facts I have presented to you are that, if you manufacturers want to have steady production, steady employ ment, steady consumption, factories running steadily to their capacity, no frozen or de clining inventories, no mad scrambles for raw materials; if you bankers want your loans promptly met as they fall due, then you must have stable money. You must back up and encourage the stabilizing pol icies of the Federal Reserve and all other moves looking toward stabilization. Social Unrest A Result When prices are falling, the debtors are always angry with the “money power”, be cause, while they do not know what has really happened, they do see that the cred- https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 19 itors have the advantage. The farmers in the West, for instance, with the price of their products going down, but their mort gages remaining the same (in dollars), know they have been injured and they argue, “This debt is a millstone around our necks. It is the fault of the bloated bondholder, of the goldbug of Wall Street.” Those who lived through the campaign of 1896 will remem ber those phrases. , When prices are falling, we have bank ruptcies and foreclosures. Even if a manager is very skillful he may not be able to prev ent disaster, so the bondholders take over his business and, as a bondholders’ commit tee is not able to handle it properly, effi ciency suffers. On the other hand, when prices are ris ing, “The high cost of living” is the cry. The person who is getting the benefit, who is raking in profits, is blamed. Then we have the “profiteer”. When prices are rising, the creditor class including bondholders, savings bank deposit ors, salaried men and wage earners feel the pinch of want. Particularly notable cases of the injustice wrought by rising prices are our Federal Judges and our Government Ex perts, forced to spend 1926 dollars but re ceiving pay according to schedules fixed many years ago. When prices are rising the “profiteer” makes money for a time, but ultimately he is often beguiled into wasting his and others’ resources. Moreover, his ill-gotten or un earned gains so anger his workmen that they strike and commit sabotage. The public, while unable to analyze, knows "who got the money”. In either case, fall ing or rising prices, hatred falls on some body, “bloated bondholder” or “profiteer”. In either case, we have class hatred as the result. Out of this spring class war, strikes, violence, sometimes bloodshed. The French have an aphorism: “After the paper money machine comes the guillotine.” So this is a pretty serious business—not merely a matter of a forty billion dollar robbery. It is a matter of class war, a matter of social and political instability, a matter of wide-spread economic hysteria. There is always discontent on the part of the loser in this gamble and the fact that the people who feel the injury do not know what has hurt them makes it all the worse. Being hard-hit, but not seeing what hit them, they are suspicious. The result is that, in the frantic effort to personify the fault, they https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 20 turn on the winners in the lottery and say, “It is your fault.” They demand" “free sil ver”, “the daddy of the daddies”, “farm relief”. They seek a quick cure for their troubles and “quick cures” are likely to be “quack cures”. There is only one real cure —one honest cure-—one just remedy, and that is to stabilize our dollar in its~'purchaslng power. - Palliatives are interesting as showing a demand for a real solution of the problem, so I will mention two of these with which I have had some personal connection. The first is an example of an attempt to solve the problem for the benefit of bond holders. I refer to the bonds of the Rand Kardex Company, Inc., of which I hold a specimen copy. These bonds are payable in a constant purchasing power, the number, of dollars paid out on account of interest and principal varying according to -.the Index Number of the United States.. Bureau of Labor Statistics. (A copy of this bond will be sent on request to Irving Fisher, care of Yale University.) Bonds so drawn -solve the problem for that particular ..bond ..con tract. But it is impracticable Io . 'get ‘the principle applied one by one to all contracts. A similar plan which attempts to solve the problem for the benefit of the: wage earners is that now in use by the PhiladeT phia Rapid Transit Company, which pays its men on a sliding scale varying with the cost of living in Philadelphia. This like wise may prevent or minimize some of thb injustice done to the employees by a change ing price level. I have studied many such plans, efforts to mitigate the evil consequences of our un stable dollar, but I have concluded that, valuable as some of them are for particular uses, the only sound, complete, equitable solution is to stabilize the dollar itself. - The Remedies There are a number of ways of stabiliz ing the dollar in a complete and final man ner. One most interesting plan, perfectly sound economically if politically practical/, is that of Professor R. A. Lehfeldt of .the University of South Africa. He proposes an International Commission to buy Upland operate the gold mines of the world, in creasing production when gold ' becomes scarce and “dear”, (that is when prices fall) and decreasing production when gold be^ comes redundant and “cheap”, (that is when prices rise), . . https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 21 Another plan, called the “Compensated Dollar Plan”, is one I have long urged upon the attention of the public and those who are interested in its details will find it explained in my book called “Stabilizing the Dollar”. ' A recent report on all the various plans which have been proposed said that this plan was the only practical plan, not fiat money, that would work under all cir cumstances and yet not throw the whole burden of world stabilization onto the United States Treasury. But let us, in seeking the ideal, not over look the ' merits of what we have. Let us remember that there is a plan which is now working, to some extent, and which will continue to work under present circum stances. That is simply the control of credit which I mentioned at the outset. As long as we have our present surplus of gold, we can stabilize the dollar without changing the weight of gold it contains, without legis lation, without greatly violating any of the traditions of the banking business or of con ventional economics. Either of two things can happen to mar this picture: First—when, through expansion of busi ness or the contracting of our gold supply, or both, the gold reserve ratio gets down to, or near- the legal limit: then we shall have to choose between two policies—we shall have to operate our banking system on lower reserve ratios, as Europe is now do ing to conserve gold, or we shall have to abandon stabilization. Second—by discoveries of new gold fields or of new methods of mining or recovering gold or by decreases in the volume of credit in use, or otherwise: then gold may become so redundant in our reserves as to exceed the 100 per cent figure. Or the Federal Reserve may be unable to swallow more of the yellow metal or to retain on its stomach what it now has. It can’t sell securities on the open market if it hasn’t any to sell. Then too gold reserves draw no interest and the member banks might insist on dividends, which can’t be paid out of idle assets. Then the time will have arrived for our present studies to bear fruit. By that time Public Opinion will have to make itself heard for real stabilization. But until one of those times arrives— when gold reserves are much too low or much too high—we can stabilize by the method which our Federal Reserve System https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 22 is now putting into force, so far as practic able without substantive legislation. The suggestions approved unanimously by the Genoa Economic Conference, of over thirty nations, which included stabilizing the value of gold by proper handling of Central bank credit, are actually being carried out, not only in America but in England; for the bank of England is likewise recognizing the obligation to prevent great inflation and de flation. In both countries the effort is ten tative and unofficial, but plans to provide real, permanent, scientific stabilization are now being more seriously considered than ever before. In short, the stabilization movement has now reached a practical stage. Thus Gov ernor Strong of the Federal Reserve Bank of New York testified for four days at the recent hearing on the Strong Bill for stab ilizing the purchasing power of the dollar. While mildly in opposition to the bill as then framed he expressed sympathy with its purpose. I may quote, as expressing his ideas, what he wrote to Collier’s Weekly, in 1923, as follows: “Labor disputes are rarely very serious, long extended or disorderly, except when they have to do with compensation, and compensation disputes almost always arise when prices are rising. “Periods of falling prices give rise to de mands for fiat money and Government sub sidies of this industry or that. “Therefore, is not the fundamental condi tion of industrial and national tranquility that of a reasonable stability of prices, as from about 1909 till toward the close of 1915? “I believe with Mr. Henry Ford that what the great body of our workingmen most de sire is security of employment and an ade quate wage that represents a fairly even and stable purchasing power.” Committees to study the problem of stab ilization have been appointed by the Invest ment Bankers’ Association, the Mortgage Bankers’ Association, the American Federa tion of Labor and other organizations. Mr. Owen D. Young of the Dawes Com mission, Chairman of the General Electric Company and Director of the Federal Re serve Bank of New York, recently said to me that I didn’tneed to “sell” him on the importance of a stable price level, that he believes it is one of the most important problems in the world. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 23 When business men generally see the para mount importance of stabilization as these men do—when they realize what will be its effect on general business conditions—poli cies undoubtedly will be adopted which will bring us this great social and economic boon. Public Opinion rules and Public Opin ion is rapidly learning that the one most important ideal for money is stability in purchasing power; that an unstable money is not a sound money; that we must evolve a system which will give us now, next year, ten years, a hundred years hence, a dollar of steady, unchanging, stable purchasing power; that then and not until then, shall we have a sound monetary system, a tranquil land wheren; justice and prosperity continue to bless the people. Reprinted from Money & Commerce. Official organ of the • Pennsylvania and West Virginia v-Rankers’ Associations and Pennsylvania Title Association, December 11, 1926. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis