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vacuum created by our artificially high interest rates caused more and more gold to be thrust upon us. It was a case involving the operation of a simple economic law which states that goods will move to that market where they can be sold to the best advantage. In response to this law, foreign gold continued to move to our markets until they became congested. By the early part of 1924 our gold stocks had become so large that arbitrary control broke down, on gold as it would have on wheat, and all gold which came in thereafter automatically became the basis for credit expansion.

The automatic relationship between gold imports and credit expansion following the breakdown of control may be seen in the developments which took place over the ensuing three and one-half year period, ending July 1927. During this period we had net imports of gold of approximately $400,000,000, and an expansion in the loans and investments of about seven hundred of our largest banks of more than $4,000,000,000. Thus every dollar of gold coming in during this period multiplied itself in credit operations more than ten times. It was impossible for the Federal Reserve banks to prevent this phenomenal expansion. They had reached the end of their power to sterilize imported gold. Once our rain barrel had been filled to overflowing, we could no longer control the use of the additional water that poured into it.

Another consequence of our goldstorage policy—and this consequence was felt acutely by our foreign debtorswas that we brought on a fall in the world's level of prices. The truth of this statement cannot be demonstrated mathematically, but it stands to reason that the transfer of $1,400,000,000 of the world's gold stock from foreign bank reserves, where it was being used as a basis for credit, to our own vaults, VOL. 142-NO. 1

where it was held in complete idleness, should artificially raise its value. If we warehoused 15 per cent or more of the world's supply of wheat in the course of a crop year, and kept it warehoused, would not the price of wheat rise? And if we could raise the price of wheat in this manner, would not the storing of 15 per cent of the world's gold supply raise its value also? The evidence seems to be unmistakable that our storage policy raised the value of gold throughout the world. And raising the value or purchasing power of gold is the same thing as reducing the level of prices.

Theory says that our policy should have caused a fall in prices, and the trend of world prices following the termination of our gold-storing activities bears out the theory. Between January 1925 and July 1927 there was a general decline in wholesale prices in all goldstandard countries, ranging from 10 per cent in the United States to 17 per cent in England. So pronounced an appreciation in the purchasing power of gold-that is what a fall in prices was bound to have an adverse effect upon foreign debtors. Their loans had been contracted when the dollar was cheap; now they had to meet interest charges on cheap loans when the dollar was more valuable. It may safely be said that in creating a condition of gold shortage throughout the world we imposed an additional burden upon our foreign debtors of approximately 10 per cent.

means

It was impossible for foreign countries to overcome the artificial gold shortage by increasing gold production at the mines or by making new economies in the use of gold. There were, however, certain economies that could be made, and our policy compelled the central banks of foreign countries to economize in every possible way. Strange as it may seem, their principal

means of economy lay in transferring a part of their gold reserves to our own banks. To accomplish this purpose they had only to buy with their own currencies the dollar balances which were being created through the sale of foreign securities in our markets, or they could make direct shipments of gold. Once they had acquired a deposit balance with our banking institutions, they not only had something which would pay them interest, but also, in many cases, something which the laws of their respective countries allowed them to count as part of their required reserves.

It was in this way that foreign banks responded to the artificial gold shortage we created. They sent us gold, which we did not want, in order to make their reserves do double duty. We have no precise means of knowing the extent to which they practised this particular form of gold economy, or how our international account now stands as the result of these operations. However, we have an estimate of the Department of Commerce for the year 1926, which shows that foreigners had deposits and short-time investments in this country of about $2,250,000,000, and that after allowing for the unfunded items they owed us there remained a net credit to foreign account of about $1,150,000,000. There is every reason to believe that our net debt to foreigners on short-time account is far greater now than it was in 1926.

A good deal of concern has been shown about this situation. It has been suggested that at any moment we might be called upon to convert these short-time investments and deposit balances into gold for export, and that the sudden withdrawal of so vast a quantity of gold would put a serious strain on our credit structure. Whether or not the fears on this score are well founded, it is to be noted that we have

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The record of our accomplishment thus far shows that we have succeeded, temporarily at least, in negativing the doctrine of the economists — first, through tariff legislation, and then, indirectly, through the pursuance of an adroit monetary policy. In order to defeat this doctrine we chose to go directly against the tide. In so doing we not only created for ourselves serious problems which have yet to be faced, but, what is also important, we inflicted upon foreign debtors certain injuries which are already plainly visible. First of all, our high-tariff policy excluded their goods at the very time they owed us money. This operated to retard the revival of their trade and the restoration of their currencies. Then our hoarding of gold contributed to the same end, preventing the development of a situation where they could have sent goods to us in spite of the tariff. Finally, our gold-storage policy gave rise to a world shortage of gold which deflated foreign prices and made it more difficult than ever for foreign debtors to pay the interest on highprice debts out of low-price products. In the light of these considerations, is it any wonder that there is a growing gulf between the United States and foreign countries? Have we really played the game?

As for ourselves, it is difficult to see wherein we have accomplished anything of a constructive nature. In the six years since our tariff legislation the problem of getting our payments has come no nearer to being solved. It

has, in fact, been aggravated by our obstructionist tactics. We have become a great creditor nation with known foreign investments of around $14,000,000,000, on which we expect to receive interest of approximately $1,000,000,000 a year. In addition to these investments, which are held privately, we hold a great mass of European war-debt obligations on which we are receiving interest and principal payments of $200,000,000 a year.

As a creditor nation we ought to be receiving these payments in goodswe ought to be importing more than we are exporting. But we are doing exactly the opposite. We are still showing a substantial export balance 'in our favor.' Instead of taking goods in payment for the yearly obligations due us we are taking promissory notes and other pieces of paper on a large scale. During the past year we made loans and investments in foreign countries of $1,500,000,000. This means that we advanced our own money to foreigners on the strength of their promissory notes, and they gave it back to us in payment for goods and past interest accumulations!

Thus far we have fared pretty well on our holdings of foreign bonds. To all outward appearances we have been getting the interest payments on these promissory notes in the normal way. In reality, however, we have been cashing one another's interest coupons. Tom received interest on his 1926 foreign bond because Dick bought one in 1927. Both will get their interest in 1928 if Harry buys one. As time goes on, Tom, Dick, and Harry must all return to the market at intervals and cash their own interest coupons by buying new bonds, or other bond buyers must be found who will cash the interest coupons for them.

As a nation, our position is not unlike that of the merchant who on making

a sale to one of his customers takes the customer's promissory note, bearing interest. At the end of the year the customer offers another promissory note in payment for the accrued interest. He then proceeds to buy more goods for which he pays with more promissory notes, repeating the same operation year after year. The problem is: How long can the merchant continue to give credit in this manner, and how long before the customer is a bankrupt?

When confronted with this perplexing problem, we are inclined to brush it lightly aside. We have been so successful in cashing the interest coupons on foreign bonds over the past six years that we are not much concerned with philosophical speculations on the future status of debtor or creditor countries. We prefer to dismiss the whole problem by agreeing with the optimist who, falling from the roof of a forty-story skyscraper, at length passed an open window on the third floor, where he was heard to remark, ‘Everything's going all right so far.'

With the continued advance in our position as a creditor country, as now seems inevitable, the question arises as to how we are going to get the payments due us if we go on showing resistance to the importation of goods. At the rate our foreign investments have been growing and will probably continue to grow, larger and larger interest payments will be due us each year. We cannot take promissory notes in payment for an indefinite period. There is a limit also to the number of sound promissory notes that can be offered. Suppose we simplify the problem as much as possible by forgetting about such items as interest and principal payments on the war debts, on the assumption that these items may be canceled at some future date by a stroke of the pen. That helps a little.

We then have to deal with foreign obligations of about $14,000,000,000, all privately owned, which cannot be got rid of through cancellation. How are the holders of these obligations going to receive their interest in years to come?

Under a goods-exclusion policy, the holders of foreign bonds may get some of their interest payments in the form of duty-free raw materials which do not compete with our own products. They may also get payments in the form of foreign services. For example, the countries in which our tourists travel and spend their money are rendering us a service. The same is true of those countries which receive remittances from our immigrant population, which carry our ocean freight, or which insure our cargoes. The more we spend for foreign services and noncompeting raw materials, the easier it will be for the holders of foreign bonds to collect their interest.

Will these items be large enough to balance the international account and provide cash for the interest coupons? We are gambling that they will be. Who knows whether we shall win or lose in this particular gamble? Mathematically, the chances are all against us. If we put on one side of the scales the rate at which the yearly interest bill of foreign debtors is accumulating, and on the other side the greatest conceivable rate of increase in the importation of services and duty-free raw materials, there is not the remotest possibility of getting a balanced relationship. Only through an act of God,' as the lawyers say, could the scales be balanced.

VI

Having created the problem of international payments, we alone can solve it. We can approach the problem in

the spirit that we are dealing with a purely personal matter of business, affecting only ourselves; or, as befits our newly acquired status as a great creditor country, we can take the broader view that we have certain responsibilities to our debtors. What are we going to do about it?

There are at least three ways of dealing with the problem. One way is to ignore it, 'sit tight,' and 'let Europe stew in its own juice.' Under this plan we should manage our trade and monetary affairs for our own immediate advantage. Although continuing to lend freely on the outside, we should have no concern whatever for the rest of the world. Eventually we should find that the countries and foreign industries to which we had made loans and sold goods could not meet their interest charges. The principal of the loans, too, would be wiped out. The problem would then be solved.

Many of the proposals which have been put forward from time to time for credit restriction or goods exclusion could lead to no other result. As a means of balancing the international account a solution of this kind would be effective, but it is surely not the kind of solution anybody wants.

A second method of dealing with the problem would be to remove its principal cause- that is, reduce the tariff and allow a greater quantity of foreign goods to be sold in our markets.

It is beginning to seem clear to the writer that our post-war tariff legislation was a mistake. There was no emergency at the time requiring emergency treatment. We were not being flooded with foreign goods. In the psychology of the moment we let our fears get the better of our judgment. Moreover, we should have realized that it is one of the easiest things in the world to put up the tariff and one of the most difficult things to get it lowered. Once

high tariff duties have been imposed, industry promptly adjusts itself to the situation; but when the same duties are taken away, the stimulus to activity is gone, industry languishes, and men are thrown out of employment. The mere uncertainty caused by an agitation for tariff reduction has a depressing effect upon business. Who shall say that because our post-war tariff legislation was a mistake we should now rectify it and deliberately plunge business into depression, as a means of solving the problem of international payments?

The alternative plan is to leave the tariff where it is, utilize more of our gold, and take the consequences. The consequences would consist of credit expansion and inflation, which should eventually lead to a decline in our export balance. Under the influence of rising costs and prices in this country, foreign industries would revive, their goods would find new openings in our tariff wall, and our export trade would encounter fresh obstacles. Sooner or later we should have an import balance sufficiently large to provide the cash for our interest coupons. The consequences might not all be pleasant in the long run, but they would seem to be preferable to the consequences of any other plan.

There is a hopeful inference to be drawn from the events of the past year that we have already embarked, in a limited way at least, upon a programme of this kind. Beginning in July 1927, we made an astounding reversal in our monetary policy. Over the preceding period of seven years we had tried, with varying degrees of success, to hold credit expansion in check; now we proceeded to release credit on a grand scale we began to utilize for credit purposes some of the gold we had sterilized prior to 1924.

unexpected move was that we were trying to do something to assist the European situation and to facilitate the exportation of our products. The whole explanation might just as easily have been put in terms of self-interest. Self-interest demanded that we make a change. The continued inflow of gold was, or should have been, a matter of the greatest concern. It must have seemed clear that gold was becoming scarce in the world and that foreign currencies could not be restored to a sound basis so long as we continued to import gold. What should we gain if we absorbed so much of the world's gold that other countries were unable to restore their currencies to a gold basis and, in desperation, were forced to seek a new standard of value? Instead of being better off we should be worse off. We should find that our vast stock of yellow gold had become a white elephant on our hands.

It was also clear that as fast as we received foreign gold it automatically gave rise to credit expansion. The gold which had been pouring into our overflowing reservoir during the preceding three and one-half years could not be controlled. The moment it flowed over the top it went into use as a basis for credit. We must have been forced at last to recognize that, while credit expansion could not be checked, the further inflow of gold could be stopped. The only effective way of doing this was to get our interest rates down to a point where gold would no longer be attracted.

The new monetary policy quickly accomplished spectacular results. It raised the value of foreign currencies, checked the fall in world prices, and stopped the flow of gold to this country. Incidentally, it provoked a storm of opposition from those who saw in our mounting volume of credit expansion

The semiofficial explanation for this inflationary tendencies.

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