MONEY as a useful tool of civilization has been known for more than a score of centuries, but only during the last four centuries of more rapid economic expansion has its utilization demanded a marked development of technical skill and a refinement of theory. This modern period was ushered in with an intensified demand in Europe for gold and silver which was the result of an evident undersupply and which was sated by the voyages of discovery and the American mines. The precious metals poured into Europe through Spain, and as the flood swelled prices mounted until, from the middle of the sixteenth century to the middle of the seventeenth, there occurred a price revolution greater in volume and in its economic, social and political effects than any other which history records. Contemporary observers, casting about for the cause of the violent and general rise of prices, first discovered and roughly stated what came to be known as the quantity theory of money. They recognized from experience that prices tend to vary directly with the quantity of money in circulation. As gold and silver became more abundant and relatively less valuable, more coins of standard weight (i.e., higher prices) had to be paid in exchange for practically all other commodities -- most of all for food products.

The sixteenth century had also suffered severely from the continuation of the long mediæval evils of clipped, debased and multitudinous coinages. This developed another contemporary generalization, known as Gresham's law, that bad money drives out good. Equipped with this new insight the stronger governments answered the call from the growing commercial community for a stricter regulation of the standards of national money.

Meanwhile, the older money-exchangers and goldsmiths, becoming bankers, had been experimenting with credit instruments, their private notes, and, in the eighteenth century, state banks and state administrations seized upon the new device. The old problem, as to whether money gets its value from the stamp of the state, or from the commercial estimation of the commodity stamped, received a partial answer from the disastrous results of John Law's paper money early in the eighteenth century, from the American issues culminating in the Continental currency which financed the Revolutionary War, and from the ultimately even more worthless assignats of the French Revolution. Money in the form of banknotes or government notes was found feasible but dangerous -- a valuable but keen-edged tool requiring sobriety and expertness in handling. The paper promise to pay must be redeemable in a precious metal -- a solid commodity.

The nineteenth century set itself to work out the technique required to safeguard this new acquisition. The difficulties of adjustment between the fluctuating relative values of gold and silver led, before the end of the century, to a widespread adoption of the most esteemed metal, gold, as the single standard, with silver and other metals restricted by the rules of a subsidiary coinage. The issue of paper money was gradually confined, under rigid regulations as to amount and reserves, to the governments alone or to central banks. The banks, deprived of the privilege of note issue, found another ample opportunity for expansion in the use of deposits and checks. This new circulating medium, more flexibly responsive to the demands of business, found also an ultimate limit in the gold supply, for experience taught that its security was proportionate to the soundness of a banking policy which rested upon gold reserves. International trade and credit, expertly manipulated, involved settlements by transactions in goods and their paper representations, with a relatively small flow of gold on balance between countries. London as the world's central financial clearing-house, with a money market furnished with private gold supplies, controlled by the Bank of England's discount rate, had become so adept that the operations of international exchange seemed almost automatic. The immense world superstructure of government notes, banknotes, checks, and international commercial obligations was safely borne by a stock of gold, which, when twice it seemed to be failing, was replenished by the huge additions of the nineteenth century to the world's gold supply.

So interlocked were the chief national economic systems by international trade, and so delicately adjusted was the whole mechanism of monetary and credit exchanges, that Bloch, an eminent French economist, wrote a book to prove that a great European war was not only unthinkable but financially impossible. All the contestants would be ruined by the mere breaking of the wires which electrically controlled the world mechanism of business. A shrewd observer in 1913 (especially if he had access to the diplomatic reports) must have foreseen the war, though he would have been unable to guess its duration and vast extent. But he would have been regarded as a madman had he prophesied that within ten years, as a result of war, such a country as Germany -- industrially strong, financially secure, and soundly trained in all that monetary and banking experience could teach -- would lie prostrate, its money practically worthless and its prices soaring to astronomical quotations. Yet monetary ruin was unprecedentedly complete not only in Germany but throughout Central and Eastern Europe; and all the so-called civilized countries, victors as well as vanquished, neutrals as well as contestants, strong nations and weak, suffered in varying degrees from depreciated money and inflated prices.

For the rehabilitation of all those afflicted countries, monetary and fiscal reform was obviously the essential and prime concern of the immediate post-war years. Payments in gold had been generally suspended and gold exports had been embargoed. The state's stamp on paper, without the security of prompt gold redemption, had again been proved inadequate. It was inevitable, therefore, that as rapidly as economic recovery made it possible, all the countries of the world should seek to under-pin their currencies with a gold basis, if not at the pre-war rate of exchange then often at a new ratio, and if not on a straight gold standard then, with the blessing of the Genoa Conference, on a gold-exchange standard which replaced a gold reserve, in considerable part, by purchases of foreign exchange held on deposit account in gold centers. So far has the universal swing to gold progressed that now, even for China, immemorially on a silver basis, Mr. Kemmerer, the specialist in countries with sick monetary systems, has prescribed a gold-exchange standard. At the time of the Genoa Conference, it was supposed that the adoption of the gold-exchange standard would insure economy in the use of gold and a large measure of stability. As a temporary measure this device was clearly necessary, but it is beginning to be doubtful whether it can be regarded as a permanent solution, at any rate without additional restrictions and safeguards. The large exchange reserves held in London under the control of European central banks are often greater than the free gold at the disposal of the Bank of England. They are a menace as long as they may be withdrawn without regard to large international financial considerations. It is also becoming clear that this type of reserve does not preclude the building up of great actual gold reserves. The most notable case in point is the Bank of France, which has increased its gold holdings to nearly 2,000 million dollars, so that now, with the United States' gold stock of nearly 4,200 million dollars, fed by the extraordinary war and post-war flow, the two countries together hold about 60 percent of the world's monetary gold. But the post-war flow to the United States has been to a country on a free gold basis, while that to France, under gold-exchange regulations, has shown a rate of increase, compared with 1914, about equal to that of the United States.

Another factor affecting the monetary demand for gold is the disappearance, since the war, of gold from circulation. It is believed that in 1913 nearly 45 percent of the total gold monetary stock, exclusive of gold hoarded in India and China, was in general circulation or in commercial use, whereas in 1928 it is estimated that only about 8 percent remained outside the holdings of the central banks. This would seem to indicate an economy of almost 3,000 million dollars in one use of gold and an equivalent increase in the quantity available for central-bank reserves, with a corresponding enhancement of the influence and responsibility of the central banks. But the disappearance of free gold from the open market has removed a buffer which formerly shielded the central-bank reserve and has made the central banks more sensitive to the fluctuations of the world market and the operations of other central banks. This more exposed position, however, may be conducive to that growing coöperation between the central banks which has been marked by the recent practice of personal conferences between their heads and by their organized collaboration in the Bank of International Settlements.

Although it is difficult to evaluate the full effects of these factors of possible economy in the utilization of the world's monetary gold stocks, the facts both as to the central-bank reserves of gold and of foreign exchange and as to the withdrawal of gold from general circulation into the coffers of the central banks are measureable with a considerable degree of accuracy. Also fairly reliable seem to be the current figures of the new gold annually produced, of the long continuing but fluctuating absorption of gold by India, and of the bank-note issues of almost all countries. But other elements essential to the understanding of the monetary problem -- such as the amount of gold annually used in industry and the arts, the rate of growth of the total world stock of gold, the variations in the quantity of deposit checks and other credit instruments, and the velocity of all the forms of monetary circulation -- are measured only by estimates, some of which are exceedingly crude even for recent years and become even more undependable the further back into pre-war decades any comparison is pushed.

Last September appeared the most recent and also the most authoritative summary of the facts, estimates and forecasts concerning a number of the fundamental factors. This is the Interim Report of the Gold Delegation of the Financial Committee of the League of Nations and its annexes, particularly the critical review of the supply and demand statistics for gold prepared by Mr. Loveday, the head of the League's Economic Intelligence Service. According to this report, India's absorption of gold, after exceptionally heavy imports about 1924 to meet the depletion of the war years, has been at the annual rate of 87 million dollars during the five year period 1925-1929, whereas during 1909-13 it was 102 million dollars per annum. Banking and investment habits are doubtless slowly growing in India, but with the recent decline in the price of silver and the small likelihood of any rapid change in the hoarding proclivities of the vast mass of India's agricultural population, the conclusion of the report seems justified, namely that it would not be safe "to anticipate any material reduction in the Indian demand for many years to come." The statistics concerning the industrial demand are defective, since some countries do not report at all, others report only the amount of new gold used by industry or the total amount of new and old gold without distinguishing the source of the old gold. Mr. Loveday estimates the present net industrial world consumption of gold at about 100 million dollars per annum. The present total production of gold is about 400 million dollars per annum. The report estimates the total demand for non-monetary purposes, including the industrial uses and the demand of India, China and certain other Oriental countries, at from 180 to 200 million dollars per annum. In its final estimate of the future monetary situation, the report conservatively starts with the lower of these two figures, namely 180 million dollars, and assumes that the future non-monetary demand will increase at the rate of 1 percent per annum. At the present time the deduction for non-monetary uses leaves a little more than half of the new gold annually mined, or something a little over 200 million dollars, available for monetary purposes.

In order to determine the monetary demand for gold, an inquiry was made covering nearly all the gold-using countries, and data were collected concerning note issues and sight liabilities together with actual gold held in reserve. Allowing for a margin of cover of 7 to 10 percent over the average legal reserve requirements, as interpreted in practice, of about 32 percent, or a round total reserve of 40 percent, the investigators found that the present total monetary gold stock only just suffices to meet the current monetary needs. If the growth of production and trade is to continue for the half century to come at anything like the same rate as for the last fifty years, demanding a corresponding increase in the aggregate of the circulating medium and the gold basis upon which it rests, then it is estimated that an annual average addition of 2 to 3 percent is required to the world's monetary gold stock in order to maintain stable prices.

The anxiety now spreading in regard to the gold problem arises from the fact or the well-founded fear that the present gold mines of the world are, or very soon will be, unable to meet this demand. Competent experts looking a decade ahead estimate the prospects of gold production from the Rand mines of South Africa, from Canada and from the United States -- the leading gold-producing regions -- as somewhat better than those furnished by responsible government officials. But even the most optimistic among the trustworthy authorities on this subject predict an imminent gold shortage. If, as a result of this shortage, prices of commodities other than gold decline far enough and long enough, gold mining will ultimately receive a stimulus. Known marginal deposits will be brought into production and the search for new mines will be prosecuted with intense vigor. Twice during the nineteenth century a long price decline has been arrested and turned to an upward movement by phenomenal gold discoveries, once at the mid-century by the finding and rapid working of great alluvial gold deposits in California and Australia, and again in the last decade of the century when the application of new technical processes to the deep reef mines of South Africa produced an unexampled gold output. After the gold rushes of the 'fifties had run their course, W. Stanley Jevons in 1863 prophesied that "centuries will probably pass without such another run of luck," although he qualified this bold assertion in a later passage by admitting that "by a very lucky chance or by a skilful and expensive search" gold might some day be found in deep "leads" or quartz reefs. Since he wrote, the great Rand workings have justified his admission, but "skilful and expensive" searches over almost all the possible gold formations on the earth's surface have as yet revealed no second Rand. The mining experts have no illusions on this score. Another such great discovery, they say, is barely possible but not likely, and such smaller increase of gold supply as may be stimulated by a considerable fall in the price level will prove insufficient if the world's gold requirement maintains its present height and recent rate of growth.

It is precisely, however, the fear of such a price decline which gives point and poignancy to the prevailing discussion of the gold problem -- a fear strongly accentuated by the recent sharp decline in prices. Observation has shown a definite and close relationship between the supply of gold and those long upward and downward movements of the price-level which are named "secular trends." Complex and variable forces operate constantly in and upon the price structure, but, other than the gold supply, no factor or set of factors influencing widely the system of commodity prices or of price groups has been found adequate to explain the fact that these long-time fluctuations have coincided with marked changes in the growth of the stock of gold which provides the critical reserve for the mass of credit transactions. It was common during the 'fifties and' sixties to explain the steady rise of prices by the extension of trade and manufactures, increasing the demand for commodities, yet it was equally common, when the long price decline set in (from 1865 in the United States and 1873 in England) to interpret the extension of trade and manufacture as increasing the supply of commodities. But when after 1895 the long downward swing gave way again to the upward trend of prices persisting to 1920, this double-faced explanation clearly was worn too thin. There were no sudden changes in the business of making, moving and selling commodities during these periods which were sufficient to account for the long price-movements in opposite directions.

Although it is fairly evident that changes in the gold supply predominantly mould the secular trends of prices, it is by no means so clear that to this factor should be ascribed a major influence upon the shorter price fluctuations which accompany business cycles. The slope of the long swing modifies in some degree the character of the shorter oscillations along its course. The studies of Mitchell and Thorp, for instance, have shown that during the declining secular trends, both in England and the United States, the duration of the depression phase of the business cycles is relatively long, while during the long upward trends the prosperity phase of the business cycles is longer and more pronounced. But an examination of price history shows no such close correspondence between business cycles and gold production as that which is in evidence between the secular trends of gold production and the secular trends of prices, as measured by the index numbers for wholesale prices stretching back in England and the United States for a century and a half. Business cycles seem to be fluctuations of a related but distinct species, operated by a complex of forces differently constituted from that which in the secular trend of prices places the gold output in a dominant position. So different, indeed, are these two species of fluctuation that it is very doubtful whether any stabilization of gold supply or control of the circulating medium could do more than to alleviate in some measure the sharpness and shorten the depression phase of business cycles. Monetary stabilization, however fundamentally desirable, is not a panacea for every ill. It is important at the present time to emphasize the difference in causation between the long, secular price movements and the shorter fluctuations. It seems probable that a long downward movement is beginning, but the recent severe depression in business is due primarily to other causes than a shortage in gold.

The business-cycle depression, apt to be sharply subversive and cataclysmic, is much in the foreground; indeed all the phases of the shorter fluctuations, seasonal and cyclical, always conceal the secular trend which Jevons described as "insidious, slow and imperceptible." It has been a matter of debate among economists whether, in the balance of advantages and disadvantages, the upward secular trend was to be preferred to the downward movement. Marshall thought that on the whole the upward trend was the better because it is marked by more resiliency and more incentive to enterprise. It is at least open to question, and deserving of much fuller investigation than has as yet been given, whether or not the sagging pressure of gradually falling prices, long and cumulatively applied, intensifies competitive effort, stimulates both "process and product invention" (to use Henry Dennison's phrase), compels fundamental reorganizations and readjustments both economic.and social, to the ultimate though painful good of mankind. The school of adversity, however, whatever its compulsory benefits, is dangerously experimental, and never willingly entered. The memory of the dismal 'forties and of the agitated 'nineties, the final terms of the previous two long price declines, is not inviting. But it should also be remembered that during those periods from 1815 to 1850, and from 1870 to 1895, two high plateaus of progress, in the 'thirties and 'eighties, jut out from the declivity of prices. The thrust of population over enormous areas, the expansion of the industrial revolution into new regions, huge strides in means of transportation -- all these took place during these downward trends, accompanied by the development of new techniques of business enterprise. Those who had relatively fixed incomes steadily benefited, while those with variable incomes learned the necessary adjustments, such as increased speed in operation or the organization of larger productive and protective units, both of labor and capital, of consumers and producers.

The present depression phase of the current business cycle will give place to the succeeding phases of revival and prosperity, and meanwhile the longer price trend, "insidious and slow," will not be "imperceptible," for it will not escape the more refined methods of statistical observation which this generation possesses. We shall soon know with certainty whether a world gold shortage is impending, but we shall not know what to do about it. With its historical tradition and its affective attributes, gold does not seem likely in any near future to be displaced as the basis of monetary values, though ways and means can be found for greater economy in its use, by such devices as a greater world-wide functioning of credit instruments based on smaller reserves, or by a systematic development of central bank clearings. For the operation of such palliatives, close international coöperation will be essential. Research also, intensive and prolonged, requiring large resources and the collaboration of many minds, will be needed. As the Bank of International Settlements succeeds in bringing the central banks into effective concert -- a coöperation from which the United States must find it impracticable to stand aloof -- and as national distrusts and prejudices are allayed, an atmosphere will be created in which alone the gold problem can be adequately studied, with any hope of finding and applying those measures which may tend to stabilize the monetary factor in the secular trend of prices.

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  • EDWIN F. GAY, Professor of Economic History, Harvard University; former President of the American Economic Association; member of the War Trade Board 1918-1919
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