The fundamental error of the interventionists consists in the fact that they ignore the shortage of capital goods. In their eyes the depression is merely caused by a mysterious lack of the people’s propensity both to consume and to invest. While the only real problem is to produce more and to consume less in order to increase the stock of capital goods available, the interventionists want to increase both consumption and investment. They want the government to embark upon projects which are unprofitable precisely because the factors of production needed for their execution must be withdrawn from other lines of employment in which they would fulfill wants the satisfaction of which the consumers consider more urgent. They do not realize that such public works must considerably intensify the real evil, the shortage of capital goods.
One could, of course, think of another mode for the employment of the savings the government makes in the boom period. The treasury could invest its surplus in buying large stocks of all those materials which it will later, when the depression comes, need for the execution of the public works planned and of the consumers’ goods which those occupied in these public works will ask for. But if the authorities were to act in this way, they would considerably intensify the boom, accelerate the outbreak of the crisis, and make its consequences more serious.8
All this talk about contracyclical government activities aims at one goal only, namely, to divert the public’s attention from cognizance of the real cause of the cyclical fluctuations of business. All governments are firmly committed to the policy of low interest rates, credit expansion, and inflation. When the unavoidable aftermath of these short-term policies appears, they know only of one remedy—to go on in inflationary ventures.
6. Foreign Exchange Control and Bilateral Exchange Agreements
If a government fixes the parity of its domestic credit or fiat money against gold or foreign exchange at a higher point than the market— that is, if it fixes maximum prices for gold and foreign exchange below the potential market price—the effects appear which Gresham’s Law describes. A state of affairs results which—very inadequately— is called a scarcity of foreign exchange.
It is the characteristic mark of an economic good that the supply available is not so plentiful as to make any intended utilization of it possible. An object that is not in short supply is not an economic good; no prices are asked for it or paid for it. As money must necessarily be an economic good, the notion of a money that would not be scarce is absurd. What those governments who complain about a scarcity of foreign exchange have in mind is, however, something different. It is the unavoidable outcome of their policy of price fixing. It means that at the price arbitrarily fixed by the government demand exceeds supply. If the government, having by means of inflation reduced the purchasing power of the domestic monetary unit against gold, foreign exchange, and commodities and services, abstains from any attempt at controlling foreign exchange rates, there cannot be any question of a scarcity in the sense in which the government uses this term. He who is ready to pay the market price would be in a position to buy as much foreign exchange as he wants.
But the government is resolved not to tolerate any rise in foreign exchange rates (in terms of the inflated domestic currency). Relying upon its magistrates and constables, it prohibits any dealings in foreign exchange on terms different from the ordained maximum price.
As the government and its satellites see it, the rise in foreign exchange rates was caused by an unfavorable balance of payments and by the purchases of speculators. In order to remove the evil, the government resorts to measures restricting the demand for foreign exchange. Only those people should henceforth have the right to buy foreign exchange who need it for transactions of which the government approves. Commodities the importation of which is superfluous in the opinion of the government should no longer be imported. Payment of interest and principal on debts due to foreigners is prohibited. Citizens must no longer travel abroad. The government does not realize that such measures can never “improve” the balance of payments. If imports drop, exports drop concomitantly. The citizens who are prevented from buying foreign goods, from paying back foreign debts, and from traveling abroad, will not keep the amount of domestic money thus left to them in their cash holdings. They will increase their buying either of consumers’ or of producers’ goods and thus bring about a further tendency for domestic prices to rise. But the more prices rise, the more will exports be checked.
Now the government goes a step further. It nationalizes foreign exchange transactions. Every citizen who acquires—through exporting, for example—an amount of foreign exchange, is bound to sell it at the official rate to the office of foreign exchange control. If this provision, which is tantamount to an export duty, were to be effectively enforced, export trade would shrink greatly or cease altogether. The government certainly does not like this result. But neither does it want to admit that its interference has utterly failed to achieve the ends sought and has produced a state of affairs which is, from the government’s own point of view, much worse even than the previous state of affairs. So the government resorts to a makeshift. It subsidizes the export trade to such an extent that the losses which its policy inflicts upon the exporters are compensated.
On the other hand, the government bureau of foreign exchange control, stubbornly clinging to the fiction that foreign exchange rates have not “really” risen and that the official rate is an effective rate, sells foreign exchange to importers at this official rate. If this policy were to be really followed, it would be equivalent to paying bonuses to the merchants concerned. They would reap windfall profits in selling the imported commodity on the domestic market. Thus the authority resorts to further makeshifts. It either raises import duties or levies special taxes on the importers or burdens their purchases of foreign exchange in some other way.
Then, of course, foreign exchange control works. But it works only because it virtually acknowledges the market rate of foreign exchange. The exporter gets for his proceeds in foreign exchange the official rate plus the subsidy, which together equal the market rate. The importer pays for foreign exchange the official rate plus a special premium, tax, or duty, which together equal the market rate. The only people who are too dull to grasp what is really going on and let themselves be fooled by the bureaucratic terminology, are the authors of books and articles on new methods of monetary management and on new monetary experience.
The monopolization of buying and selling of foreign exchange by the government vests the control of foreign trade in the authorities. It does not affect the determination of foreign exchange rates. It does not matter whether or not the government makes it illegal for the press to publish the real and effective rates of foreign exchange. As far as foreign trade is still carried on, only these real and effective rates are in force.
In order to conceal better the true state of affairs, governments are intent upon eliminating all reference to the real foreign exchange rate. Foreign trade, they think, should no longer be transacted by the intermediary of money. It should be barter. They enter into barter and clearing agreements with foreign governments. Each of the two contracting countries should sell to the other country a quantity of goods and services and receive in exchange a quantity of other goods and services. In the text of these treaties any reference to the real market rates of foreign exchange is carefully avoided. However, both parties calculate their sales and their purchases in terms of the world market prices expressed in gold. These clearing and barter agreements substitute bilateral trade between two countries for the triangular or multilateral trade of the liberal age. But they in no way affect the fact that a country’s national currency has lost a part of its purchasing power against gold, foreign exchange, and commodities.
As a policy of foreign trade nationalization, foreign exchange control is a step on the way toward a substitution of socialism for the market economy. From any other point of view it is abortive. It can certainly neither in the short run nor in the long run affec
t the determination of the rate of foreign exchange.
Remarks About the Nazi Barter Agreements
The barter and clearing agreements which the Nazi Government of the Reich concluded with various foreign countries have been misinterpreted by the vast literature on the subject. As these misinterpretations are the basis of many current errors concerning monetary problems, it seems expedient to devote a few remarks to them.
The considerations which motivated foreign governments to enter into such agreements with the Reich were not uniform. Neither were the political and economic consequences of these agreements homogeneous. We may deal with the problems involved by discussing first the case of the agreement with Switzerland and then those with the countries of the European southeast.
The Swiss banks had, before Hitler seized power, lent comparatively enormous sums to German business. Moreover, one of Switzerland’s main industries, tourism, depended to a great extent on German patrons. The German foreign exchange control laws gave the German authorities the power to prohibit all payments to Swiss banks and to prevent Germans from visiting the country. The clearing agreement was the only means for the Swiss to salvage at least a part of their German assets and to induce the Reich to permit a limited number of Germans to spend a holiday in the Swiss hotels.
The case of the Balkan agreements is even more interesting as their meaning was still more distorted by misinterpretation.
Let us look at an example. The Reich and one of the southeastern countries of Europe—we may call it Balkania—concluded an agreement concerning the mutual exchange of commodities, which could be bought or sold on the world market for 20 million dollars. Balkania had to give a world-market value of 10 million dollars in food and raw materials, Germany had to give a world-market value of 10 million dollars in manufactured goods. The peculiar feature of the bargain was that these commodities bought and sold were in the terms of the contract not valued according to their world-market price, but at a higher rate, let us say 10 per cent above the prices of the world market. For the goods Germany had to buy, Balkania was charged 11 million instead of 10, but on the other hand Balkania was credited for the goods it sold with 11 million instead of 10. This overvaluation was totally, or at least to a great extent, concealed in the rate of exchange between the Reichsmark and the balkan, the monetary unit of Balkania’s currency system, which the barter agreement fixed at a level different from the actual rate of exchange.
Let us assume that the dollar was actually worth 10 balkans on the world market. By virtue of the barter agreement, Balkania sold to Germany food and raw materials for which English businessmen offered too million balkans, for 110 million, and bought manufactured goods which she could buy from English or American exporters for 100 million balkans, for 110 million.
In order to understand the meaning of this strange procedure, we have to realize that the loss and the gain from these overvaluations compensated each other only for the whole nations, but not for the individual citizens. For socialist Germany, where under Hitler all business was nationalized, this made no difference at all. But in Balkania domestic production and domestic trade were still based on private ownership; only the foreign trade of Balkania was controlled by the government. There it was of great consequence that those burdened by the overvaluation of the imported goods and those favored by the overvaluation of the exported goods were not the same people. The terms of the barter agreement resulted, therefore, in a shift of income from some goups of citizens (of course, the black sheep of the government) to other groups of citizens (of course, the government’s pet children). The government of Balkania distributed the boon of the transaction in this way:
Higher prices paid to the producers of the exported food and raw materials
5 million
Gains (legal and illegal) of the government agency entrusted with the execution of the barter agreement and of the “friends” of the government managing it
1 million
Gains retained by the treasury
5 million
The losses of the transaction, on the other hand, were distributed in this way:
Higher prices of imported commodities paid by those who were favored by the higher prices of the exported goods
1 million
Higher prices of imported goods paid by other citizens
5 million
Higher prices of imported goods paid by the government (e.g., for arms, railroad equipment, etc.)
4 million
It is obvious that the friends of the government and the peasants producing food and raw materials realized gains of 5 million, whereas the nonagricultural sections of the population were burdened with 5 million additional expenditure. Such an effect was in line with Balkania’s whole economic policy; like many other contemporary governments, the rulers of Balkania made every effort to favor the agricultural section of the population at the expense of the nonagricultural section.
The political consequences of these agreements were twofold: Balkania’s government became dependent on the Reich, but its power at home increased. The government now disposed of a fund which could be used for the benefit of its friends, who were on the payroll of the company or government agency entrusted with the execution of the barter agreement. Moreover, the government had the power to discriminate against those groups of the peasantry who did not support the government or who were members of a linguistic or religious minority. The products which had to be exported to Germany were purchased only from the sympathetic producers. The nonsympathisers were barred from the enjoyment of the benefits of the treaty; they had to sell their entire crop at the lower prices corresponding to the world market prices. In Yugoslavia, for instance, the Catholic Croat peasants complained that the government purchased only from Serbs. It is impossible to discover whether this complaint was really well founded; in any case, the Croats did not blame the Nazis, they blamed the Yugoslavian government.
The barter agreements gave Germany a kind of monopoly of the trade with the countries of southeastern Europe which could not fail to link these countries politically with the Reich. From the Nazi point of view, this practice meant a skillful use of the domestic economic antagonisms within these countries for the achievement of their own political ends. To the governments of the Balkan states, these barter agreements offered an opportunity of initiating a policy favoring the farming class at the expense of the nonagricultural classes. What the industrial countries of Western and Central Europe achieved by tariffs and other measures discriminating against the products of foreign agriculture and what the United States achieved by some of the agricultural measures of the New Deal, was in Rumania, Hungary, Bulgaria, and Yugoslavia achieved by the barter treaties with Germany.
Faced with the problem of this German economic offensive in the Balkans, Great Britain was helpless. It had to withdraw from markets where it could buy only at prices higher than those in other countries. Consequently, the governments of the Balkan countries concerned declared that there were no pounds available for the payment of imports from Great Britain and refused to grant import licenses. Commerce between Great Britain and these countries was severely restricted.
The same was no less true with regard to all other countries of Western Europe and of America.
Such was the true nature of these much talked about clearing agreements which were hailed by many authors as the dawn of a new age of monetary management.
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1. See above, pp. 408–410.
2. See above, p. 458.
3. See below, section 6 of this chapter.
4. Cf. P. A. Samuelson, “Lord Keynes and the General Theory,” Econometric a, 14 (194Ó), 187; reprinted in The New Economics, ed. S. E. Harris (New York, 1947), p. 145.
5. If a bank docs not expand circulation credit by issuing additional fiduciary media (either in the form of banknotes or in the form of deposit currency), it cannot generate a boom even if it lowers the amount of interest charged below t
he rate of the unhampered market. It merely makes a gift to the debtors. The inference to be drawn from the monetary cycle theory by those who want to prevent the recurrence of booms and of the subsequent depressions is not that the banks should not lower the rate of interest, but that they should abstain from credit expansion. Professor Haberler (Prosperity and Depression, pp. 65–66) has completely failed to grasp this primary point, and thus his critical remarks are vain.
6. Cf. Machlup, The Stock Market, Credit and Capital Formation, pp. 256–201.
7. Cf. League of Nations, Economic Stability in the Post-War World, Report of the Delegation on Economic Depressions, Pt. II (Geneva, 1945), p. 173.
8. In dealing with the contracyclical policies the interventionists always refer to the alleged success of these policies in Sweden. It is true that public capital expenditure in Sweden was actually doubled between 1932 and 1939. But this was not the cause, but an effect, of Sweden’s prosperity in the ‘thirties. This prosperity was entirely due to the rearmament of Germany. This Nazi policy increased the German demand for Swedish products on the one hand and restricted, on the other hand, German competition on the world market for those products which Sweden could supply. Thus Swedish exports increased from 1932 to 1938 (in thousands of tons) : iron ore from 2,219 to 12485; pig iron from 31,047 to 92,980; ferro-alloys from 15,453 to 28,605; other kinds of iron and steel from 134,237 to 256,146; machinery from 46,230 to 70,605. The number of unemployed applying for relief was 114,000 in 1932 and 165,000 in 1933. It dropped, as soon as German rearmament came into full swing, to 115,000 in 1934, to 62,000 in 1935, and was 16,000 in 1938. The author of this “miracle” was not Keynes, but Hitler.
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