Paper token money was re-invented in Europe in the 17th century when goldsmiths began issuing receipts to those who had deposited gold with them. These receipts came to be accepted as a means of payment because people knew that they could convert them into gold at any time. This is one of the origins of the modern banking system. At one time any bank could issue its own notes, but later this became, in most countries, a government monopoly—in Britain through the semi-official Bank of England.
The first paper notes were "as good as gold" in the sense that they were convertible on demand into a fixed amount of gold laid down by law. For nearly one hundred years from the end of the Napoleonic Wars to the outbreak of the First World War notes in England were fully convertible into gold at a rate of about ¼ oz per £. During this period the "I promise to pay the bearer on demand the sum of five pounds" (there were no £1 notes then) meant that the Bank of England would give you about 1¼ oz of gold for the note. Now you will only get another note.
With convertibility, the management of a paper currency is relatively easy, since the number of notes in circulation is regulated by the economy as its demand for money rises and falls.
Convertibility of paper notes into a fixed amount of gold was suspended in Britain during the First World War, resumed in 1925 and abandoned in 1931. Currency today in all countries is inconvertible paper (token) money (topped up by metallic coins). The problems of managing an inconvertible paper currency are immensely greater than those of managing a convertible paper currency since it is the monetary authority itself which now has to gauge how much money the economy needs. The amount is no longer more or less automatically regulated by the economy itself, but is determined by the government through its monetary authority. It is not impossible to get the amount approximately right from studying economic trends (level of economic activity, growth of population); it was done in the Weimar Republic after the terrible runaway inflation immediately after the First World War as well as in Britain after 1920. But governments with a monopoly in the issue of inconvertible paper currency face the same temptations as the rulers in the past who issued debased coins: printing money can serve as an easy source of finance. Indeed, convertibility was suspended during the First World War (as it had also been during the Napoleonic Wars) precisely in order to finance the war.
The effect of over-issuing inconvertible paper notes is exactly the same as debasing gold or silver coins: a rise in the general price level. This inflation is in fact the modern equivalent of debasement. It is the depreciation of an inconvertible paper money just as debasement is a depreciation of coined real money.
The word "over-issue" of course implies that there is a "correct" amount of an inconvertible paper currency to misuse. This "correct" amount is that whose face-value equals that of the gold which would be in circulation were it the currency, the amount (total weight) of gold that the economy requires as determined by the formula we discussed last month (no. of transactions x total prices, divided by the velocity of circulation of money).
Suppose that, with inconvertibility, "pound" continues to be defined as ¼ oz of gold and suppose that the amount of money required by the economy, measured in weights of gold, is 100m. oz. To be correct — not to be over-issued — the face-value of the inconvertible currency must total £400m. This is the only amount which will maintain the definition of one pound = ¼ oz of gold.
Inflation as a policy
If the government issues, say, notes with a face-value of £800m, or 100 per cent more than the economy requires, what will happen? The economy still needs the same amount of money, measured in terms of the weight of the money-commodity, as before — 100m oz. of gold. The issue of a paper currency with a total face-value above this figure — and £800m would be the nominal face-value of 200m oz of gold — will not alter this. What will is the real, as opposed to the legal amount of gold designated by the word "pound". £800m, instead of representing 200m oz of gold, will become, in economic practice, the equivalent of 100m oz. "Pound" will change from being the name of ¼ oz of gold to be the name of 1/8 oz (100/800).
The standard of price will have effectively been changed so that, as with a debased coinage, all prices will rise — in this case by 100 per cent, the same proportion as the over-issue of the currency. Once again, this rise won't take place all at once but will gradually work its way through the economy till the general price level has risen by 100 per cent.
The over-issue of an inconvertible paper currency, or inflation, always results in an increase in the general level of prices. This has been confirmed so many times that it can be regarded as an established law of monetary economics.
Over-issuing an inconvertible paper currency has been the cause of the continuous rise in the general price level since the last World War. Governments everywhere have resorted to inflationary currency policies because this is an easy way of raising money to finance their spending — and of course government spending has grown immensely this century. But there is a difference compared with past inflations. In the past when governments inflated the currency they knew exactly what they were doing and what the result would be. Thus the government during the First World War knew full well that the result would eventually be a rise in prices. But today governments seem no longer to realise that there is this direct causal link.
The economics of inconvertible paper currencies has been forgotten under the influence of economic thinkers who proclaimed that they had devised new and better theories. The man mainly responsible for confusing the question here is John Maynard Keynes (1883-1946). Keynes, who was already a leading British economist in the 1920s was at one time aware of the consequences of currency over-issue, but that was before he developed his "general theory of employment, interest and money", the title of his major work published in 1936.
In this work Keynes argued that, in order to ensure full employment, governments should concentrate on trying to control the economy by appropriate tax and spending policies. He relegated monetary policy to a secondary role, saying that it should be framed to fit in with the government's tax and spending policies. Governments interpreted this as meaning that they could safely issue whatever amount of money they needed to carry out their policies, without having to worry about whether or not this might be more than the economy needed. Predictably, they over-issued the currency and the general price level rose.
The first Keynesian budget was that of 1940, when inflation was once again deliberately adopted as a way of financing the war. This policy was continued after the war to finance other government spending, including that on social reform measures (education, health service, social security benefits). While the post-war boom lasted it seemed to some that Keynesian policies had at least achieved the aim of full employment, if not that of a stable price level, and Keynes' view that a certain amount of inflation encouraged investment came to be generally accepted. This myth has now been exploded, as recent years have seen growing inflation accompanied by growing unemployment. As a result Keynes is now almost completely discredited (though he still has a few supporters left in Labour Party and TUC circles). Keynesian economics is now being replaced by a new school known as the "Monetarists" (because they reject Keynes' teaching that monetary policy doesn't matter) who at least realise the connection between an increase in the "money supply" (however defined) and an increase in the general level of prices.
Printing £ notes!
When it is said that government spending is financed by recourse to the printing press, this should not be taken to mean that the government simply prints more paper notes and uses them directly to pay, for instance, its suppliers or civil service salaries. This does indeed happen in some countries but in Britain the method is not so crude as this. What essentially happens is that the government always makes available enough credit for the banking system (commercial banks, discount houses) to be able to lend it whatever it wants. The process works something like this: (i) the government, through the Bank of England, sells bonds to the Big Four Banks (Barclays, Lloyds, Midlands, National Westminster); (ii) to get money to pay for these bonds the banks call in some of the short-term loans they have made to the discount houses; (iii) the discount houses go to the Bank of England which, as the lender of last resort, lends them what they need, at a price — what used to be called the bank rate. The resulting increase in credit in the banking system means, sooner or later, an increased demand for currency (notes and coins). This the Bank of England, as the note-issuing authority, passively makes available by a simple transfer from its Issue Department to its Banking Department. As and when necessary the former arranges for more notes to be printed. So lax is control over the issue of notes these days that Parliament is told afterwards by a mere Treasury Minute which passes automatically unless challenged.
The politician in Britain who comes closest to a real understanding of inflation is Enoch Powell. But there is one thing lacking in his analysis: a concept of what would be the "correct" amount of convertible currency to issue to maintain price stability, or, what is the same thing from another angle, its purchasing power. Powell lacks this concept because it can only be explained on the basis of Marx's Labour Theory of Value (1) and the last thing that Powell is (or wants to be) is a Marxist!
Inflation can be understood only after the acceptance that money is itself a commodity, a product of labour produced for sale, having its own value determined in the same way as that of other commodities (by the amount of socially necessary labour incorporated in it). Despite the surface appearance, gold is still the money-commodity, both internally and for external trade. It has been replaced as the circulating medium by tokens, the metallic coins and coloured paper notes we use in everyday transactions, but is still the ultimate standard of price.
It is still gold that determines whether or not a currency has been over-issued. The various paper currencies of the world are still defined, in economic reality, as weights of gold, even though most of them are no longer legally so. This economic definition of currencies in terms of weights of gold is continually changing; their "gold content" is being continually reduced as a result of inflation.
Although it follows from the Marxian analysis of inflation that the continual rise in the general price level could be stopped by strictly limiting the issue of paper money, it is not the business of socialists to tell the capitalist class how to run their economy. We must not be understood as advocates of a non-inflationary monetary policy since we are against capitalism with or without inflation. An end to inflation would not leave workers much better off; their struggle to defend wages and conditions would still have to continue whatever the currency policy of the government.
We are for a system of society in which inflation could not arise as there would be no money. On the basis of the common ownership of the means of wealth production and their democratic control by the whole people, wealth can be produced in abundance to satisfy people's needs. In socialism every man, woman and child will have free access to the abundant store of wealth set aside for individual consumption. There will be no need for money. Further, being based on common ownership, there will be no private property and so no basis for the exchange of goods out of which money evolved. A moneyless society, then, is our answer to inflation.
(1) Marx explains inflation clearly and simply in the section on "coins and symbols of value" in Chapter III of Vol I of Capital.
The first paper notes were "as good as gold" in the sense that they were convertible on demand into a fixed amount of gold laid down by law. For nearly one hundred years from the end of the Napoleonic Wars to the outbreak of the First World War notes in England were fully convertible into gold at a rate of about ¼ oz per £. During this period the "I promise to pay the bearer on demand the sum of five pounds" (there were no £1 notes then) meant that the Bank of England would give you about 1¼ oz of gold for the note. Now you will only get another note.
With convertibility, the management of a paper currency is relatively easy, since the number of notes in circulation is regulated by the economy as its demand for money rises and falls.
Convertibility of paper notes into a fixed amount of gold was suspended in Britain during the First World War, resumed in 1925 and abandoned in 1931. Currency today in all countries is inconvertible paper (token) money (topped up by metallic coins). The problems of managing an inconvertible paper currency are immensely greater than those of managing a convertible paper currency since it is the monetary authority itself which now has to gauge how much money the economy needs. The amount is no longer more or less automatically regulated by the economy itself, but is determined by the government through its monetary authority. It is not impossible to get the amount approximately right from studying economic trends (level of economic activity, growth of population); it was done in the Weimar Republic after the terrible runaway inflation immediately after the First World War as well as in Britain after 1920. But governments with a monopoly in the issue of inconvertible paper currency face the same temptations as the rulers in the past who issued debased coins: printing money can serve as an easy source of finance. Indeed, convertibility was suspended during the First World War (as it had also been during the Napoleonic Wars) precisely in order to finance the war.
The effect of over-issuing inconvertible paper notes is exactly the same as debasing gold or silver coins: a rise in the general price level. This inflation is in fact the modern equivalent of debasement. It is the depreciation of an inconvertible paper money just as debasement is a depreciation of coined real money.
The word "over-issue" of course implies that there is a "correct" amount of an inconvertible paper currency to misuse. This "correct" amount is that whose face-value equals that of the gold which would be in circulation were it the currency, the amount (total weight) of gold that the economy requires as determined by the formula we discussed last month (no. of transactions x total prices, divided by the velocity of circulation of money).
Suppose that, with inconvertibility, "pound" continues to be defined as ¼ oz of gold and suppose that the amount of money required by the economy, measured in weights of gold, is 100m. oz. To be correct — not to be over-issued — the face-value of the inconvertible currency must total £400m. This is the only amount which will maintain the definition of one pound = ¼ oz of gold.
Inflation as a policy
If the government issues, say, notes with a face-value of £800m, or 100 per cent more than the economy requires, what will happen? The economy still needs the same amount of money, measured in terms of the weight of the money-commodity, as before — 100m oz. of gold. The issue of a paper currency with a total face-value above this figure — and £800m would be the nominal face-value of 200m oz of gold — will not alter this. What will is the real, as opposed to the legal amount of gold designated by the word "pound". £800m, instead of representing 200m oz of gold, will become, in economic practice, the equivalent of 100m oz. "Pound" will change from being the name of ¼ oz of gold to be the name of 1/8 oz (100/800).
The standard of price will have effectively been changed so that, as with a debased coinage, all prices will rise — in this case by 100 per cent, the same proportion as the over-issue of the currency. Once again, this rise won't take place all at once but will gradually work its way through the economy till the general price level has risen by 100 per cent.
The over-issue of an inconvertible paper currency, or inflation, always results in an increase in the general level of prices. This has been confirmed so many times that it can be regarded as an established law of monetary economics.
Over-issuing an inconvertible paper currency has been the cause of the continuous rise in the general price level since the last World War. Governments everywhere have resorted to inflationary currency policies because this is an easy way of raising money to finance their spending — and of course government spending has grown immensely this century. But there is a difference compared with past inflations. In the past when governments inflated the currency they knew exactly what they were doing and what the result would be. Thus the government during the First World War knew full well that the result would eventually be a rise in prices. But today governments seem no longer to realise that there is this direct causal link.
The economics of inconvertible paper currencies has been forgotten under the influence of economic thinkers who proclaimed that they had devised new and better theories. The man mainly responsible for confusing the question here is John Maynard Keynes (1883-1946). Keynes, who was already a leading British economist in the 1920s was at one time aware of the consequences of currency over-issue, but that was before he developed his "general theory of employment, interest and money", the title of his major work published in 1936.
In this work Keynes argued that, in order to ensure full employment, governments should concentrate on trying to control the economy by appropriate tax and spending policies. He relegated monetary policy to a secondary role, saying that it should be framed to fit in with the government's tax and spending policies. Governments interpreted this as meaning that they could safely issue whatever amount of money they needed to carry out their policies, without having to worry about whether or not this might be more than the economy needed. Predictably, they over-issued the currency and the general price level rose.
The first Keynesian budget was that of 1940, when inflation was once again deliberately adopted as a way of financing the war. This policy was continued after the war to finance other government spending, including that on social reform measures (education, health service, social security benefits). While the post-war boom lasted it seemed to some that Keynesian policies had at least achieved the aim of full employment, if not that of a stable price level, and Keynes' view that a certain amount of inflation encouraged investment came to be generally accepted. This myth has now been exploded, as recent years have seen growing inflation accompanied by growing unemployment. As a result Keynes is now almost completely discredited (though he still has a few supporters left in Labour Party and TUC circles). Keynesian economics is now being replaced by a new school known as the "Monetarists" (because they reject Keynes' teaching that monetary policy doesn't matter) who at least realise the connection between an increase in the "money supply" (however defined) and an increase in the general level of prices.
Printing £ notes!
When it is said that government spending is financed by recourse to the printing press, this should not be taken to mean that the government simply prints more paper notes and uses them directly to pay, for instance, its suppliers or civil service salaries. This does indeed happen in some countries but in Britain the method is not so crude as this. What essentially happens is that the government always makes available enough credit for the banking system (commercial banks, discount houses) to be able to lend it whatever it wants. The process works something like this: (i) the government, through the Bank of England, sells bonds to the Big Four Banks (Barclays, Lloyds, Midlands, National Westminster); (ii) to get money to pay for these bonds the banks call in some of the short-term loans they have made to the discount houses; (iii) the discount houses go to the Bank of England which, as the lender of last resort, lends them what they need, at a price — what used to be called the bank rate. The resulting increase in credit in the banking system means, sooner or later, an increased demand for currency (notes and coins). This the Bank of England, as the note-issuing authority, passively makes available by a simple transfer from its Issue Department to its Banking Department. As and when necessary the former arranges for more notes to be printed. So lax is control over the issue of notes these days that Parliament is told afterwards by a mere Treasury Minute which passes automatically unless challenged.
The politician in Britain who comes closest to a real understanding of inflation is Enoch Powell. But there is one thing lacking in his analysis: a concept of what would be the "correct" amount of convertible currency to issue to maintain price stability, or, what is the same thing from another angle, its purchasing power. Powell lacks this concept because it can only be explained on the basis of Marx's Labour Theory of Value (1) and the last thing that Powell is (or wants to be) is a Marxist!
Inflation can be understood only after the acceptance that money is itself a commodity, a product of labour produced for sale, having its own value determined in the same way as that of other commodities (by the amount of socially necessary labour incorporated in it). Despite the surface appearance, gold is still the money-commodity, both internally and for external trade. It has been replaced as the circulating medium by tokens, the metallic coins and coloured paper notes we use in everyday transactions, but is still the ultimate standard of price.
It is still gold that determines whether or not a currency has been over-issued. The various paper currencies of the world are still defined, in economic reality, as weights of gold, even though most of them are no longer legally so. This economic definition of currencies in terms of weights of gold is continually changing; their "gold content" is being continually reduced as a result of inflation.
Although it follows from the Marxian analysis of inflation that the continual rise in the general price level could be stopped by strictly limiting the issue of paper money, it is not the business of socialists to tell the capitalist class how to run their economy. We must not be understood as advocates of a non-inflationary monetary policy since we are against capitalism with or without inflation. An end to inflation would not leave workers much better off; their struggle to defend wages and conditions would still have to continue whatever the currency policy of the government.
We are for a system of society in which inflation could not arise as there would be no money. On the basis of the common ownership of the means of wealth production and their democratic control by the whole people, wealth can be produced in abundance to satisfy people's needs. In socialism every man, woman and child will have free access to the abundant store of wealth set aside for individual consumption. There will be no need for money. Further, being based on common ownership, there will be no private property and so no basis for the exchange of goods out of which money evolved. A moneyless society, then, is our answer to inflation.
Adam Buick
(1) Marx explains inflation clearly and simply in the section on "coins and symbols of value" in Chapter III of Vol I of Capital.
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That's all of the March 1980 issue of the Socialist Standard on the blog.
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