PAUL MORITZ WARBURG INFLATION AS A WORLD PROBLEM AND Paul Moritz Warburg was born in Germany in 1868. He rose to prominence in the banking world as a member of Kuhn, Loeb & Co. He resigned all directorships and trusteeships on appointment by President Wilson as member of the Federal Reserve Board for the term 1914-18. He was of the greatest service to his country in the direction of financial affairs during the War. At present he is Chairman of the International Acceptance Bank, Inc., New York City. Mr. Warburg has written and spoken on public finance and is recognized as an authority in this field. This address was given at a meeting of the Academy of Political Science in New York April 30, 1920. THERE is no doubt that from the economist's point of view our topsy-turvy globe looks gravely ill just now. Mr. World lies prostrate, and the doctors at his bedside are putting their heads together in anxious consultation. A Princeton specialist diagnoses the case as one of acute inflation. If he could only arrest it he believes he could save the poor man. It is this terrible inflation, he contends, that causes Mr. World's high index temperature and disturbed circulation and that makes him consume so much and produce so little of essential substances. "No," replies another Professor, "he is so inflated only because we cannot cure his condition of under-production and over-consumption." "Nonsense," says Dr. Vandersnip, "you have doped him too much, that's what causes the trouble. Stop using artificial stimulants and drugs and he will come through." "How could he have survived if I had not doped him?" says Mr. Muchado, the surgeon, "and, having accustomed him to the drugs how could I withdraw them from one day to another?" "Let me stabilize him!"-urges Prof. Irving, another specialist. "His blood pressure is unbalanced; let me stabilize it, that would cure him forever!" Poor Mr. World looks at his doctors and feels very low-he does not believe they quite understand his case. What is the matter with Mr. World? The truth is that he has just passed through a very severe attack of his old trouble-war. He has never been quite free from it. Every now and then he had a more or less acute spell. But whenever it was over he soon forgot all about it and, instead of trying to mend his ways and find a permanent cure, he went back to his old bad habits. This last attack, however, was so grave that Mr. World has made up his mind to sign a pledge that he will thoroughly reform his mode of living-if only he can survive. Will he make good when he gets well, or will he forget again? Who knows? But in any event the doctors must get him back on his feet and give him another chance. How can they do it? Let me discuss the case not from the point of view of the learned specialists, but from that of the plain country practitioner. In the life and death struggle of war, sound economic precepts have to give way to the dictates of self-preservation. What orderly corporation could dare to issue millions of funded obligations for the purpose of covering running expenditures without any corresponding addition to its assets? But Mr. World increased his obligations by more than $200,000,000,000, while his plant and operating efficiency deteriorated at the same time. These loans were the drugs, they were necessary to save the patient, they stimulated his activities, they gave him a feeling of strength and confidence-while, as a matter of fact, each successive loan, like a drug, further weakened him and made recuperation so much more difficult. Can there be any doubt that from the day of the armistice it should have been our earnest endeavor as fast as possible to arrest the use of drugs, not only on the part of ourselves but also on the part of our friends, and even our one-time enemies? But so thoroughly was the world "doped" that it took over a year from the date of the armistice for peoples to begin to rec ognize that they were living on a fictitious basis of prosperity; that by continuing to incur more debts, new wealth could not possibly be created, but that instead by increasing the national indebtedness and currencies they were simply depreciating the value of investments saved in the past. The historian will be amused to register the utterly impracticable and freakish theories and plans that, from time to time, were propounded when our generation was first faced with the problems of price inflation and depreciation of exchanges. Today we smile at the thought that men who consider themselves leaders in economic and financial questions should seriously have entertained the view that prices could be permanently kept down by price fixing, or prosecutions, and that depreciation of exchanges was due largely to Wall Street manipulations; that exchanges could be kept at par simply by organizing a national institution which should clear all transactions in foreign exchanges. To-day we have no difficulty in understanding that once gold payments are suspended, foreign exchanges largely express the differential between various degrees of price inflation and money depreciation in the various countries affected, and the different conditions of productivity and credit. We have no difficulty, furthermore, in fastening in our minds the conclusion that now that the United States Government has definitely, as we hope, adopted a policy of living within its income, countries that persevere in covering current deficiencies by piling up additional indebtedness cannot expect to be able to arrest the fall of their exchanges in our markets, by the simple process of incurring new foreign loans. It is not my ambition in these short remarks to present any new views concerning the causes of inflation, which are generally understood, but rather to dwell for a moment upon the relative position of sequence and importance of its various stages as they impress the country doctor. When war is declared the first thing that happens is that the government post-haste orders all the things immediately required for the carrying on of the struggle. (Simultaneously people are withdrawn from their regular occupations and others must be attracted to take their places.) The chief aim at that juncture is to get the things and to get them at once; the question of price becomes a consideration of almost negligible importance. Moreover, in order to stimulate production to highest efforts and beyond its normal peace capacity, attractive prices must be offered. Large prospective profits, in turn, bring about a competitive demand for materials and labor, and prices are thus started on their long upward flight. Government war expenditures are incurred with terrific speed and, as prices go up, expenditures rises in a constantly growing measure. War funds must be procured at once, while (aside from the dampening influence that over-taxation would exercise on the war spirit of a country and on its eagerness to increase war production) it takes time to pass laws, to devise new sources of revenues and to organize the machinery with which to collect taxes. Government bonds must, therefore, be issued and once the beginning is made, subsequent flotations follow in ominously quick succession. Moreover, high profits and high wages produce extravagance, and no matter how hard any government may try, it has been shown that everywhere government issues had to be placed in increasingly larger amounts than could be absorbed by the actual savings of the people. It is at this stage only that banking inflation begins to become a factor of far-reaching importance. As long as the countries maintain their gold standards, the necessity to preserve the power of commanding gold, or the fear of losing gold, or the apprehension that banking liabilities are expanding beyond the safe limits laid down by law or tradition, act as effective brakes against over-expansion in banking and thereby on overspeculation and excessive rises on prices. In normal times new evidence of wealth is produced by the addition of new tangible objects to the country's balance sheet, less what was consumed in the course of their production. Expressed in unscientific language, this is what would generally constitute the annual savings of a nation. To the extent that in normal times savings do not catch up with the production of new objects, bank credit temporarily will be called upon to fill the gap. But as long as a gold basis is adhered to, there is a distinct limit up to which expansion may go, when necessity or caution will force a halt. Banking expansion normally increases, therefore, in a definite relation to actual savings-hothouse growth on top of actual savings being limited by the relation to gold reserves which must be maintained. In times of war these boundary lines are removed. The steel ring that before held tightly in its grasp the bulging bale is now converted into a weak rubber band. Investments and deposits do not grow any more as tangible assets of value are added to the country's resources, but they are swelled by government obligations issued for services of no lasting value, and even for work that destroys assets instead of producing them. Moreover, the rise of prices naturally increases the loan structure, which can now grow without let or hindrance, for serious consideration is no longer given to the shrinking of the gold reserve and, savings being unable to absorb government bonds as fast as they are issued, reserve balances are created and currencies are issued against loans on government bonds, or as in some countries, against direct advances to the government. As long as reserve balances are created and circulation is issued only against selfliquidating paper, which represents things in course of production, and as long as this process is kept within a safe relation to gold, there may be more or less acute banking expansion, but there would not be any cause to call it inflation. It is when bank loans, reserve balances or circulation are being created against things that do not represent any tangible value, and gold reserves are disregarded, that we face inflation in its classic form. Indeed, with us that inflation took place, when government securities to the extent of approximately one and a half billions became the basis for Federal Reserve bank loans, even though, due to particularly fortunate circumstances, we were able to preserve a remarkably strong gold protection. (This was only possible, however, because at the beginning of the war we had a vast gold treasure wastefully decentralized, in scattered bank reserves, or in actual circulation, and because we were able to concentrate this gold effectively, and to add to it a billion dollars which came to us from foreign countries.) It is of the utmost importance that we realize the fundamentalthough in protracted wars unavoidable-part played by government borrowing in causing inflation. I can hardly perceive |