INFLATION: IN WHAT SENSE IT EXISTS;
HOW IT CAN BE CONTROLLED

MY ridle tonight, as I conceive it, is a very modest
one. I am here, by the invitation of your President,
on the understanding that the Institute desires to
discuss the question of Inflation, and that I am to
make a statement, as methodically as I can, to open
the discussion. My purpose, then, is mainly to clear
the issues for debate ; and if I add an expression of
my own opinion on some of these issues it may serve
perhaps to present a target for the attacks which I
am sure will follow, and thus to set the ball rolling.
There is no doubt that considerable anxiety exists,
an anxiety which has been expressed in very com-
petent quarters, upon what is called inflation. I may
refer, for instance, to a very able article by Mr. Oswald
Falk in the Nineteenth Century for July 1916, in which
he not obscurely hints that the international position
of London itself may possibly be involved if some-
thing is not done to check this inflation. Mr. Hartley

1 An Address delivered to the Institute of Actuaries on 26th March,
1917.

Withers in the Economist has continually returned
to this subject. Professor Nicholson has introduced
it, although his study is not completed yet, in the
Economic Journal for last December. We are wait-
ing for the figures upon which his statement is based,
and consequently I cannot now deal with his position. 1
I might refer also to the references which have
appeared from time to time from the pen of the dis-
tinguished City Editor of the Morning Post, who has
several times drawn our attention to the same point.
Mr. Withers says in The Economist : " We believe
that inflation has already done much harm by raising
discontent in the country and increasing the cost of
the war, owing to the rise of prices that it has helped
to cause, and that everything should be done to check
it." Well, we may admit perhaps that the rise of
prices is to be deplored, though I should like to point
out what is, of course, very obvious that the rise of
prices is an effective check upon consumption, and
at the same time a very valuable stimulus to pro-
duction, and not only to production, but, if we are
thinking of the case of this country, to supply from
other countries. In fact, there is a natural harmony
about the action of the rise of prices when the rise
of prices is due to scarcity. What precisely is meant
when it is suggested, as Mr. Withers suggests, that

1 The figures were afterwards published in a paper on Statistical
Aspects of Inflation, read before the Royal Statistical Society, June 19th,
1917, and printed in the Society's Journal for July, 1917.
this rise of prices is partly due to inflation I do not
know. Mr. Withers is cautious ; lie says " partly "
due to inflation. He specifies particularly the Trea-
sury note issue and the advances that have been
made by banks in various countries, not only the
advances made by State banks, but the increase in
bank deposits, so far as it represents advances to the
public, an increase of what we regard in this country
as currency bankers' money.

I think it will be convenient before going further
to make a more or less formal distinction between the
different senses in which the word " inflation " has
been used. I make no apology for introducing what
some people would call an academic discussion to an
audience of this kind. First, I think we have what
may be called legal or internal depreciation, depre-
ciation as known to law ; that is, loss of parity of
either coins or notes or other legal tender currency
in comparison with the standard unit, the standard
unit in this country being the gold sovereign (not
bar gold). If there were an inflation and a conse-
quent depreciation of this kind, it would be mea-
sured at once by the depreciation of the particular
element of currency in terms of the standard unit.
Supposing, for instance, that element were Treasury
notes, we should find them at a discount in terms
of the sovereign. Further, it might, if it went far
enough, result in what William Cobbett used to call
two prices : we should have a double price quotation

for everything a gold price, and a currency price
representing the element of the currency which was
inflated and depreciated. I am not aware that there
has been any depreciation of this kind in Great
Britain. I have been on the look-out for it inces-
santly, but I have not come across even an isolated
case, although it is difficult to prove negatives, and
it is conceivable that somebody may have offered a
premium on the sovereign. I cannot speak so posi-
tively for France ; I have been told that in France
there is a premium on gold, but I do not think there
is any quotation. That may again be owing to an
act of State. We do not know how far the markets
are free. In Germany we know there cannot be two
prices. Germany enacted a law on the 23rd Novem-
ber, 1914, which exactly corresponds to our Lord
Stanhope's Act, which was passed during the
Napoleonic Wars in 1811, an Act which made it
penal to buy or sell gold coin at a higher price than
its face value. That law was passed to put a stop to
a bullion agitation promoted by Lord King, who had
ordered his tenants to pay him either in gold or in
paper to the value of the gold. The Act was abso-
lutely effective. We do not know that two prices
ever existed after the passing of Lord Stanhope's
Act. The Americans tried a gold Act of the same
kind in 1864, and were absolutely unsuccessful, the
only result being that their paper at once jumped
40 points higher discount. Lord Stanhope's Act was
effective, and the German Act apparently is effective.
We find no quotations of gold in Germany, and we
do not find double prices ; prices there are presumably
paper prices.

Let me now pass to a second sense in which a
currency may be said to be depreciated. It may be
depreciated in an external sense as a whole. It may
lose its parity in terms of some foreign currency. In
that case this international depreciation would be
shown by the exchange rate, but for my part I do not
admit that the exchange rate is a proof of the depre-
ciation of the currency. I do not think it holds, vice
versa, that we can infer depreciation of currency from
the exchange rate. For instance, the American ex-
change was depreciated in the most extraordinary
manner in the first week of August 1914. I was told
that exchange on London was actually sold at 7
dollars instead of 4'86 dollars. Nobody ever sug-
gested that that argued a depreciation of the American
currency in that ratio. There certainly was no infla-
tion of the American currency. At any rate, nobody
I suppose imagines that the American currency
was in any way depreciated. The high exchange
rate arose from circumstances mainly accidental
the refusal on our part of accommodation which we
had been usually ready to extend to America at that
time. Many other examples of the same sort might
be given. I could never agree with the Bullion
Report of 1810 in holding that the premium on
exchange was a necessary proof of the depreciation of
our currency ; and it is worth observing that most
of the very eminent Cambists who gave evidence
before that Bullion Committee were opposed to the
Eeport of the Committee on that point. They were,
perhaps, in the best position to know what accidental
circumstances will sometimes disturb the exchange,
and they held that the discount on exchange could
not be taken as proof of the depreciation of our
paper.

It is worth while, however, to see what the rates are
at the present time. There are no exchange dealings
with enemy countries. I will divide the remaining
exchanges into three groups : first, the more im-
portant Neutral exchanges, secondly the exchanges
with our chief Allies, and thirdly the Scandinavian
exchanges. Our most important Neutral ex-
change is with the United States, and we know that
that exchange dropped rather unfortunately in
September 1915 ; but for the last fifteen months
or so it has remained remarkably steady at 4*76
instead of 4*866, a discount of a little more than 2 per
cent. It is difficult to know for certain whether it
is a discount at all, because we do not know what
the gold point is. We do know that owing to the
high freights and the high insurance rate the range
of the gold points has been very greatly widened
during the war. I have tried many times to get a
statement in regard to the actual gold point, but it
is not forthcoming. Perhaps there is no very definite
market. But I am told that practically the 2 per
cent, does not represent much more than the distance
between the gold point and the par ; at any rate
the United States exchange is fairly steady. With
Amsterdam, another important exchange, at the
present moment the position is fairly favourable,
2^ per cent, discount. I do not lay much stress upon
the discount on the Amsterdam exchange, because
it is conceivable that there are objections to settling
that exchange by the export of gold, as Amsterdam
is dangerously near to the Enemy ; so that even if
it were a discount of 10 per cent. I do not think that
would prove any depreciation in our currency. It
might be interesting as a sign that we were restrict-
ing the export of gold to Holland, and nothing more.
When we come to South American countries there
is a rather unpleasant discount in those exchanges.
Roughly, averaging the countries, the discount is
about 7j per cent. With Spain the discount is
nearly 11 \ per cent., and with Switzerland nearly
5 per cent. The Spanish and the Swiss exchanges
are, perhaps, not very important to us, but the South
American is more important. It may be held, of
course, that the freight and insurance are extremely
high on the South American exchange, and that that
explains the slump, as it were, in the rate.

When we come to the exchanges with our Allies
our position is most favourable. However depre-
ciated our own currency may be, it is clear that, if
the rate of exchange is a test, their currencies are in
a worse position. The exchange on Paris is 10 per
cent, premium, Petrograd 76| per cent., and Italy
nearly 48 per cent. I do not want to lay stress on
that position; we should be glad to see these ex-
changes at par.

Passing to Scandinavia we find that all the Scandi-
navian exchanges, taking them as a whole, are 7j per
cent, against us, but that is very easily explained.
Scandinavia, at the present moment, is not on a gold
basis ; it is true she is using gold, but she has appre-
ciated gold deliberately, and 7j discount there largely
represents the extent to which gold in Scandinavia
is appreciated beyond the value which it has in other
parts of the world. They have done that after de-
liberate reflection, with a view to stopping the rise of
prices in their own countries ; because they conceive
that after the war there will be a fall in prices, and they
want to cut off the upper peak of the movement,
to stop the rise and so to lessen the distance from
which they can see there will be a fall afterwards.
It may be good policy. Of course there are a great
many complicated reactions in the operation of ex-
change rates, and it must be rather difficult to sum up
the net result of this exchange policy on the whole. 1

[ l The policy seems to have been abandoned, at least so far as re-
mittances from the Netherlands Bank are concerned. Cf. the Report
of this Bank, for the year ending March 31st, 1918.]
However that may be, it is obvious that is a remedy
we never could apply here. We do not wish to keep
gold out of the country far from it. We have to
make such enormous payments to New York, to say
nothing of any other centre, that we want all the
gold we can get. We cannot make a formal and
deliberate appreciation of gold here as compared with
other countries.

As to the German exchange, about the only test
of it the most important test at any rate is the
New York exchange, a discount of 30*7 per cent,
as compared with our 2 per cent, on New York.
But it must be observed in regard to all this matter
of exchanges that the exchanges are not working
freely; first, because trade itself is restricted, both
exports and imports, and secondly, because the ordi-
nary arrangement by which the balance of trade is
adjusted by gold movements is almost completely
paralysed by the action of the belligerent Govern-
ments. Gold cannot move freely. As Mr. Withers
very neatly put it some time ago : " The world is
now divided into two classes of countries : those
which refuse gold and those which refuse to part with
it." I think it is clear from the rates of exchange
that even Great Britain does not go out of its way
to facilitate the export of gold. I will leave it at
that. I do not agree with Professor Cassel, 1 that
we can argue from discount on exchange that the

1 Cf. his articles in the Economic Journal, March and September, 1916.



INFLATION 229

currency of the country whose foreign exchange is at
a discount is depreciated. Present circumstances are
too exceptional for us to draw any inference of that
kind. Even in peace time, the inference would be
doubtful, and open to such exceptions as in the case
of the American exchange, already noticed. Upon
the whole, then, I do not admit that a depreciation
of our currency is proved by the present state of the
foreign exchanges.

Now I come to what I think is probably at the
bottom of people's minds when they speak of inflation.
They are not thinking so much of the parity between
our currency and some other, or the parity between
one element in our currency and our standard. They
are really thinking of the rise of prices. It is that
in their minds that argues inflation ; at any rate, it
is the rise of prices that they wish to correct. This,
of course, is entirely to change the point of view.
Here we are considering, not the depreciation of
something in terms of gold, but the depreciation
of gold itself ; and that is extremely important, be-
cause it is clear that the depreciation of gold itself
is not a local question, but a world- wide question ;
it is not a question that we can control here, even if
we wish to. Gold is depreciated nearly as much in
the United States as it is in Great Britain. It would
be quite as much if trade were absolutely free between
Great Britain and the United States, and every kind
of article was in exchange between the two countries.



230 PAPERS ON CURRENT FINANCE

I have been unable to get a formal index number
from the United States, although I ordered it more
than five months ago. As far as I can judge from
isolated quotations and remarks, the level of prices
in the United States is about as high as here. Two
days ago I had a letter from Dr. Irving Fisher, who
is the greatest authority on this point, and according
to a chart which he sent me I make out that prices
in the United States have risen 60 per cent, since the
war began. It must be remembered that they were
very much higher than our prices before the war I
cannot say how much at the moment, as we have
no precise measure of the difference but everyone
knows that prices in the United States were, on the
whole, much higher than our prices. Therefore a
60 per cent, rise would probably bring them some-
where near the level of our prices now, which have
risen 100 per cent. There is probably no important
difference between the average levels in the two
countries. We have no doubt what the rise has
been in this country. We have accurate index num-
bers, more particularly the number established by
Mr. Sauerbeck and now published by the Statist
newspaper, which I think would be correct within
a limit of error of about 5 per cent. According to
that number, prices have exactly doubled since war
broke out. I ought to say, however, that when the
war broke out in July prices were rather lower than
they had been ; they had fallen from 85 in the



INFLATION 231

previous three years to 81, and in the opinion of many
experts we were then on the eve of a crisis, or rather
a depression of trade one of the ordinary periodic
depressions of trade there being a general depre-
ciation not only in the prices of commodities but in
the prices of securities. Possibly in the case of
securities the war was casting its shadows before,
to some extent. There had been a drop in prices in
any case, so that it is perhaps hardly fair to take the
figure for July as a base when we are calculating
the rise due to the war. It would make a difference
of some 4 points. But, broadly speaking, prices have
not risen more in this country than in other countries,
certainly other European and western countries. I
have been trying to make out accurate figures, but
they have no index numbers in most countries, and
one can only judge from estimates made from time
to time ; but it is quite clear that prices are higher
in Germany, that they are about half as high again
in Austria, and about three times as high in Hungary.
The prices there are prodigious, according to the
only returns I have been able to see. In the case
of meat the prices are seven times as high as they
were before the war. I do not know very accurately
what the prices are in Scandinavia ; they have been
deliberately lowered now. Complaints come from
all countries of the rise of prices. It must be so,
because it is gold itself that has depreciated, and as
all these countries are on a gold basis, or else on the



232 PAPERS ON CURRENT FINANCE

basis of currency which is at a discount on gold, prices
in all countries will be similarly affected, though in
different degrees.

It may be asked what would have been the course of
prices but for the war ? Prices have been rising on the
average ever since 1896, at about the rate of 2 per
cent, per annum. That rise is explained by the large
increase in the gold supplies ; but I do not suppose that
the gold supplies alone would account for much more
than this 2 per cent, rise on the average. Perhaps
I ought to say a word here about the theory of prices.
Price is a function of two variables : it varies directly
in proportion to the supply of money of all kinds
and inversely in proportion to the quantity of goods
or transactions requiring to be handled by money.
The more you increase the quantity of goods handled
by money, money remaining the same, the more prices
fall ; the more you increase money, the goods remain-
ing the same, the more prices rise. The general re-
lation admits of simple statement, although in work-
ing it out we are often faced with complications of
detail. For instance, what is money ? You have
to take account of bank deposits, cheques, and the
various forms of purchasing power, and that is not
a particularly simple thing. But in fundamental
principle nothing could be clearer or plainer. Dr.
Johnson put it very well. He was told that in the
Island of Skye twenty eggs might be bought for a
penny, whereupon he observed : " Sir, I do not



INFLATION 233

gather from this that eggs are plenty in your miser-
able island, but that pence are few."

To what, then, is due this rise of prices that has
undoubtedly taken place since the war ? In the first
place, to the large production of gold which is the
basis of all our credit, but mainly to the enormous
increase of purchasing power which has been created
by the various belligerent Governments, quite apart
from the form which that purchasing power has
taken. Our own expenditure is about 6,000,000 a
day, and I think the total expenditure may be esti-
mated at about 20,000,000 a day for all belligerents.
The war expenditure of the five principal belligerents
is known to be 18| millions a day, so that it can hardly
be under 20 millions for the whole of the belligerent
Powers ; say, 7,300 millions a year, or if we allow for
double entry in connection with loans, roughly 7,000
millions a year. In our case the additional expen-
diture of Government is more than as large as the
total expenditure of the nation in peace time. No
one proposes to restrict that expenditure of Govern-
ment, I suppose. The various belligerent Govern-
ments are struggling to obtain the military material
and other necessaries for carrying on the war, and it
would be absurd to attempt to restrict their power
of obtaining that material. I do not think it makes
very much difference by what precise machinery they
exercise that power. For instance, if the belligerent
Governments were able to buy merely in exchange



234 PAPERS ON CURRENT FINANCE

for their own scrip, their own credit, without using
currency at all, I do not think we should have a
much smaller rise of prices. They would be still in
the market for the same amount, and would be com-
peting with the same intensity. Is there any reason
for supposing, therefore, that the level of prices
would be much lower ? My own belief is that there
is not. The level of prices is really the result of the
enormous expenditure of the Governments, and as
long as that expenditure is maintained and exerted
the level of price will roughly be maintained. This
is the root fact, I maintain, at the bottom of the rise
of prices.

But I do think it makes some difference by what
machinery the purchases are made. In the act of
purchase the effect will be the same, but if you make
the purchase by means of an increase of currency
you leave behind after the purchase the purchasing
power you have created, and I think that constitutes
a real difference in the position. You are left with
a mass of purchasing power in the hands of the
general public which would not have been in their
hands in that form but for the particular way in which
the Government made its purchases. It would be
better, for instance, as far as that is concerned, if
the Government could make all its purchases by
forced loans without using currency at all. By what
means have the purchases been actually made ?
They have been made, in the first place, taking the



INFLATION 235

world broadly, by enormously increased issues of
notes. The French note issue was trebled and the
Russian note issue increased four times. Our own
note issue has only increased slightly, and the issue
of bank notes hardly at all. The new currency note
issue has altogether reached the amount of more
than 140,000,000 ; but against that must be set the
value of the gold whose place has been taken by the
currency note, most of which gold has been exported
to the United States. I think it will be found that
the excess issue of currency notes over the gold
displaced by the currency notes is, after all, a very
small matter, not in any way comparable with the
rise of prices, nor an increase that would have con-
tributed very much to that rise of prices. Then in
certain countries enormous advances have been made
by the State Banks. The Bank of France advanced
400,000,000 to the Government, most of it gratui-
tously and none of it at more than 1 per cent. It
behaved in the way it always does behave in times
of crisis, admirably. The State is under very great
obligation to that bank, so much so that meetings
have been held in France of merchants and finan-
ciers calling on the Government to extend the bank
monopoly for thirty years without asking for any
concessions from the bank. The extension of the
monopoly is usually made an occasion for asking for
concessions, but on this occasion the feeling is that
the State owes so much to the Bank of France that



236 PAPERS ON CURRENT FINANCE

the bank has earned its monopoly for another thirty
years without further consideration.

Then in all countries there has been a very great
increase of divisional money, silver and other forms
of small change. Perhaps that does not count for very
much, but I think it has some effect. In this country
in normal times the circulation of silver is about one-
fourth in value of the circulation of gold, so that it
really is a considerable element in our price basis.
What is most important for this country but not so
important I think for many others is the increase
in bank deposits. We are accustomed to consider
the draft upon a bank as the very best form of money,
cash in the highest sense of the word, especially if
that bank happens to be the Bank of England. A
draft on the Bank of England would be considered
cash, perhaps, in any part of the civilised world. In
this country we make a very large use of Bank of
England advances when we are in difficulties for
want of currency. I have found very great difficulty
in estimating what has been the precise increase of
bank deposits in this country. Our banking returns
are always miserably inadequate and unworthy of
the country ; but during the war, ever since the
large loan of 1915, they have been suspended alto-
gether, so that we only have the annual account
made up for a particular day, and everyone knows
what that means as a basis for an estimate. We
have, in fact, no scientific basis at all. I think it is



INFLATION 237

a matter to be very much deplored. You will re-
member what was said about Austria when the
Austrian Bank suspended its returns. I am sorry
that we should have in any degree followed an ex-
ample of that kind, because I think myself there
was no reason whatever for it. I cannot see that
the banks have anything to be ashamed of. It is
a sort of morbid timidity that seems to cause the
withholding of these returns without which there can
be no proper basis for scientific action. However,
as far as I can make out, the bank deposits have not
increased more than some 250,000,000 during the
war, to which may be added about 120,000,000 for
the Bank of England, or under 400,000,000 alto-
gether for the whole banking system.

Compare that with the total of deposits before the
war of something like 1,200,000,000. There is a
33 per cent, increase of bank deposits, and that is
the most serious figure relating to inflation that can
be found in our accounts the expansion of bank
deposits by something like 33 per cent. But that
will not account for 100 per cent, rise in prices ;
nor is it anything like so large as the correlative
forms of expansion in other countries, the expansion
of notes and State bank advances and so forth. The
State bank advances have been very small here as
far as one knows. I do not know what the advances
may be at any given time, but supposing them to
be 70,000,000 or 80,000,000, we have no figure that



238 PAPERS ON CURRENT FINANCE

can be classed as a figure of expansion here that at
all corresponds to the great movement of prices. It
must be observed that in some foreign countries they
have been increasing the use of cheques, and that
has been another cause of rise of prices. In France,
Russia and Germany the greatest efforts have been
made to extend the use of the cheque, and that has
had just the same effect as the expansion of the note
issue. Generally speaking, I am inclined to think there
has been an economy in the use of metallic money
and in the use of notes all over the world that there
has been a more rapid circulation of money. During
the Napoleonic wars it was proved that the rapidity
of circulation of the bank note doubled during some
ten years. I admit the case is not quite parallel.
The fact was that we were just beginning to under-
stand banking economy at that time; our clearing
house had been established only twenty years before,
and we had just begun new experiments in the machi-
nery of cheque banking ; and it is possible, therefore,
that the increased velocity was not due to the war
but to the natural development of our banking
system. But I am inclined to think that the pres-
sure caused by war does make the sixpence a
little more nimble than it otherwise would be. Then
there is the question of the emptying of hoards.
Large amounts have been brought from hoards in
France and in Germany. I do not know if we shall
get any in India from the new Indian Loan, from



INFLATION 239

the great hoards there, or through ornaments being
melted down. This has been an addition to the
amount of gold available for currency, and just as
important, in its effect on prices, as if new gold had
come from the mines. These are the general causes,
on the money side, of the rise of prices.

Passing to the side of commodities, there has been
a shortage in productive power tending so far to make
commodities scarce, but of course this has been com-
pensated very largely by increased effort and by
women's labour, and by the labour of other persons
not usually employed in normal times. I am bound
to say there has been in this country a great margin
for an increase in productivity. When you hear that
women coming fresh to an industry were able to
turn out five times the previous output of a skilled
workman, it is impossible not to feel that we were
working well within our power when the war broke
out. I would also refer to the decrease of available
tonnage, and the rise of freights. High freight rates
do not, strictly speaking, I think, restrict the supply
of commodities generally, but they may restrict it
locally. They may prevent us, for instance, from
bringing goods from the United States which we might
otherwise have had, and they may bring about a local
scarcity here and therefore cause local high prices.
There has been a certain failure in the harvest, partly
due to the shortage of fertilisers. Those, I think,
are the principal causes on the side of commodities.