Readings in Money and Banking / Selected and Adapted

by Chester Arthur Phillips

The cumulative consequence would be like the cumulative consequence of a long continued decline in gold production. After a season or two of declining bank reserves, tight money, and so on, a sudden collapse might be occasioned, and apparently caused, by the announcement of some particular seigniorage adjustment. Then there might be a decline in prices much greater than in proportion to the bullion change.

But the working of the compensated dollar would not be in the least analogous to the operation of gold inflation or contraction, even as Professor Taussig supposes it. The plan always works cumulatively toward par, never cumulatively away from par. One often sees a wagon with its wheels on a street-railway track having some difficulty getting off; the front wheels have to be turned at a large angle before they are forced out of their grooves; then of a sudden they jump away. This is analogous to the delayed "flare-up" of prices which Professor Taussig supposes under the influence of a long continued decline or increase in the gold supply. But if the driver instead of trying to turn out is trying to keep the wagon on the track he will pull the horse back at every tendency to turn to the right or left. The more the horse turns to the right the harder will the driver endeavor to turn him to the left. Clearly the effect of the driver's efforts will be to avert or delay, not to aggravate or hasten, any jumping out of the grooves which other causes may tend to produce.

In other words, if it takes as much time as Professor Taussig fears for a pressure on prices to move them, then so much the more certain is it that, under the plan, deviations from par, though they may be persistent, cannot be either rapid or wide. A long continued small deviation gives plenty of time for the counter pressure exerted by the compensating device to accumulate and head off any wide deviation.

Suppose that, following Professor Taussig's ideas, some cause such as an increase of gold production would, in the absence of the compensated dollar plan, gradually lift the price level as follows: during the first year, not at all; during the second year, 1 per cent.; during the third year, 2 per cent.; after which would come a "flare-up" of 10 per cent. We may suppose then that, if the plan were in operation during the first year, there being no deviation visible, there would be no change in the weight of the dollar. After the first month of the second year when prices were 1 per cent. above par, the weight of the dollar would according to the plan be raised 1 per cent. If this were unavailing, so that in the second month the deviation were still 1 per cent., the weight of the dollar would be again increased 1 per cent. Every month, as long as the deviation of 1 per cent. lasts, the weight of the dollar would receive an additional 1 per cent. Unless some effect were produced on the supposed original schedule of deviations, the weight of the dollar of the second year would be increased 12 per cent., and by the end of the third year by 24 per cent. more, or 36 per cent. in all. But it is clear that by this time, with so swollen a dollar, the "flare-up" scheduled for the fourth year could not occur, but that a counter movement would set in—in fact, would have set in long before the dollar became so heavily counterpoised. Nor could the result of the counterpoise, even if so heavy, be to swing suddenly prices far below par. Prices would, by hypothesis, yield slowly and again give time for taking the counterpoise off. If the price level sank, say to 1 per cent. below par for six months, then to 2 per cent. for another six months and to 3 per cent. in the next six months, evidently the entire 36 per cent. would be taken off in eighteen months (since 1 × 6 + 2 × 6 + 3 × 6 = 36). The compensating device is thus similar to the governor on a steam engine. It is the balance wheel that is largest and hardest to move which is the most easily controlled by the governor. So if the "flare-up" theory is true, the system will work more perfectly than if it were not true.

4. "It would not work unless every single mint in the world employed it." This is an error. Although it could be easily shown to be politically inadvisable for one nation alone to operate the plan, this would not be economically impossible. Those who hold the contrary are deceived by the term "mint price." They reason that our mint price ($18.60 an ounce of gold, 9/10 fine) and England's mint price (£3 17s. 10-1/2d. for gold 11/12 fine) are now "the same," and that, consequently, if our price were lowered 1 per cent., i. e., to $18.41, while the English price remained unchanged, all our gold would be taken to England to take advantage of the "higher" price there. But these comparisons between English and American prices are based on the present "par of exchange" ($4.866 of American money for the English sovereign): which par of exchange is in turn based on the relative weights of the dollar and the sovereign. As soon as our dollar were made 1 per cent. heavier, not only would the new American mint price go down 1 per cent., but the par of exchange would also go down 1 per cent., to $4.82. Consequently, the new mint price of $18.41, although in figures it is lower than the old, yet, being in heavier dollars, would still be "the same" as the English mint price of £3 17s. 10-1/2d. This sameness of mint price as between the two countries means at bottom merely that an ounce of gold in America is equivalent to an ounce of gold in England.

It is true that each increase in the weight of the virtual dollar in America—in other words, each fall in the official American price of gold—would at first discourage the minting of gold in America. The miner would at first send his gold to London, where the mint price was the same as formerly, and realize by selling exchange on the London credit thus obtained. But the rate of exchange would soon be affected through these very operations, by which he attempted to profit, and his profit would soon be reduced to zero; the export of gold to England would increase the supply of bills of exchange in America drawn on London and lower the rate of exchange until there would be no longer any profit in sending gold from the United States to England and selling exchange against it. When this happened it would be as profitable to sell gold to American mints at $18.41 per ounce as to ship it abroad; and $18.41 in America would be the exact equivalent at the new par of exchange ($4.82) of the English mint price of £3 17s. 10-1/2d.

5. "The system would be destroyed by war." Professor Taussig fears that if money were stabilized, the system would itself be upset by war. "Any war would put an end to it." To this I would reply: first, that if war did put an end to it the system would do good so long as it lasted and its discontinuance would do no more harm than the existence of our present unscientific system is doing at all times; secondly I do not see any reason for thinking that war would put an end to it.

Possibly Professor Taussig has in mind the first form in which I explained the plan, viz., in my book, The Purchasing Power of Money. In that form one country was to serve as a centre and all other countries were to have the gold exchange standard in terms of gold reserves in the central country, just as now the Philippines have a gold exchange standard with reference to the United States and India with reference to England. Professor Taussig's objection would undoubtedly apply, to some extent, in cases where the plan was carried out through the gold exchange mechanism. But where the system was independently established in each country simply parallel to the systems in other countries, there would be no more need for its abandonment in case of war than for the abandonment now by Germany of the gold standard because England, its enemy, has the gold standard also. We know, of course, that in time of war, the gold standard is often temporarily abandoned in favor of a paper standard; and the new proposal would not escape such a difficulty. This, however, would not be due to the international character of the plan, but to the exigencies of war.

6. "The multiple standard is not ideal. Especially is it faulty when the cause of price movements is entirely a matter of the abundance or scarcity of goods in general." Those who hold this objection point out that an ideal standard would not be one which always smooths out the price level but one which discriminates and leaves unchanged such rises and falls as are due to general scarcity and abundance of goods. There is much to be said in favor of such discrimination as an ideal. It must be admitted that the compensated dollar plan would not discriminate between changes in the price level due to the scarcity or abundance of goods in general and those due to changes in money and credit. It must be further admitted that a theoretically ideal standard would take some account of this distinction. But the compensated dollar plan does not claim to be ideal. The plan would simply correct the gold standard to make it conform to a multiple commodity standard. It does not pretend to correct the multiple commodity standard to make it conform to some "absolute" standard of value.