The inflation of currency and prices presented in these figures was moderate in comparison with conditions in central and eastern Europe, where the flood of paper money broke all bounds; the quantity of currency in 1919, compared with 1913, was in Germany 875, in Rumania over 1,100, in Austria and in Poland higher still.
724. Effect upon foreign exchange.—Leaving aside the grave effects of these rapid changes in the price level on the earnings and income of different classes, there is a particular reason for studying them in their relation to international trade. We have had occasion to note previous changes in the price level, such as the rise in prices before 1914; but these earlier changes were more moderate, and what is still more important, were about the same in different countries. The changes resulting from the issue of paper money were not only more abrupt; they were different in individual countries, as can be seen from the figure in the last section. The price level in any country depended upon the particular amount of paper money which the government of that country felt obliged to issue. The prices of Europe were no longer gold prices, steadied at a common level by the inflow and outflow of gold; they had no common level, they lost their former steadiness. With these changes the time-honored basis of international transactions, the old par of foreign exchange, disappeared.
725. Par of exchange on the gold standard.—The significance of the change can be most readily appreciated if we consider a simple case, say that of an English spinner who buys raw cotton in the United States. The American wants dollars; the Englishman has pounds sterling to offer. It does not matter in which unit the bargain is expressed, whether the American gets the right to draw an order on the Englishman for so many pounds sterling and sells this to a bank for dollars, or whether the price is fixed at so many dollars, and the Englishman makes payment by buying a bill for that amount with his pounds sterling. In either event one party to the bargain must deal in the monetary unit of the other. Under the old system both units were perfectly definite weights of gold. A merchant knew, within narrow limits, how much he had to pay or to receive. The gold in £1,000 was equal to the gold in $4,866. Sterling exchange was at par in New York when the pound was quoted at 4.866. Exchange could not vary far from par, for the cost of shipping the gold itself was only about two cents per pound sterling, and the gold of either country was perfectly acceptable in the other.
726. Foreign exchange on a paper standard.—Consider now the situation after England has driven gold out of circulation by the over-issue of paper money. The pound sterling has become a “paper pound,” of which the value stands in no fixed relation to a definite weight of gold, but is determined by a new set of factors, particularly by the condition of the English treasury and the prospect of an expansion or contraction of the paper currency. The American can no longer count with any assurance on the value to him in dollars of a sum due him in pounds sterling three months hence; the Englishman is no longer in a position to calculate how many pounds sterling he will need to pay a debt contracted in dollars. The rate of exchange, instead of being fixed close to 4.866, may go down to 4.50, 4.00, 3.00—there is no limit to its depression or to the sharpness of its fluctuations. The student should note particularly two elements which are important in an analysis of the situation. First, international transactions involve a considerable time interval, say three months, within which events may occur that will make sweeping changes in rates. Second, the purchasing power of paper money at home, where prices are fixed by contract or affected by custom, does not change in accordance with the rate at which it is estimated in foreign exchange. As a result there is a “spread” in the factors determining profit or loss in international transactions which makes foreign trade extremely speculative, and makes its flow fitful and irregular.
QUESTIONS AND TOPICS
1. Dangers arising from the German political constitution. [W. H. Dawson, What is wrong with Germany?, London, 1915; Veblen, Imperial Germany, Chap. 5.]
2. “German industry considered as a factor making for war.” [H. Hauser, Economic Germany, London, 1915, a pamphlet of 33 pages.]
3. Commercial aims of Germany in the war. [Snow and Kral, German trade and the war, Washington, 1918, pp. 11-14.]
4. How do you explain the fact that the direct expenditures for war by the Entente were more than double those of the Central Powers?
5. What portion of the cost of the war fell upon your individual family? [Tabulate money costs under taxes, contributions, losses. Who bears the cost of government bonds? Estimate “real” costs in the form of extra exertion, diminished consumption, decline in purchasing power of the family income.]