A Tract on Monetary Reform

by John Maynard Keynes

ITALY

III. The Seasonal Fluctuation.

Thus the Theory of Purchasing Power Parity tells us that movements in the rate of exchange between the currencies of two countries tend, subject to adjustment in respect of movements in the “equation of exchange,” to correspond pretty closely to movements in the internal price levels of the two countries each expressed in their own currency. It follows that the rate of exchange can be improved in favour of one of the countries by a financial policy directed towards a lowering of its internal price level relatively to the internal price level of the other country. On the other hand a financial policy which has the effect of raising the internal price level must result, sooner or later, in depressing the rate of exchange.

The conclusion is generally drawn, and quite correctly, that budgetary deficits covered by a progressive inflation of the currency render the stabilisation of a country’s exchanges impossible; and that the cessation of any increase in the volume of currency, due to this cause, is a necessary pre-requisite to a successful attempt at stabilising.

The argument, however, is often carried further than this, and it is supposed that, if a country’s budget, currency, foreign trade, and its internal and external price levels are properly adjusted, then, automatically, its foreign exchange will be steady.[36] So long, therefore, as the exchanges fluctuate—thus the argument runs—this in itself is a symptom that an attempt to stabilise would be premature. When, on the other hand, the basic conditions necessary for stabilisation are present, the exchange will steady itself. In short, any deliberate or artificial scheme of stabilisation is attacking the problem at the wrong end. It is the regulation of the currency, by means of sound budgetary and bank-rate policies, that needs attention. The proclamation of convertibility will be the last and crowning stage of the proceedings, and will amount to little more than the announcement of a fait accompli.

[36] Dr. R. Estcourt, criticising one of my articles in The Annalist for June 12, 1922, writes: “The arrangement would not last for any appreciable period unless, as a preliminary, the Governments took the necessary steps to balance their budgets. If that were done, the so-called stabilisation speedily would become unnecessary; exchange would stabilise itself at pre-war rates.” This passage puts boldly an opinion which is widely held.

There is a certain force in this mode of reasoning. But in one important respect it is fallacious.

Even though foreign trade is properly adjusted, and the country’s claims and liabilities on foreign account are in equilibrium over the year as a whole, it does not follow that they are in equilibrium every day. Indeed, it is well known that countries which import large quantities of agricultural produce do not find it convenient, if they are to secure just the quality and the amount which they require, to buy at an equal rate throughout the year, but prefer to concentrate their purchases on the autumn period.[37] Thus, quite consistently with equilibrium over the year as a whole, industrial countries tend to owe money to agricultural countries in the second half of the year, and to repay in the first half. The satisfaction of these seasonal requirements for credit with the least possible disturbance to trade was recognised before the war as an important function of international banking, and the seasonal transference of short-term credits from one centre to another was carried out for a moderate commission.

[37] Whilst the fact of seasonal pressure is well ascertained, the exact analysis of it is a little complicated. Food arrivals into Great Britain, for example, are nearly 10 per cent heavier in the third and fourth quarters of the year than in the first and second, and reach their maximum in the fourth quarter. (These and the following figures are based on averages for the pre-war period 1901–1913 worked out by the Cambridge and London Economic Service). Raw material imports are more than 20 per cent heavier in the fourth and first quarters than in the second and third, and reach their maximum in the three months November to January. Thus the fourth quarter of the year is the period at which there are heavy imports of both food and raw materials. Manufactured exports, on the other hand, are distributed through the year much more evenly, and are about normal during the last quarter. Allowing for the fact that imports are paid for, generally speaking, before they arrive, these dates correspond pretty closely with the date at which seasonal pressure is actually experienced by the dollar-sterling exchange. In France, since the war, imports in the last quarter of the year seem to have been quite 50 per cent heavier than, for example, in the first quarter. In Italy the third quarter seems to be the slackest, and the last quarter, again, a relatively heavy period. When we turn to the statistics for the United States we find the other side of the picture. August and September are the months of heavy wheat export; October to January those of heavy cotton export. The strength of the dollar exchanges in the early autumn is further increased by the financial pressure in the United States during the crop-moving period, which leads to a withdrawal of funds from foreign centres to New York.

It was possible for this service to be rendered cheaply because, with the certainty provided by convertibility, the price paid for it did not need to include any appreciable provision against risk. A somewhat higher rate of discount in the temporarily debtor country, together with a small exchange profit provided by the slight shift of the exchanges within the gold points, was quite sufficient.