A Tract on Monetary Reform

by John Maynard Keynes

We have scarcely realised how far our thoughts have travelled during the past five years. But to re-read the famous Cunliffe Report on Currency and Foreign Exchange after the War, published in 1918, brings vividly before one’s mind what a great distance we have covered since then. This document was published three months before the Armistice. It was compiled long before the unpegging of sterling and the great break in the European exchanges in 1919, before the tremendous boom and crash of 1920–21, before the vast piling up of the world’s gold in America, and without experience of the Federal Reserve policy in 1922–23 of burying this gold at Washington, withdrawing it from the exercise of its full effect on prices, and thereby, in effect, demonetising the metal. The Cunliffe Report is an unadulterated pre-war prescription—inevitably so considering that it was written after four years’ interregnum of war, before Peace was in sight, and without knowledge of the revolutionary and unforeseeable experiences of the past five years.

Of all the omissions from the Cunliffe Report the most noteworthy is the complete absence of any mention of the problem of the stability of the price-level; and it cheerfully explains how the pre-war system, which it aims at restoring, operated to bring back equilibrium by deliberately causing a “consequent slackening of employment.” The Cunliffe Report belongs to an extinct and an almost forgotten order of ideas. Few think on these lines now; yet the Report remains the authorised declaration of our policy, and the Bank of England and the Treasury are said still to regard it as their marching orders.

Let us return to the regulation of note issue. If we agree that gold is not to be employed in the circulation, and that it is better to employ some other criterion than the ratio of gold reserves to note issue in deciding to raise or to lower the bank rate, it follows that the only employment for gold (nevertheless important) is as a store of value to be held as a war-chest against emergencies and as a means of rapidly correcting the influence of a temporarily adverse balance of international payments and thus maintaining a day-to-day stability of the sterling-dollar exchange. It is desirable, therefore, that the whole of the reserves should be under the control of the authority responsible for this, which, under the above proposals, is the Bank of England. The volume of the paper money, on the other hand, would be consequential, as it is at present, on the state of trade and employment, bank-rate policy and Treasury Bill policy. The governors of the system would be bank-rate and Treasury Bill policy, the objects of government would be stability of trade, prices, and employment, and the volume of paper money would be a consequence of the first (just—I repeat—as it is at present) and an instrument of the second, the precise arithmetical level of which could not and need not be predicted. Nor would the amount of gold, which it would be prudent to hold as a reserve against international emergencies and temporary indebtedness, bear any logical or calculable relation to the volume of paper money;—for the two have no close or necessary connection with one another. Therefore I make the proposal—which may seem, but should not be, shocking—of separating entirely the gold reserve from the note issue. Once this principle is adopted, the regulations are matters of detail. The gold reserves of the country should be concentrated in the hands of the Bank of England, to be used for the purpose of avoiding short-period fluctuations in the exchange. The Currency Notes may, just as well as not—since the Treasury is to draw the profit from them—be issued by the Treasury, without the latter being subjected to any formal regulations (which are likely to be either inoperative or injurious) as to their volume. Except in form, this régime would not differ materially from the existing state of affairs.

The reader will observe that I retain for gold an important rôle in our system. As an ultimate safeguard and as a reserve for sudden requirements, no superior medium is yet available. But I urge that it is possible to get the benefit of the advantages of gold, without irrevocably binding our legal-tender money to follow blindly all the vagaries of gold and future unforeseeable fluctuations in its real purchasing power.

II. The United States.

The above proposals are recommended to Great Britain and their details have been adapted to her case. But the principles underlying them remain just as true across the Atlantic. In the United States, as in Great Britain, the methods which are being actually pursued at the present time, half consciously and half unconsciously, are mainly on the lines I advocate. In practice the Federal Reserve Board often ignores the proportion of its gold reserve to its liabilities and is influenced, in determining its discount policy, by the object of maintaining stability in prices, trade, and employment. Out of convention and conservatism it accepts gold. Out of prudence and understanding it buries it. Indeed the theory and investigation of the credit cycle have been taken up so much more enthusiastically and pushed so much further by the economists of the United States than by those of Great Britain, that it would be even more difficult for the Federal Reserve Board than for the Bank of England to ignore such ideas or to avoid being, half-consciously at least, influenced by them.

The theory on which the Federal Reserve Board is supposed to govern its discount policy, by reference to the influx and efflux of gold and the proportion of gold to liabilities, is as dead as mutton. It perished, and perished justly, as soon as the Federal Reserve Board began to ignore its ratio and to accept gold without allowing it to exercise its full influence,[56] merely because an expansion of credit and prices seemed at that moment undesirable. From that day gold was demonetised by almost the last country which still continued to do it lip-service, and a dollar standard was set up on the pedestal of the Golden Calf. For the past two years the United States has pretended to maintain a gold standard. In fact it has established a dollar standard; and, instead of ensuring that the value of the dollar shall conform to that of gold, it makes provision, at great expense, that the value of gold shall conform to that of the dollar. This is the way by which a rich country is able to combine new wisdom with old prejudice. It can enjoy the latest scientific improvements, devised in the economic laboratory of Harvard, whilst leaving Congress to believe that no rash departure will be permitted from the hard money consecrated by the wisdom and experience of Dungi, Darius, Constantine, Lord Liverpool, and Senator Aldrich.

[56] The influx of gold could not be prevented from having some inflationary effect because its receipt automatically increased the balances of the member banks. This uncontrollable element cannot be avoided so long as the United States Mints are compelled to accept gold. But the gold was not allowed to exercise the multiplied influence which the pre-war system presumed.

No doubt it is worth the expense—for those that can afford it. The cost of the fiction to the United States is not more than £100,000,000 per annum and should not average in the long run above £50,000,000 per annum. But there is in all such fictions a certain instability. When the accumulations of gold heap up beyond a certain point the suspicions of Congressmen may be aroused. One cannot be quite certain that some Senator might not read and understand this book. Sooner or later the fiction will lose its value.

Indeed it is desirable that this should be so. The new methods will work more efficiently and more economically when they can be pursued consciously, deliberately, and openly. The economists of Harvard know more than those of Washington, and it will be well that in due course their surreptitious victory should swell into public triumph. At any rate those who are responsible for establishing the principles of British currency should not overlook the possibility that some day soon the Mints of the United States may be closed to the acceptance of gold at a fixed dollar price.