Organic Interpretations Hawtrey

Organic Interpretations Of Crises; I. R. G. Hawtrey

It is hard to imagine views more completely opposite to those of Robbins than those expressed by Hawtrey on the origin of the 1930 crisis and the methods by which it could have been avoided. Accord­ing to Robbins restriction of credit would have made it possible to maintain the gold standard and induce the indispensable fall in costs, while for Hawtrey the same result would have been obtained by the opposite process of making credit easier. The lowering of the discount rate in 1927 by the Federal Reserve Banks is strongly criticized by Robbins, whereas Hawtrey thinks it the right method to follow, and blames the United States for interrupting it. The raising of the rate in 1927 he regards as a disastrous reversal of policy, and he similarly criticizes the raising of the discount rate in London after 1929. When the depression had begun an open-market policy should have been energetically followed. A half-hearted move in this direction had been made by the Federal Reserve Banks, but it was quite inadequate. The depression in the United States was precipitated just in propor­tion as the accumulation of gold in that country increased. In direct contradiction of Robbins's thesis Hawtrey casts the responsibility for the crisis on the insatiable demands of France and the United States for gold; demands far in excess of the production of the mines. He compares the state of the money market at that time to a tragic episode in the defence of Calcutta, in 1758, by Governor Holwell. "In 1930 and 1931," he writes, producers all over the world found demand dwindling relentlessly. In desperate efforts to keep going they cut prices deeper and deeper. Their frantic competition for such demand as remained might be compared with the desperate struggles of the prisoners in the Black Hole of Calcutta to save themselves from suffocation by getting near the two small windows which were the only means of ventila­tion. It is said that it was only by inadvertence that Surajah Dowlah shut up 146 prisoners in a cell 18 feet by 15 feet. He merely fol­lowed precedent in committing prisoners to the guard-room. In their agony the victims sought to bribe the guards to carry an appeal for mercy to Surajah Dowlah. But he was asleep and the guards dared not awake him. He was very like a central bank. And the writer adds:

When, the next morning, he sent for Holwell, who had been in command of the garrison and was among the twenty-three survivors, Surajah Dowlah manifested no interest in the fate of the prisoners but wanted to find out where the East India Company's treasure was hidden.

Hawtrey shows no tenderness for the central banks, which, with their eyes fixed on their gold reserves, were not interested in the gradual suffocation of the economic system. For in his eyes the fluctuations of credit—by which he means bank credit—are the sole cause of booms and depressions, and the central banks are the masters of credit. He thus joins a long line of economists going back as far as the Currency School, and where his originality lies is in combining his views with a particularly clear conception of income and its circula­tion, which forms as it were the skeleton of all his books. He defines income as the total of all the amounts that remunerate the various services that combine in the productive process. He does not include in it sums that come from the sale of a good previously acquired by the expenditure of earlier income. When we sell a stock-exchange security we 'disinvest' capital acquired earlier with income already expended once. The sum received is not part of income, for the latter consists only of sums paid for 'new' services rendered. What Hawtrey calls "income" is what we call net income, as distinguished from gross income. Hawtrey calls it "consumers' income," where the French would say "consumable income."

Now, the price-level is a function, at each instant, of the aggregate expenditure of income by a community, and rises or falls with it. Expenditure of income includes, of course, both consumption expendi­ture and saving expenditure, the latter being only a particular way of spending income. This conception has been summed up by Hawtrey himself in his latest book as follows.

By the consumers' income I mean simply the total of incomes expressed in monetary units. It is much more fundamental in monetary theory than the quantity of money. The consumers' income is the source of general demand, composed of consumption demand and of the demand for capital goods. For though it is traders, not consumers, who buy capital goods for use in production, the funds used by the traders are ultimately derived, through the investment market, from the consumers' income. And while the consumers' income is the source of demand, demand in turn is the source of the consumers' income. That is to say, the money spent on the purchase of goods is the source of the incomes of those who produce and deal in the goods. So long as an unchanging stream of money continues to flow through the consumers' income to demand and back through demand to the consumers' income, activity will be maintained.

But how can income be increased? Simply and solely by bank credit.1 Credit granted by one private person to another merely dis­places income, the expenditure being made by the borrower instead of by the lender. But when banks grant credit they create new money and a new income. And, conversely, when they restrict or stop credit they diminish the aggregate income. Now, credit is essentially unstable. An increase of credit increases consumable incomes and consequently expenditure as well. There follows a rise of prices lead­ing to an increase in profits, which impels traders to increase produc­tion and demand new credits, which in their turn will raise prices, and so the process continues. Credit sets in motion a cumulative rise. Can this movement go on indefinitely? No, replies Hawtrey, because the banks are limited in granting credit by the extent of their reserve, which is dependent on the central gold reserve of the country. Other­wise there would be no limit to the rise of prices and the expansion of production. But, if credit ceases, a cumulative movement in the opposite direction will start. Incomes diminish, prices fall, bringing about a fresh reduction of incomes, etc., and the depression grows until the banks feel themselves in a position to resume the granting of credit.

These rises and falls of prices, therefore, result entirely from increases and reductions of bank credit, and the economic cycle is a purely monetary phenomenon. Since the banks create money, they act in reality like a government which issues paper money. The process of expansion and depression under the influence of credit is identical with the process of inflation and deflation under the influence of paper money. So the conclusion follows that to deliver a country from depression, or to check too severe a depression, credit must be facilitated and purchasing power increased, while in the opposite case credit must be restricted. The manipulation of the discount rate—raising and lowering it—is the principal means by which the modern banking system can prevent crises, or combat them when they have begun. So it is understandable now why the views of Robbins and Hawtrey on the policy followed by England and the United States in the crisis of 1930 are in such complete disagreement.

Hawtrey's great merit is to have described with admirable clarity the creation and circulation of net income. His definitions of ' con­sumers' income' and 'consumers' outlay' provide a valuable plan for understanding the circulation of production incomes to consumption and vice versa: it ought to figure in every manual of political economy. It renders the same service to the understanding of dynamic problems as Walras's plan does to that of the interdependence of prices in a static system. It is similar and equally useful, as we shall see presently, to that constructed by Ohlin and the Stockholm school to elucidate the relations between income, saving, and investment.

On the other hand, the use that Hawtrey makes of it for the inter­pretation and treatment of crises (especially that of 1930) is open to grave objections, and we must call attention to the chief of these. Between inflation and deflation of paper money on the one hand and the expansion and contraction of credit on the other Hawtrey sees almost a relation of identity. We have shown elsewhere1 how the identification of the two processes appeared in English doctrine at the beginning of the nineteenth century. From the time of Ricardo —and even from the time of John Law—the assimilation of convertible paper money created by credit with inconvertible paper is constantly reappearing. It is to be found again, implied if not expressly formu­lated, in all Hawtrey's works, and therein lies serious confusion. It follows that by applying to a rise in prices due to excessive issue of inconvertible paper the remedies whose aim is to prevent or correct the consequences of a credit crisis, he makes, in our opinion, a thera­peutic error.

Bank credit is a repayable instrument. It is granted normally only for a short term. It cannot, therefore, suffice to maintain a price-level which, if it is to be lasting, assumes a certain quantity of money (metal or paper) remaining in circulation. There is no reason to think that lowering the rate of discount would have succeeded in 1930 in check­ing a fall in prices that was the result of the increasing volume of goods thrown on the market. To this Hawtrey would reply that credit itself creates income, for the sums lent by the banks are used as wages, for buying raw materials, and so forth, and the saving these incomes give rise to is no less genuine than that produced by other means than bank credit. We agree, but the incomes thus created are mortgaged in advance by a debt to the bank which must one day be repaid, and this repayment will be accomplished by a stoppage of money, and consequently of incomes. It is for this very reason that a mere lower­ing of the discount rate has always proved powerless to encourage entrepreneurs to 'start again' after a crisis.

Apart from this argument, concerned with the treatment of crises in general and that of 1930 in particular, we may follow Pigou, the shrewd successor of Alfred Marshall, in saying in opposition to Hawtrey that in a purely monetary theory account must be taken not only of the quantity of money but of its rapidity of circulation. Now, this varies, quite apart from the banks, by the action of the income-owners themselves. Moreover, if it is true that the supply of credit plays an important part in increasing or reducing purchasing power, the banks are not alone in causing these movements, for it is the merchants, the industrialists, and the State who demand credit, so that their state of mind exerts a powerful influence on its expansion or contraction. To concentrate attention on the supply of credit is to remove from the problem the often decisive influence of demand.

Hawtrey's views, on account of the position he holds at the Treasury, have on many occasions inspired British economic policy. He, like Keynes—though the two differed from each other on many minor points—was able, and will still be able, to make the financial authorities of his country listen to him. But his views, none the less, which make everything depend on increases or decreases in purchasing power, and which may tempt statesmen by the ease with which they can be put into practice, are far from being universally accepted.