Part 11

The Chancellor arrived at his after-war debt charge of £380 millions by estimating for a gross debt on March 31, 1919, of £7980 millions, which he reduces to a net debt of £6856 millions by deducting half the expected face value of loans to Allies, £816 millions, and £308 millions for loans to Dominions and India's obligation. But is he, in fact, entitled to count on receiving any interest at all from our Allies for some years to come after the war? If not, then on that portion of our debt which is represented by loans to Allies we shall have to meet interest for ourselves. He also gave an imposing list of assets in the shape of balances in hand, foodstuffs, land, securities, building ships, stores in munitions department, and arrears of taxation, amounting in all to nearly £1200 millions. It is certainly very pleasant to consider that we shall have all these valuable assets in hand; but against them we have to allow, which the Chancellor altogether omitted to do, for the big arrears of expenditure and the huge cost of demobilisation, which is at least likely to absorb the whole of them. On the whole, therefore, although we can claim that our war finance is very much better than that of our enemies, it is difficult to avoid the conclusion that it might have been very much better than it is, and that it is not nearly as good as it is represented to be by the optimistic fancy of the Chancellor of the Exchequer.

INTERNATIONAL CURRENCY

June, 1918

An Inopportune Proposal--What is Currency?--The Primitive System of Barter--The Advantages possessed by the Precious Metals--Gold as a Standard of Value--Its Failure to remain Constant--Currency and Prices--The Complication of other Instruments of Credit--No Substitute for Gold in Sight--Its Acceptability not shaken by the War--A Fluctuating Standard not wholly Disadvantageous--An International Currency fatal to the Task of Reconstruction--Stability and Certainty the Great Needs.

As if mankind had not enough on its hands at the present moment, a number of well-meaning people seem to think that this is an opportune time for raising obscure questions of currency, and trying to make the public take an interest in schemes for bettering man's lot by improving the arrangements under which international payments are carried out. Nobody can deny that some improvement is possible in this respect, but it may very well be doubted whether, at the present moment, when very serious problems of rebuilding have inevitably to be faced and solved, it is advisable to complicate them by introducing this difficult question which, whenever it is raised, will require the most careful and earnest consideration.

Since, however, the question is in the air, it may be as well to consider what is wrong with our present methods, and what sort of improvements are suggested by the reformers. At present, as every one knows, international payments are in normal times ultimately settled by shipments from one country to another of gold. Gold has achieved this position for reasons which have been described in all the currency text-books. Mankind proceeded from a state of barter to a condition in which one particular commodity was used as the chief means of payment simply because this process was found to be much more convenient. Under a system of barter an exchange could only be effected between two people who happened to be possessed each of them of the thing which the other one wanted, and also at the same time to want the thing which the other one possessed, and the extent of their mutual wants had to lit so exactly that they were able to carry out the desired exchange. It must obviously have been rare that things happened so fortunately that mutually advantageous exchanges were possible, and the text-books invariably call attention to the difficulties of the baker who wanted a hat, but was unable to supply his need because the hatter did not want bread but fish or some other commodity.

It thus happened that we find in primitive communities one particular commodity of general use being selected for the purpose of what is now called currency. It is very likely that this process arose quite unconsciously; the hatter who did not want bread may very likely have observed that the baker had something, such as a hit of leather, which was more durable than bread, and which the hatter could be quite certain that either he himself would want at some time, or that somebody else would want, and he would therefore always be able to exchange it for something that he wanted. All that is needed for currency in a primitive or any other kind of people is that it should be, in the first place, durable, in the second place in universal demand, and, in the third place, more or less portable. If it also possessed the quality of being easily able to be sub-divided without impairing its value, and was such that the various pieces into which it was sub-divided could be relied on not to vary in desirability, then it came near to perfection from the point of view of currency.

All these qualities were possessed in an eminent degree by the precious metals. It is an amusing commentary on the commonly assumed material outlook of the average man that the article which has won its way to supremacy as currency by its universal desirability, should be the precious metals which are practically useless except for purposes of ornamentation. For inlaying armour and so adorning the person of a semi-barbarous chief, for making into ornaments for his wives, and for the embellishment of the temples of his gods, the precious metals had eminent advantages, so eminent that the practical common sense of mankind discovered that they could always be relied upon as being acceptable on the part of anybody who had anything to sell. In the matter of durability, their power to resist wear and tear was obviously much greater than that of the hides and tobacco and other commodities then fulfilling the functions of currency in primitive communities. They could also be carried about much more conveniently than the cattle which have been believed to have fulfilled the functions of currency in certain places, and they were capable of sub-division without any impairing of their value, that is to say, of their acceptability. Merely as currency, precious metals thus have advantages over any other commodity that can be thought of for this purpose.

So far, however, we have only considered the needs of man for currency; that is to say, for a medium of exchange for the time being. It is obvious, however, that any commodity which fulfils this function, that is to say, is normally taken in payment in the exchange of commodities and services, also necessarily acquires a still more important duty, that is, it becomes a standard of value, and it is on the alleged failure of gold to meet the requirements of the standard of value that the present attack upon it is based. On this point the defenders of the gold standard will find a good deal of difficulty in discovering anything but a negative defence. The ideal standard of value is one which does not vary, and it cannot be contended that gold from this point of view has shown any approach to perfection in fulfilling this function. It could only do so if the supply of it available as currency could by some miracle be kept in constant relation with, the supply of all other commodities and services that are being produced by mankind. That it should be constant with each one of them is, of course, obviously impossible, since the rate at which, for example, wheat and pig-iron are being produced necessarily varies from time to time as compared with one another. Variations in the price of wheat and pig-iron are thus inevitable, but it can at least be claimed by idealists in currency matters that some form of currency might possibly be devised, the amount of which might always be in agreement with the amount of the total output of saleable goods, in the widest sense of the word, that is being created for man's use.

It need not be said that this desirability of a constant agreement between the volume of currency and the volume of goods coming forward for exchange is based on what is called the quantitative theory of money. This theory is still occasionally called in question, but is on the whole accepted by most economists of to-day, and seems to me to be a mere arithmetical truism if we only make the meaning of the word "currency" wide enough; that is to say, if we define it as including all kinds of commodities, including pieces of paper and credit instruments, which are normally accepted in payment for goods and services. This addition of credit instruments, however, is a complication which has considerably confused the problem of gold as the best means of ultimate payment. Taken simply by itself the quantitative theory of money merely says that if money of all kinds is increased more rapidly than goods, then the buying power of money will decline, and the prices of goods will go up and vice versa. This seems to be an obvious truism if we make due allowance for what is called the velocity of circulation. If more money is being produced, but the larger amount is not turned over as rapidly as the currency which was in existence before, then the effect of the increase will inevitably be diminished, and perhaps altogether nullified. But other things being equal, more money will mean higher prices, and less money will mean lower prices.

But, as has been said, the question is very greatly complicated by the addition of credit instruments to the volume of money, and this complication has been made still more complicated by the fact that many economists have refused to regard as money anything except actual metal, or at least such credit instruments as are legal tender, that is to say, have to be taken in payment for commodities, whether the seller wishes to do so or not. For example, many people who are interested in currency questions would regard at the present moment in this country gold, Bank of England notes, Treasury notes, and silver and copper up to their legal limits as money, but would deny this title to cheques. It seems to me, however, that the fact that the cheque is not and cannot be legal tender does not in practice affect or in any way impair the effectiveness of its use as money. As a matter of fact cheques drawn by a good customer of a good bank are received all over the country day by day in payment for an enormous volume of goods. In so far as they are so received, their effect upon prices is exactly the same as that of legal tender currency. This fact is now so generally recognised that the Committee on National Expenditure has called attention to the financing of the war by bank credits as one of the reasons for the inflation of prices which has done so much to raise the cost of the war. It is, in fact, being generally recognised that the power of the bankers to give their customers credits enabling them to draw cheques amounts in fact to an increase in the currency just as much as the power of the Bank of England to print legal tender notes, and the power of the Government to print Treasury notes.

Thus it has happened that by the evolution of the banking system the use of the precious metals as currency has been reinforced and expanded by the printing of an enormous mass of pieces of paper, whether in the form of notes, or in the form of cheques, which economise the use of gold, but have hitherto always been based on the fact that they are convertible into gold on demand, and in fact have only been accepted because of this important proviso. Gold as currency was so convenient and perfect that its perfection has been improved upon by this ingenious device, which prevented its actually passing from hand to hand as currency, and substituted for it an enormous mass of pieces of paper which were promises to pay it, if ever the holders of the paper chose to exercise their power to demand it. By this method gold has been enabled to circulate in the form of paper substitutes to an extent which its actual amount would have made altogether impossible if it had had to do its circulation, so to speak, in its own person. From the application of this great economy to gold two consequences have followed; the first is that the effectiveness of gold as a standard of value has been weakened because this power that banks have given to it of circulating by substitute has obviously depreciated its value by enormously multiplying the effective supply of it. Depreciation in the buying power of money, and a consequent rise in prices, has consequently been a factor which has been almost constantly at work for centuries with occasional reactions, during which the process went the other way. Another consequence has been that people, seeing the ease with which pieces of paper can be multiplied, representing a right to gold which is only in exceptional cases exercised, have proceeded to ask whether there is really any necessity to have gold behind the paper at all, and whether it would not be possible to evolve some ideal form of super-paper which could take the place of gold as the basis of the ordinary paper which is created by the machinery of credit, which would be made exchangeable into it on demand instead of into gold.

It is difficult to say how far the events of the war have contributed to the agitation for the substitution for gold of some other form of international currency. It would seem at first sight that the position of gold at the centre of the credit system has been shaken owing to the fact that in Sweden and some other neutral countries the obligation to receive gold in payment for goods has been for the time being abrogated. The critics of the gold standard are thus enabled to say, "See what has happened to your theory of the universal acceptability of gold. Here are countries which refuse to accept any more gold in payment for goods. They say, 'We do not want your gold any more. We want something that we can eat or make into clothes to put on our backs.'" This is certainly an extremely curious development that is one of the by-products of war's economic lessons. But I do not feel quite sure that it has really taught us anything new. All that has ever been claimed for gold is that it is universally acceptable when men are buying and selling together under more or less normal circumstances. It has always been recognised that a shipwrecked crew on a desert island would be unlikely to exchange the coco-nuts or fish or any other commodities likely to sustain life which they could find, for any gold which happened to be in the possession of any of them, except with a view to their being possibly picked up by a passing ship, and returning to conditions under which gold would reassume its old privilege of acceptability.

During the war the shipping conditions have been such that many countries have been hard put to it, especially if they were contiguous to nations with which the Entente is at present at war, to get the commodities which they needed for their subsistence. The Entente, with its command of the sea, has found it necessary to ration them so that they should have no available surplus to hand on to the enemy. They have very naturally endeavoured to resist these measures, and in order to do so have made use of the power that they exercise by their being in possession of commodities which the Entente desires. They have shown a tendency to say that they would not part with these commodities unless the Entente allowed them to have a larger proportion of things needed for subsistence than the Entente thought necessary for them, and it was as part of this battle for larger imports of necessaries that gold has been to some extent looked upon askance as means of payment, the preference being given to things to eat and wear rather than to the metal. These wholly abnormal circumstances, however, do not seem to me to be any proof that gold will after the war be any less acceptable as a means of payment than before. The Germans are usually credited with considerable sagacity in money matters, with rather more, in fact, I am inclined to think, than they actually possess; they, at any rate, show a very eager desire to collect together and hold on to the largest possible store of gold, obviously with a view to making use of it when the war is over in payment for raw materials, and other commodities of which they are likely to find themselves extremely short. America also has shown a strong tendency to maintain as far as possible within its borders the enormous amount of gold which the early years of the war poured into its hands. While such is the conduct of the chief foreign nations, it is also interesting to note that one comes across a good many people who, in spite of all the admonitions of the Government to all good citizens to pay their gold into the banks, still hold on to a small store of sovereigns in the fear of some chain of circumstances arising in which only gold would be taken in payment for commodities. On the whole, I am inclined to think that the power of gold as a desirable commodity merely because it is believed to be always acceptable has not been appreciably shaken by the events of the war.

This does not alter the fact that, as has been shown above, gold, complicated by the paper which has been based upon it, cannot claim to have risen to full perfection as a standard of value. In primitive times the question of the standard of value hardly arises. Transactions are for the most part carried out and concluded at once, and any seller who takes a piece of metal in payment for his goods does so with the rough knowledge of what that piece of metal will buy for him at the moment, and that is the only point which concerns him. The standard of value only becomes important when under settled conditions of society long-term contracts bulk large in economic transactions. A man who makes an investment which entitles him to 5 per cent. interest, and repayment in 30 years' time, begins to be very seriously interested in the question of what command over commodities his annual income of 5 per cent. will give him, and whether the repayment of his money at the end of 30 years will represent the repayment of anything like the same amount of buying power as his money now possesses. It is here, of course, that gold has failed because, as we have seen, the process has been a fairly steady one of depreciation in the buying power of the alleged standard and a rise in the prices of other commodities. This means to say that the investor who has accepted repayment at the end of 30 years of the amount that he lent, be it £100 or £10,000, has found that the money repaid to him had by no means the same buying power as the money which he originally invested.

Within limits this tendency of the standard of value towards depreciation has possessed considerable advantages, probably much greater advantages than would have followed from the contrary process if it had been the other way round. If we can imagine that the currency history of the world had been such that a constantly diminished quantity of currency in relation to the output of other commodities had caused a steady fall in prices, it is obvious that there might have been a very considerable check to the enthusiasm of industry. It has indeed been contended that the scarcity of precious metals which, with the absence of an organised credit system, produced this result during the later Roman Empire was a very important cause of the decay into which that Empire fell. I do not feel at all convinced that this effect would necessarily have followed the cause. It seems to me that the ingenuity of enterprising man is such that the producer might, and probably would, have found means for facing the probability of depreciation in price. But it is always an empty pastime to try to imagine what would have happened "if things had been otherwise." What we do know is that a period of rising prices, especially if the rise does not go too fast, stimulates the enterprise of producers, and sets business going actively, and consequently it may at least be claimed that the failure of the gold standard to maintain that steadiness of value which is an obvious attribute of the ideal standard has at least been a failure on the right side, by tending to depreciation of the value of currency, and so to a rise of the prices of other commodities. Obviously, people will tuck up their sleeves more readily to the business of production and manufacture if the course of the market in the product which they hope to sell some day is likely to be in their favour rather than against them.

And when all is admitted concerning the failure of the existing standard of value, the question is, what substitute can we find which will carry with it all the advantages that gold has been shown to possess, and at the same time maintain that steadiness of value which gold has certainly lacked? We hear airy talk of an international currency based on the credit of the nations leagued together to promote economic peace. It is certainly very obvious that the diplomatic relations of the world require complete reform, and the system by which the nations at present settle disputes between themselves has been found by the experience of the last four years to be so disgusting, so barbarous and so ridiculous that all the most civilised nations of the world are determined to go on with it until it is stopped for ever. Nevertheless, obvious as it is that some kind of a League of Nations is essential as a form of international police if civilisation is to be rescued from destruction, it is very doubtful whether such an organisation could, at least during the first half-century or so of its existence, be called upon to tackle so difficult a question as that of the creation of an international currency based on international credit. In the first place, what will be required more than anything else after the war in economic matters will be the elimination of all possible reasons for uncertainty; so much uncertainty and difficulty will be inevitable that it seems to me to be almost criminal to add to those uncertainties by an outburst of eloquence on the part of currency reformers if there were any danger of their recommendations being accepted. It will be difficult enough to know where the producers of the world are to get raw material, find efficient labour, and then find a market for their products, without at the same time upsetting their minds with doubts concerning some kind of new-fangled currency that is to be created, and in which they are to be made to accept payment, with the possibilities of changes in the system which may have to be effected owing to some quite unforeseen results happening from its adoption. The gold standard, with all its failures, we do know; we also know that something may be done some day to remedy them if mankind can produce a set of rulers capable of approaching the question with all the knowledge and experience required; but to substitute this system at a time of great uncertainty for one which might or might not work would seem to be tempting Providence in an entirely unnecessary manner at a time when it is above all necessary to get the economic ship as far as possible on an even keel.

If the proposed substitute is to succeed it will have to be at least as acceptable as gold, and at the same time its quantity must be so regulated as to be at all times constant in relation to the output of commodities. Can we pretend that the economic enlightenment of mankind has yet reached a point at which such a currency could be produced and regulated by the Governments of the world and be accepted by their citizens?

BONUS SHARES

July, 1918

A Deluge of Bonus Shares--The Effect on the Market--A Problem in Financial Psychology--The Capitalisation of Reserves--The Stock Exchange View--The Issue of Bonus-carrying Shares--The Case of the A.B.C.--A Wiser Variation from Canada--Bonus Shares on Flotation--An American Device--Midwife or Doctor?--The Good and Bad Points of Both Systems.

Of the many kinds of Bonus shares, the one which has lately been most prominent in the public eye is that which is produced by the capitalisation of a reserve fund. There has lately been a perfect epidemic of this kind of Bonus share, which is almost as plentiful as the caterpillars in the oak trees and the green fly on the allotments. The reason for this outburst is apparently the anxiety which the directors of many prosperous industrial companies feel lest the high dividends which good management and sound finance in the past have enabled them to pay should lay them open to misunderstanding and attack by well-meaning people who think that it is a crime for a company to earn more than a certain percentage on its capital.

This explanation was very frankly given by the directors of Brunner, Mond and Company, when they lately capitalised part of their reserves. The company, they stated, has for many years paid a dividend on its Ordinary shares of 27-1/2 per cent., and "the directors feel that there is a widespread impression that this is the rate of profit earned on the total of the capital invested, and consequently that the company is making an unfair profit out of its customers and the labour it employs. This is by no means the case." It is a lamentable proof of the backward state of the economic education of this country that it should be necessary for well-financed and prosperous concerns to take steps to make it quite clear to the public that they are not earning more than they appear to be. In a well-educated community it would be perceived at once that it is the well-financed and prosperous companies which improve production in the interests of their shareholders, their workmen, and the public; that the price which the public pays for a commodity is ultimately the price at which the worst financed and worst managed companies can just manage to keep alive; that the higher profits earned by the better companies are not wrung out of the pockets of the community, or their workmen, but are the result of good management and good finance; and that the more the good companies are encouraged to go ahead and drive the bad ones out of existence, the better will the community be served, and the better will be the chance of the workmen to get good wages. These platitudes are of course, only true in a state of free competition. If there is anything like monopoly the public and the workers are fully justified in being suspicious and examining the source from which high dividends are produced.

Such being the reason why this outburst of capitalisation of reserves first began--since in these days all capitalists and those who have to manage capital feel that they are working under criticism, which is not only jealous and suspicious (as it should be), but is also too often both ignorant and prejudiced--it is interesting to note that the movement which was so started has been stimulated by its very exhilarating effect on the market in the shares of the companies concerned. Why this should be so it is difficult at first sight to say. What happens is merely this--that a company, let us suppose, for the sake of simplicity, with a capital consisting wholly of 3,000,000 Ordinary shares, has accumulated out of past profits, or out of premiums on new issues of shares, a reserve fund of £1,000,000. Its net profit has lately averaged £400,000, and it has, year by year, distributed £300,000 in the shape of a 10 per cent. dividend to its shareholders, and put £100,000 into its reserve fund, which is represented on the other side of the balance-sheet by buildings and plant and a certain amount of first-class investments. If the directors now decide to capitalise that £1,000,000 of reserve fund, the only effect is that each shareholder will be given one new share for every three which he holds in the existing capital, the reserve fund will be wiped out, and the ordinary capital will be increased from £3,000,000 to £4,000,000. None of the shareholders will be in actual fact better off to the extent of one halfpenny, because all will be in the same position with regard to one another; their relative shares in the enterprise will not have been altered. If we imagine, by way of simplifying the problem, that all the Ordinary shares were in one hand, that one holder would have had in his Ordinary shares a claim to the total assets of the company, that is to say, to its earning power as long as it is a going concern, and to whatever its assets realise if it went into liquidation; the fact that £1,000,000 worth of the assets had been bought out of past profits or premiums paid on new issues of shares would have already added to the value of the claim that he had on the property of the company, and no addition would be made to that value by turning the reserve fund into shares.

In other words, the reserve fund is already the property of the shareholders, and to convert it from reserve fund into capital, making them a present of new shares, which merely represent their claim to the assets held against the reserve fund, is as empty a gift as presenting a man with a piece of paper informing him that he is the owner of his own hat. All this remains equally true if, besides the ordinary capital, there is a considerable amount outstanding of Preference shares and Debenture debt. In any case, the Ordinary shareholders possess a claim to the earning power of the company when prior charges have been satisfied, and to whatever surplus may remain on liquidation after first charges have been paid off in full. Whether that interest of theirs is represented by a larger or smaller number of shares, or by shares of a larger or smaller denomination, or by a reserve fund upon which they have a claim when all other claims have been settled makes no difference whatever as a matter of academic fact. Apart from the sentiment of the matter, there is no reason why ordinary capital should have any nominal value.

As to the earning power of the company, that, of course, is not affected one whit by the process. The earning power of the company is all in the assets--the plant, machinery and other property--plus the elusive qualities which are bound up in the word "goodwill," representing the selling power, organisation, and the expectation of future profits. The capitalisation of the reserve simply affects the manner in which the liabilities of the company are arranged, and the existence of a reserve fund merely means that the Ordinary shareholders have a claim to a larger amount than their nominal holding in case of liquidation. It does not matter in the least whether this larger claim is handed to them in the shape of a certificate, since the nominal amount of their claim has nothing whatever to do with the amount that their claim realises to them annually in the shape of dividends, or in the event of liquidation, from the realisation of the company's assets.

In fact, the capitalisation of reserves is sometimes criticised by economic purists as a retrograde step because it seems likely to encourage the directors to be extravagant in the matter of dividends. In the example which we supposed above of the company with a capital of three millions and reserve fund of one million, if the reserve fund is turned into Ordinary shares and the earning power of the company remains the same there may obviously be a temptation to the directors to modify the prudent policy under which they had hitherto placed one hundred thousand a year to reserve, because if they continued it the shareholders would discover they were really no better off and that they simply got a lower rate of dividend on the larger amount of shares, and that their actual receipts from the company were exactly the same as before. And if the earning power of the company remained the same and the directors left off placing the one hundred thousand a year to reserve, and paid away the whole of the net profit in dividend, it is clear that the progressive expansion of the company's business would be to that extent checked. On the other hand, there is a contrary argument that as long as the company has a large reserve fund there is a possibility that dissatisfied shareholders may agitate for a realisation of sufficient assets to enable that reserve fund to be distributed, especially if it has been wholly acquired out of past profits. In this case the capitalisation of the reserve fund puts this temptation out of their reach since, when once the reserve fund has been capitalised, it can only be got at by greedy shareholders through the process of liquidation. Since, however, the shareholder in these times is not quite so short-sighted as he used to be, there is not perhaps really very much advantage in this point.

But since, as has been shown, capitalisation of reserves has no effect upon the earning power and assets of the company, it is interesting to try and discover why the rumour and announcement of such an intention on the part of the board of directors is nearly always accompanied by a rise in the shares of the company affected. If the shareholder is merely to be given a larger nominal claim, which does not in the least affect the value of the assets which that claim concerns, and if the relative amount of his claim is exactly the same with regard to the other shareholders, it is clear that the rise in the value of the shares is based entirely either on a psychological mistake on the part of the public and its financial advisers, or on the fact that the transaction called attention to the value of the shares which have hitherto been undervalued in the market. Probably the movement arises from both these causes. A large number of people think they are better off if they have a larger nominal share, without considering that all the other shareholders are at the same time having their claim increased, that the assets to which they all have a claim are not being increased, and that, consequently, if a sharing-out process were to take place they would all be exactly as they would have been if no such capitalisation of reserves had been carried out. And if a sufficient number of people think that a share or any other commodity is more valuable, it thereby becomes more valuable, because value is nothing else than the amount, whether in money or other commodities, at which a commodity can be disposed of.