Money and Interest. The Business Cycle. It is hard
to say briefly anything objective and useful about
money, even ignoring all the preaching about its evils.
Denunciation is largely based on confusing it with
wealth, and wealth (also commonly confused with
income) is merely one form of power. Here the classical
political economists deserve credit; they tried to get
behind its mask or “veil,” though, as has been shown,
what they said about economic reality was largely
fallacy. And they strangely ignored for the most part
the main problem that arises from the use of money.
That problem is the periodic occurrence of “hard
times,” alternating somewhat cyclically with prosper-
ous periods. Some exception is called for by J. S. Mill's
treatment of speculation and crises (op. cit., Book III,
Ch. XII). “Mercantilist” writers had held that abun-
dance of money causes good business, either directly
or by way of lower interest rates. In the 1740's, David
Hume published his Essays with the pivotal idea that
with an increasing quantity of money, selling prices
rise more rapidly than cost prices, thus raising profits,
and conversely for falling prices—which causes busi-
ness prosperity and depression, the latter with unem-
ployment and misery.
From the sixteenth century, writers noticed the
effect of rising prices (due to influx of silver and gold
from the New World) in favoring debtors at the ex-
pense of creditors. Adam Smith noted the loss incurred
by receivers of feudal rents, etc., which had been
converted into cash from payment in kind. The infla-
tion of the period of the French Revolutionary and
Napoleonic wars led to demands that obligations be
repaid in money of the same value as that in which
they were contracted. Meanwhile, John Locke and
others had been developing in explanation the “quan-
tity theory of money”—or quantity and circulation
velocity, as even Locke recognized the role of the
latter.
A pivotal idea for cycle (or “conjuncture”) theory,
but slow to be recognized, is the general fact already
mentioned, that supply-and-demand adjustments work
on the “feedback” principle, like a speed-governor on
an engine, a thermostat, etc., and that all such mecha-
nisms produce oscillations. Thus any price normally
shows cycles of rise and decline, more or less regular,
extensive and prolonged—as normal-price theory
should recognize. The basis of the phenomenon is “lag”
in response of an effect to its cause. When the produc-
tion of “x” is profitable (say of hats, an example from
Russian propaganda) it tends to expand, but time is
required for new supply to reach the market and re-
duce the price, and, meanwhile, under individualistic
control, the movement tends to be overdone, “glutting”
the market and reversing itself. (This is abstractly an
argument for central advance planning and control—if
it could be guided by complete foresight and were free
from evils of its own.) The cycles for an item will be
longer as it takes longer to expand production
or to
exhaust an existing supply or its sources. Further, a
price bulge that would naturally be temporary is likely
to be mistaken for a trend, prolonging the effects
through reduction of current output to prepare for a
later increase. This is obvious with livestock, when
animals that would have been marketed are held back
for breeding purposes; similar causes operate elsewhere.
Familiar facts make the value of money an extreme
case for oscillation. The current “price”—the recipro-
cal of the general price-level—is not conspicuous, and
the position of equilibrium is vague in comparison with
commodities which have an organized market or a
known cost of production. And, more important, the
self-perpetuation and self-aggravating tendency of
price-movements is magnified. Rising prices make it
seem preferable to hold goods rather than money and
so to speed up the turnover of money; this stimulates
real production, especially through bank loans, creating
deposits which circulate as equivalent to more money.
Hence further rise of prices and greater profit margins,
and so on. But shortage of labor and decrease of its
quality, along with rising wages, help bring the boom
to an end—which tends to be precipitate and may
cause a panic in the loan market. Typical and pivotal
is a sharp contraction in the capital-goods industries,
spreading to those serving consumption. In the depres-
sion of the 1930's about half the calamitous unemploy-
ment occurred in the field of “durables,” which had
furnished about a fifth of the total employment.
In general, what happens at the peak of a boom—its
collapse and a drastic reversal of the trend—is readily
explained and even predictable; and in principle the
boom is largely remediable through monetary and fiscal
action. But no one knows just when to act or how much
action to take, and the public mind opposes “killing
prosperity,” and in any case tends to blame the “money
power” for the unfavorable consequences. At the bot-
tom of the cycle the situation is very different. It is
not clear why the decline stops just where it does, or
why the pickup is slow, which gives many observers
the impression of a stable equilibrium along with ex-
tensive idleness of labor and other resources. This is
self-contradictory, but explanation of the situation in-
volves many factors and discussion beyond the scope
of this article. Adjustments, including liquidations, must
be carried out, requiring time; and an essential fact
is that potential investment opportunities must be seen
far ahead, and seized by individuals. On the whole
subject, controversy is abundant.
A major aspect is the relation between monetary
phenomena and the interest rate—or rates. Boom con
ditions raise the demand for money in the investment
market and throughout the economy. At the time of
a collapse, the need for “cash” to meet commitments
may create a “panic” or near panic, causing a demand
for loans at fantastically high rates, not connected with
the long-run determination of the rate by investment
opportunities. Under such conditions one can hardly
speak of “the” rate of interest. Where the security
seems good, loans may be available at very low rates,
and otherwise only at very high rates, or not at all,
forcing bankruptcies. A full discussion would prompt
analysis of the Great Depression of the 1930's, the
“New Deal” measures, and the role of the ideas publi-
cized especially by John Maynard Keynes (later Lord
Keynes), who stressed the aspect of interest as a rent
on cash, rightly as regards very short-period changes.
From the pivotal fact of the wide instability of the
general price level and its consequences follow two
others: first, that money, and circulating credit, must
be “managed”—a policy of laissez-faire here has
“intolerable” results; but secondly, that the manage-
ment cannot be very effective, consistently with social
freedom in economic and other respects. The measures
taken under the “New Deal” administration of the
1930's to deal with unemployment and distress (“pump
priming” through public make-work projects) were
ineffective; unemployment was finally cured by the
outbreak in Europe of World War II.
