Uneasy Money

Clara Mattei, associate professor of economics at the New School for Social Research, recently published a book, The Capital Order: How Economists Invented Austerity and Paved the Way to Fascism, (University of Chicago Press) in which she argues that the fiscal and monetary austerity imposed on Great Britain after World War I to restore the gold standard at the prewar parity of pound to the dollar provided a model for austerity policies imposed by Mussolini in Italy when he took control of the Italian state in the early 1920s. In making her argument, Mattei identifies Hawtrey, Director of Financial Enquiries in the British Treasury for the entire interwar period, as the eminence grise behind the austerity policies implemented by the Treasury and the Bank of England to restore convertibility at the prewar parity.

Mattei’s ideological position is obviously left of center, and her attempt to link British austerity policies during the 1920s with the rise of fascism in Italy furthers her ideological agenda. Although that agenda is not mine, my only interest here is to examine her claim that Hawtrey was the intellectual architect of the austerity policies she deplores. I leave it to others to assess her broader historical claims.

In her introductory chapter, Mattei (p. 10) justifies her attention to Hawtrey, by claiming that his “texts and memoranda . . . would serve as the guidelines for British austerity after World War I,” describing the Treasury officials Sir Basil Blackett and Sir Otto Niemeyer, under whom Hawtrey served, as “working at his side,” as if they were Hawtrey’s subordinates rather than the other way around. At the end of the chapter, Mattei (p. 20) writes: “I was riveted by the evidence of Hawtrey’s persuasion of the other two bureaucrats, and in turn how the two bureaucrats, neither one a trained economist, came to be missionaries in campaigns to export the British austerity agenda to other countries around the globe.” In a later passage (p. 171), she elaborates:

In the face of unrelenting opposition, Niemeyer and Blackett needed solid intellectual grounds to urge the chancellor of the exchequer to move for dear money and drastic cuts in public expenditures. In examining the controllers’ confidential Treasury files—virtually the only direct source of information we have about their economic beliefs—one is struck by the ubiquity and influence of the economist Ralph G. Hawtrey, the primary source of economic knowledge for Blackett and especially for Niemeyer. In fact, there is ample evidence that Hawtreyan economics refined and strengthened the economic stance of the senior Treasury officials, so as to enable the emergence of a full-blown austerity doctrine.

Given her emphasis on the documentary record left by Hawtrey during his nearly three decades as the in-house economist at the Treasury, I would have expected to see more than just the few direct quotations and citations from the voluminous internal memos written by Hawtrey to his Treasury colleagues to which Mattei makes general reference. The references to Hawtrey’s communications with his colleagues provide few specifics, while the more numerous citations to his writings seem to misinterpret, misrepresent or mischaracterize Hawtrey’s theoretical and policy views.

It should also be noted that Mattei’s estimation of Hawtrey’s influence at the Treasury is not shared by other researchers into Hawtrey’s life and career. R. D. C. Black, who wrote an admiring biographical essay on Hawtrey for the British Academy of which Hawtrey became a member in 1935, wrote dismissively of Hawtrey’s influence at the Treasury.

Hawtrey drew up many and varied reports and memoranda on economic and financial matters which are now to be found among the papers of senior Treasury officials of that period, but the impression prevails that they did not receive much attention, and that the Financial Enquiries Branch under Hawtrey was something of a backwater.

R. D. C. Black, “Ralph George Hawtrey, 1879-1975.” In Proceedings of the British Academy, 1977, p. 379.

Susan Howson, in her biographical essay on Hawtrey, believed that Hawtrey was influential eary in his tenure as Director of Financial Enquiries, primarily because of his important role in drafting the financial resolutions for the Genoa Conference of 1922, about which more will be said below, but that his influence declined subsequently. Mattei cites both Black and Howson in her book, but does not engage with their assesment of Hawtrey’s influence at Treasury. Mattei also cites the unpublished doctoral dissertation of Alan Gaukroger on Hawtrey, which focuses specifically on his service as Director of Financial Enquiries at the Treasury, but does not engage with his detailed assement, based on exhaustive reading of relevant Treasury memoranda, of Hawtrey’s influence on his Treasury colleagues and superiors. Here is how Gaukroger characterizes those memoranda:

In the case of Hawtrey, who was to some extent an outsider to the very small and closely knit group of influential policy makers, the written memorandum was his method of attempting to break into, and influence, the powerful central group. . . .

Many of Hawtrey’s memoranda were unsolicited. He produced them because he was critical of some spect of Government policy. In some of these memoranda there is a marked tone of anger. This was particularly apparent during the late 1920s when the United Kingdom had returned to the Gold
Standard and Hawtrey believed that the Bank of England was pursuing a foolish and unnecessarily high interest rate policy. At this time, his memoranda, critical of Bank or even Treasury policy, could, for such a mild-mannered man, be quite savage in tone. Often, his memoranda were produced as a result of a specific request. On a very small number of occasions they were produced as a result of a direct request for guidance, or information, from the Chancellor of the Exchequer. At other times Hawtrey prepared a memorandum as a result of a Parliamentary Question. Often a senior colleague wanted support in reparing a memorandum and would seek to use Hawtrey’s expertise, particularly with regard to currency and foreign exchange. Hawtrey would invariably write an unsolicited memorandum after press criticism of Treasury Policy.

A. Gaukroger, “The Director of Financial Enquiries.” Ph.D. Thesis. University of Huddersfield, 2008, pp. 29-32

In criticizing the austerity doctrines and policies of the British Treasury and the Bank of England in the decade after World War I, Mattei mounts a comprehensive attack on Hawtrey’s views (or what she inaccurately represents to be his views) to which she, unlike other researchers, ascribes immense influence. She begins with the decision to restore the gold standard and the subsequent deflationary policy adopted in the1920-22 period to reverse the wartime and postwar inflations, and subsequently to restore the gold standard at the prewar parity of the pound to the dollar ($4.86). Mattei’s overestimation of Hawtrey’s influence is evidenced by her failure even to mention the 1918 interim report of the Cunliffe Commission (headed by the former Governor of the Bank of England Lord Cunliffe) recommending the prompt restoration of the gold standard in as close a form as possible to the prewar gold standard. Although no precise parity was specified, the goal of minimizing the departure from the prewar gold standard (except for not reintroducing a full-bodied gold coinage) made the prewar parity to the dollar, restored in 1919 to its prewar gold parity of $20.67/ounce, the obvious benchmark for restoration.

Her next object of criticism is Hawtrey’s advocacy of deflation in his 1919 article “The Gold Standard,” to reverse, if only partially, the inflation during and after the war that had cut the purchasing power of the pound by roughly 60%. The inflation, especially the postwar inflation, had been deeply unsettling, and there was undoubtedly strong political pressure on the government to halt the inflation. Although opposed to both inflation and deflation, Hawtrey believed that some deflation was needed to achieve stabilization, especially given that the US, which had restored convertibility of the dollar into gold in June 1919, would likely adopt a deflationary policy.

Mattei cites Hawtrey’s approval of the April 1920 increase in Bank rate by the Bank of England to an unprecedented 7% to break the inflationary spiral then underway. Inflation was quickly tamed, but a brutal deflation followed, while Bank rate remained at 7% for more than 12 months before a half a percent cut in April 1922 with further half-percent cuts at bimonthly intervals till the rate was reduced to 3% in July 1922.

Hawtrey’s support for deflation was less categorical and durable than Mattei claims. Prices having risen much faster than wages since the war started, Hawtrey thought that deflation would cause prices to fall before downward pressure on wages started. (See G. C. Peden, The Treasury and British Public Policy 1906-1959, Oxford: Oxford University Press, p. 154.) Once unemployment increased and wages came under significant downward pressure, Hawtrey began to call for easing of the dear-money policy of the Bank. Montague Norman, Governor of the Bank of England, aware of Hawtrey’s criticisms of Bank of England policy, shared his annoyance with Hawtrey in a letter to his counterpart at the Federal Reserve, Benjamin Strong, mentioning criticism from “a ‘leading light’ of the Treasury [who] made it his particular business to quarrel with the policy of the Treasury and the Bank of England.” (See G. C. Peden, Id. pp. 155-56.) Hawtrey later articulated the basis for his criticism.

In 1920 it was justifiable to keep up Bank rate so long as there was any uncertainty whether inflation had been successfully checked. But even in the late summer of 1920 there was no real doubt that this was so, and by November 1920, it was abundantly clear that the danger was in the opposite direction, and was that of excessive deflation.

Hawtrey, A Century of Bank Rate, London: Longmans, Green and Co., 1938, p. 133.

Mattei further attacks Hawtrey for his central role in the Genoa Conference of 1922, which, besides resolutions on other topics of international concern, adopted resolutions aimed at restoring the international gold standard. As early as in his 1919 article on the gold standard and in his important book Currency and Credit of the same year, Hawtrey was warning urgently that restoring the gold standard could cause severe–possibly disastrous–deflation unless countries rejoining the gold standard cooperated to moderate their demand for gold reserves when setting fixed parities between their currencies and gold.

Hawtrey therefore proposed that countries other than the US and Britain rejoin the gold standard by discharging their obligations in dollars or pound sterling, which were either (in the case of the dollar) already convertible into gold, or (in the case of sterling) likely to be convertible in the future. By freeing national central banks from the need to hold actual gold reserves to discharge their obligations, the Genoa proposals aimed to limit the international demand for gold, thereby moderating or eliminating the deflationary pressure otherwise entailed by restoring the gold standard. Additionally, the resulting demand by central banks to hold sterling-denominated liabilities would ease the pressure on the British balance of payments, thereby making room for the Bank of England to reduce Bank rate.

Ignoring Hawtrey’s anti-deflationary intent in drafting those resolution, Mattei focuses on the legal independence for central banks proposed by the resolutions, intended to insulate them from demands by national governments to print money to fund fiscal deficits, money printing by governments or by banks under government pressure to do so, having been, historically, a primary cause of inflation. Mattei further misrepresents Hawtrey’s call for monetary management to avoid the likely deflationary consequences of an unmanaged restoration of the prewar gold standard as evidence that Hawtrey desired to impose an even more draconian austerity on British workers than an unmanaged restoration of the gold standard would have imposed, thereby imputing to Hawtrey an intention precisely the opposite of what he meant to accomplish.

Mattei equates Hawtrey’s support for central-bank independence in the Genoa Resolutions with hostility to democracy. Quoting from Hawtrey’s 1925 article “Currency and Public Administration,” which, she suggests, betrays a technocratic and anti-democratic mindset that he shared with contemporary Italian theoreticians of fascism, Mattei seizes on the following passage:

The central bank is free to follow the precept: “never explain; never regret; never apologize.” It need make no statement of policy. Critics may rage for nine days, but in face of the silence imposed by tradition they do not keep it up.”

Hawtrey, “Currency and Public Administration” Public Administration 3(3):232-45, 243

Mattei subjects the elitist tone of Hawtrey’s defense of central bank independence to withering criticism, a criticism echoed by her ideological opposite Milton Friedman, but she neglects to quote an important explanatory passage.

The public interest in the broadest sense is profoundly affected by currency administration. Those who deprecate criticism fear an ill-judged pressure at critical times. Experience shows that, whenever an expansion of credit is developing to excess, a formidable opposition arises in the trading world to an increase in bank rate. When on the other hand, business is in a state of depression, no one minds what happens to bank rate. The influence of outside pressure is, therefore, just the contrary to what is required.

Perhaps that is so, because criticism is confined to financial and trading circles. When credits is expanding, traders want to borrow, and resent any measures which makes borrowing more difficult or more expensive. When business is depressed, they do not want to borrow. In neither case are they impelled to look beyond their own affairs to the effect of credit on the public interest.

Id.

It is interesting that Hawtrey would have written as he did in 1925 given his own recent experience in criticizing the dear money policy generally followed by the Bank of England since 1921 when the Bank of England steadfastly refused to lower Bank rate despite his own repeated pleas for rate reductions and criticisms of the Bank’s refusal to respond to those pleas.

In his lengthy and insightful doctoral dissertation about Hawtrey’s tenure at the Treasury, Alan Gaukroger, relying far more intensively and extensively than Mattei on the documentary record of Hawtrey’s tenure, discusses a Treasury Memorandum written by Hawtrey on December 5, 1925 soon after Bank of England raised Bank rate back to 5% after briefly reducing it to 4% immediately after restoration of the prewar parity with dollar in April.

The raising of the Bank rate to 5% is nothing less than a national disaster. That dear money causes unemployment is a proposition which ought not to admit of dispute. Not only is it the generally accepted opinion of theoretical economists, but it was well recognised by practical financiers and men of business before economists paid much attention to it.

Gaukroger, p. 194

Gaukroger (p. 193) also reports, relying on a recorded interview of Hawtrey conducted by Alexander Cairncross in 1965, that upon hearing the news that Bank rate had been raised back to 5%, Hawtrey went directly to Niemeyer’s office to express his fury at the news he had just heard, only to find, after he had begun denouncing the increase, that Montagu Norman himself had been seated in Niemeyer’s office behind the door he had just opened. Direct communication between Hawtrey and Norman never resumed.

Gaukroger also reports that Hawtrey’s view was dismissed not only by the Bank of England but by his superior Otto Niemeyer and by Niemeyer’s deputy Sir Frederick Leith-Ross, who invidiously compared Hawtrey in opposing an increase in Bank rate to Rudolf Havenstein, President of the German Reichsbank during the German hyperinflation of 1923.

As already mentioned, Mattei accuses Hawtrey of having harbored a deflationary bias owing to a belief that a credit economy is inherently predisposed toward inflation, a tendency that must be counteracted by restrictive monetary policy.

Mattei’s accusation of deflationary bias rests on a misunderstanding of Hawtrey’s monetary theory. In Hawtrey’s theory, if banks create too much credit, the result is inflation; if they create too little, the result is deflation. No endogenous mechanism keeps credit creation by banks on a stable non-inflationary, non-deflationary path. Once inflation or deflation sets in, a cumulative process leads to continuing, even accelerating, inflation or deflation. To achieve stability, an exogenous stabilizing mechanism, like a metallic standard or a central bank, is needed to constrain or stimulate, albeit imperfectly, credit creation by the banking system. It was only in the special conditions after World War I and the collapse of the prewar gold standard, which had been centered in London, that Hawtrey believed a limited deflation would be useful in pursuing the generally accepted goal of restoring the prewar gold standard. But the postwar deflation was far more extreme than the deflation contemplated, much less endorsed, by Hawtrey.

Mattei infers from Hawtrey’s support for deflation to reverse the postwar inflation, that he regarded inflation as a greater and more dangerous threat than inflation, without acknowledging that he regarded the 1920-22 deflation as excessive and unjustified. She also cites his endorsement of restoring convertibility of the pound at the prewar ($4.86) parity against the dollar, despite the deflationary implications of that restoration, as further evidence of Hawtrey’s approval of deflation. But Mattei ignores Hawtrey’s repeated arguments that, given the high rate of unemployment in Britain, there was ample room, even after restoration of the prewar parity, for the Bank of England to have reduced Bank rate to promote increased output and employment.

The advance of Bank rate to 5% in March 1925 supervened on a condition of things which promised to bring the pound sterling to par with the dollar without any effort at all. Credit was expanding and the price level in the United States, which may be taken as indicating the price level in terms of gold, was rising. This expansive tendency came abruptly to an end. The rediscount rate, it is true, was raised in New York, but only to 3.5%, and till 1928 the American Federal Reserve Bank adhered to moderate rediscount rates and a policy of credit relaxation. The deflationary tendency in the gold standard world was due to the continuance of dear money in London. In British industry unemployment remained practically undiminished.

Hawtrey, A Century of Bank Rate, London: Longmans, Green and Co., 1938, pp. 137-38

While Mattei acknowledges that Hawtrey favored easing monetary policy after the restoration of the prewar parity, she minimizes its significance by citing Hawtrey’s recommendation to increase Bank rate in 1939 from the 2% rate at which it had been pegged since July 1932. But by 1940 British inflation had risen above 10%, substantiating Hawtrey’s fear, with Britain about to enter into World War II, of renewed inflation.

Mattei even imputes a sinister motivation to Hawtrey’s opposition to inflation, suggesting that he blamed inflation on the moral turpitude of workers lacking the self-discipline to save any of their incomes rather than squander it all on wasteful purchases of alcohol and tobacco, in contrast to the virtuous habits of the bourgeoisie and the upper classes who saved a substantial portion of their incomes. In doing so, Mattei, in yet another misunderstanding and mischaracterization, mistakenly attributes an over-consumption theory of inflation to Hawtrey. The consumption habits of the working class are irrelevant to Hawtrey’s theory of income and prices in which total income is determined solely by the amount of credit created by the banking system.

If substantial idle resources are available, a reduced lending rate encourages retail and wholesale businesses and traders to increase their holdings of inventories by increasing orders to manufacturers who then increase output, thereby generating increased income which, in turn, leads to increased purchases of consumer and capital goods. The increase in output and income causes a further increase the desired holdings of inventories by businesses and traders, initiating a further round of increases in orders to manufacturers so that further increases in output and income are constrained by the limits of capacity, whereupon further reductions in lending rates would cause inflation rather than increased output.

While the composition of output between investment goods and consumption goods is governed, in Hawtrey’s theory, by the savings habits of households, the level of total output and income and the rate of inflation or deflation are determined entirely by the availability of credit. It was precisely on this theoretical basis that Hawtrey denied that increased public spending would increase output and employment during a depression unless that spending was financed by credit expansion (money creation); if financed by taxation or by borrowing, the public spending would simply reduce private spending by an equal amount. Mattei recognized the point in connection with public spending in her discussion of Hawtrey’s famous articulation of the Treasury View (see Hawtrey, “Public Expenditure and the Demand for Labour,”), but failed to recognize the same theoretical argument in the context of spending on consumption versus spending on investment.

I close this post with a quotation from Hawtrey’s Trade Depression and the Way Out, 2nd edition, a brilliant exposition of his monetary theory and its application to the problem of inadequate aggregate demand, a problem, as Keynes himself admitted, that he dealt with before Keynes had addressed it. I choose a passage from the last section, entitled “The Fear of Inflation,” of the penultimate chapter. Evidently, Mattei has not studied this book (which she does not cite or refer to). Otherwise, I cannot imagine how she could have written about Hawtrey in her book in the way that she did.

The fears that efforts to expand credit will be defeated in one way or anotherby the pessimism of traders are not wholly irrational. But that pessimism is no more than an obstacle to be overcome. And the much more usual view is that inflationary measures take effect only too easily

The real obstacle to measures of credit expansion is not the fear that they will not be effective, but the fear that they will. [author’s emphasis]

Yet what can be more irrational that that fear? The term inflation is very loosely used; sometimes it means any expansion of the currency or of bank credit, or any such expansion not covered by metallic reserves; sometimes it means an issue of currency by way of advances to the Government or else an issue backed by Government securities. But whatever the precise measures classed as inflationary may be, their common characteristic and the sole source of danger attributed to them is that they tend to bring about an enlargement of demand and a consequent rise of prices. And an enlargement of demand is the essential condition of recovery. To warnthe world against inflation is to warn it against economic revival.

If the economic system of the world had adjusted itself to the existing price level, there would be good reason to object to a renewed change. Inflation is rightly condemned, because it means an arbitrary change in the value of money in terms of wealth. But deflation equally means an arbitrary change in the value of money. The reason why inflation is more condemned and feared is that it is apt to appear convenient and attractive to financiers in difficulties. The consequences of deflation are so disastrous and the difficulties of carrying it out so great that no one thinks it necessary to attach any stigma to it. And since from time to time deflation has to be applied as a corrective of inflation, it is given the status of an austere and painful virtue.

But essentially it is not a virtue at all, and when it is wantonly imposed on the world, not as a corrective of inflation but as a departure from a pre-existing state of equilibrium, it ought to be regarded as a crime against humanity. [my emphasis]

Just as deflation may be needed as a corrective to an inflation to which the economic system has not adjusted itself, so at the present time inflation is needed as a corrective to deflation. If the monetary affairs of the world were wisely governed, both inflation and deflation would be avoided, or at any rate quickly corrected in their initial stages. Perhaps the ideal of monetary stability will be achieved in the future. But to start stereotyping conditions in which prices are utterly out of equilibrium with wages and debts, and with one another, would be to start the new polcy under impossible conditions.

The dread of inflation has been greatly accentuated by the experiences of the years following the war, when so many countries found that the monetary situation got completely out of control. The vicisous circle of inflation gained such power that it wrecked both the tax system and the investment market; it cut off all the normal resources for meeting public expenditure, and left Governments to subsist on issues of paper money. No country would willingly endure such a situation.

But that kind of monetary collapse does not come easily or suddenly. There is, I believe, no case in history in which inflation has got out of hand in less that three years. [author’s emphasis] . . .

The fear that one slip from parity means a fall into the abyss is entirely without foundation. Especially is that so when deflation is raging. The first impact of a monetary expansion is then felt rather in increased output than in higher prices. It is only when industry has become fully employed that the vicious circle of inflation is joined and prices begin to rise.