6. It was alleged in Germany that the favourable conditions of the balance of payments in 1922 could not exercise a beneficial influence on the German exchange because a great amount of foreign exchange was hoarded instead of being offered on the market. To this abnormal shortening of the supply of foreign bills there corresponded a similar abnormal expansion in the demand.
• Even in 1922, despite the fact that the great depreciation of the mark had already caused enormous losses to foreign possessors of German money, the sales of marks abroad continued. According to a German official publication (Deutschlands Wirt-schaftslage, Berlin, 1923), even in October 1922 the quantity of paper marks sold through some few foreign banking houses amounted to 22 milliards.
t See Plutus of August 1 st, 1923. Also Eucken, Kritische Betrachtungen zum deutschen Geldproblem, 1923, p. 13, and Lansburg, "Die Zahlungsbilanz," in Bank, July 1923. The latter maintains that in 1922, after exports, the expenditure by foreign travellers represented the most important credit item of the German balance of payments.
The disequilibrium between the demand and supply of foreign bills was the result of the following factors:
(a) Having little faith in the political and economic future of Germany and desiring to avoid taxes, German industrialists formed the habit of leaving abroad a part of the profits from exports; that is, the difference between the cost of production and the price which they received by selling abroad.
(b) Even a great part of the foreign money which was obtained by the sale of securities, houses, land, etc., was either left abroad (the "flight of capital") or hoarded at home, so that it did not come on to the exchange market.
(c) The numerous decrees which surrounded the buying of foreign exchange with difficulties, helped to lessen the supply because the possessor of foreign exchange would not give it up at any price, fearing that he would be unable to re-purchase it later when the need arose. If the authorities wished to relieve the foreign exchange market by prohibiting the purchase of foreign exchange by persons who were not traders, it was necessary to supplement the measures restricting the purchase of foreign exchange by issuing stable value securities which would offer to possessors of paper marks the possibility of investing their savings safely. This was the opinion of financial writers: but the proposal was not accepted because it was feared that, following a further depreciation of the mark, the Reich would have to bear at that too h'eavy a burden when it had to redeem the securities. But this argument was groundless, because the issue of a stable-value loan should have formed part of a general plan for the stabilization of the mark.
(d) There was a brisk demand for foreign exchange on the part of German possessors of paper marks. More and more, as the mark depreciated, the phenomenon was understood by the public and the mark ceased to be wanted as a "store of value." The mark balances of industrial firms and even of private persons were converted into shares and into foreign exchange. A considerable amount of foreign exchange was therefore continually withdrawn from the market for the purpose of more or less permanent investment. At certain times, as in October 1921, July and August 1922, and in January 1923 after the occupation of the Ruhr, the purchase of foreign exchange by the public assumed the proportions of a pathological phenomenon. The feverish acquisition of foreign exchange explained in great part the rapid fall of the mark which occurred at these periods. The situation of the foreign exchange market then appeared completely dominated by the purchases of the public, which were the consequence of the panic created by political events.
The very rapid and sharp depreciation of the mark was mainly at those times due to psychological causes, operating especially in Germany. Indeed, it was observed at those times that the impetus for the rise of the dollar originated in the German bourses and not in foreign markets, where the mark was generally quoted at a rate somewhat higher than that in Berlin. No one could blame the German investors, who sought to escape the consequences of the depreciation of the mark, by buying foreign exchange. After the "slaughter of the innocents" occasioned by the depreciation of the currency, it could not be expected that the public should continue to deposit their own money in the savings banks or invest it in Government bonds.
(e) As depreciation progressed, the mark was continually rendered more unfit for the function of the circulating medium, and for this purpose foreign exchange took the place of German money. In this way a part of the foreign currencies came to be permanently diverted into the channels of internal circulation.
(/) The depreciation of the mark stimulated an ever-growing speculation in foreign exchange. In this way a certain quantity of foreign currency which passed continually from hand to hand in speculating circles, was diverted from the money market.
(g) The purchase of foreign exchange was a method frequently used by "real" trade for diminishing the risks arising from the fluctuations of the exchange. Merchants who sold goods for future delivery for payment in paper marks protected themselves against the risk of the future depreciation of the mark by buying, at the time the contract was concluded, a corresponding quantity of foreign exchange. The practice of calculating prices in foreign money, which became widespread in the second half of 1922, as a protection against the risks of the depreciation of the paper mark, also resulted in a marked rise in the demand for foreign exchange, because merchants who assumed the obligation of paying a sum in paper marks, varying according to the rate of exchange on the day of payment, had to protect themselves against eventual losses by buying foreign exchange. This practice of insuring against the risk of the depreciation of the mark, which became more and more common towards the end of 1922, contributed therefore to the deterioration of the situation in the foreign exchange market.
In certain branches of industry, in which it was necessary to take account of risks arising from obligations contracted in foreign money, it was felt to be desirable to counteract these risks with guarantee funds in foreign exchange. That happened, for example, in assurance firms.
Hence, under conditions of the depreciation of the circulating medium, the foreign exchange market presented an altogether extraordinary appearance. When the currency is stable the demand for foreign exchange is determined by the necessity of making payments abroad. But in Germany, to this normal demand was added an entirely abnormal demand, which was principally provoked by the desire to invest savings securely in foreign exchange. It is worth mentioning that for a long time there was also a brisk demand for marks by foreigners who speculated for a rise in German money, while in Germany many people speculated for a fall. The large purchases of marks by foreigners for some time checked the rise of the exchanges. But when foreigners ceased to buy marks and a great part of the marks (either notes or bank deposits) possessed by them were offered in Germany for foreign exchange, shares, houses, goods, etc., the depreciation of German money in terms of foreign currencies and goods in the home market was intensified.
7. There is no doubt that the abnormal demand for foreign exchange on the part of the German public who determined to take part in the fi ght of capital must cause a depreciation of the exchange. This depreciation, however, could not go beyond certain limits if the quantity of marks had not been increased. In fact, the increase in the prices of foreign currencies had immediate effect on the prices of imported goods, and that—had the money income of consumers remained stable — -would have meant that prices which passed a certain limit would quickly become prohibitive. It was only due to the rise in money incomes, which was the consequence of the increase in the circulation, that it was possible that imported goods, which were sold at rising prices because of the depreciation of the exchange, could find buyers.
Besides, if the amount of the circulation and the volume of credit did not increase, there would be limits to the supply of paper marks in the foreign exchange market, and, on the whole, this supply could not be very large. The great mass of the public could not much lessen their normal purchases of consumption goods in order to buy foreign money; and manufacturers needed their money, especially for buying raw materials, paying workers, etc.* When the public sold securities, houses or land in large quantities with the object of buying foreign money with the receipts from the sales, obviously such sales were only possible while there were people with sufficient means for buying those goods and securities. If the original value (according to the cost of production or of purchase) of the goods or securities offered for saie exceeded the amount of the money saved, then either (a) the vendors must sell at a lower cost and suffer losses, which, if they went beyond a certain limit, would check sales, and therefore also the flight of capital; or (b) the purchasers must buy the goods and securities with the aid of bank credits. But in this second case it is the bank credits which stimulate the flight of capital abroad; and credit restriction would, therefore, be an efficacious obstacle to this flight.
Sometimes it happens that the demand for foreign money on the part of certain classes in country X is so inelastic that the total sum spent, in the money of X, in the purchase of foreign money increases when the currency of X is depreciated. Something like this situation arises in practice when an increase in the price of foreign currencies, instead of reducing purchases of foreign goods, induces importers to anticipate their purchases. If, besides, exports are also rather inelastic, it may be said that the depreciation of the exchange, rather than provoking reactions which re-establish the equilibrium, tend, instead, to increase the disequilibrium of the balance of payments and to accentuate the depreciation of the currency. But even in this case, if the quantity of money in the country with depreciating exchange, and therefore the money incomes of its people, is not increased, the rise in the value of foreign currencies will not go beyond a certain limit. In fact, the people of that country cannot spend more than a certain sum on foreign goods and on the purchase of foreign currencies. Besides, depreciating exchange will stimulate foreigners to purchase shares, houses, and land, so that for this reason also the depreciation cannot go beyond a certain limit.
Also, it is most improbable that the total curve of the demand for foreign money on the part of a country will remain inelastic for a long time. As soon as the public realizes that the Government has firmly decided not to increase the note issues, confidence in the national currency is re-established and the abnormal demand for foreign currencies ceases. In fact, when the mark was finally stabilized in
* The influence of an increase in the velocity of circulation will be examined in Chapter iv.
November 1923, the demand for foreign exchange was immediately reduced, and the only demand in the market was that occasioned by the normal needs of trade.
Hence, in order that the abnormal demand for foreign exchange for hoarding should exercise a detrimental influence for a long time on the national paper money (as happened in Germany), it is necessary that this demand should be fed, continually, by new issues of paper money, which also cause distrust to spread continually.
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