The most urgent business of post-war economists was to understand and correct the disequilibrium in international economic relations in the post-war world. Churchill’s announcement of 28 April 1925 was the most salient manifestation of an impulse to reinstate the financial normality that had been swept away by the First World War. Before 1914 virtually the whole world – with China the main exception – adhered to the gold standard, a system that sought to make gold the essence of anything reckoned as money, thus reducing the various national currencies to merely measures of certain amounts of gold. In an age of imperial rivalry, gold was the world’s financial emperor who brooked no borders.
The gold standard was destroyed in 1914. All of the belligerent nations (save the United States) discarded the gold standard and experienced rapid inflations. At the close of the war, Germany, Austria and Russia plunged into hyperinflation that annihilated traditional parities.[11] The end of the war also brought reparations, which applied new pressures to exchange rates. Some feared that the burden of reparations on the defeated powers would depreciate their exchange rates, as the defeated countries, in order to pay for reparations, sought to capture export markets by cheapening their exports.
Australia, too, effectively left the gold standard with war. Australian currency had been fixed to gold since the establishment of the Sydney Mint in 1855. With war the gold standard became a fiction, the note issue expanded, and in the six-year period following 1913–14 consumer prices rose by 60 per cent. With both the Australian pound and sterling separated from the gold standard, the rate of the exchange between the two pounds became variable. By 1924 the Australian pound had deviated from pound sterling by four per cent, a small deviation but the largest in 70 years, and the deviation scandalised many.
In seeking to understand this monetary instability, the four economists could draw on two opposing tendencies in monetary thought: one of which might be called ‘neo-quantity theorising’, and the other ‘post-quantity theorising’.
Principal among neo-quantity theorists was Brigden’s patron, Edwin Cannan, and to a lesser degree, Irving Fisher. Fisher had popularised the Quantity Theory in a so-called ‘equation of exchange’:
MV = PT
where the symbol, M stood for the stock of money, V for the number of times M was turned over in the year (the velocity of circulation), P the price of a basket of goods during the year, and T the volume of trade over the year.
The Quantity Theory of Cannan and Fisher was logically distinct from the gold standard. But as quantity theorists wanted the money supply limited, and as the gold supply was limited, the notion of ‘making money gold’ was appealing. Therefore neo-quantity theorists favoured a restoration of the link with gold, although some (like Fisher) preferred the link to be a variable one. In Australia the neo-quantity theorists were in control of the newly instituted Notes Issue Board which controlled the quantity of Australian currency, and they applied a regime of monetary restriction from which they expected a restoration of the link to gold (Coleman 2001b).
The alternative to the Quantity Theory might be called ‘post-quantity theorising’, the leading articulator of which was Keynes in his Tract on monetary reform. This alternative accepted that the Quantity Theory bore truth, but maintained that the truth it bore was incomplete, conditional, even potentially misleading. They attached a significance to ‘credit’ and bank lending, which the Quantity Theory never had. To the ‘post-quantity theorists’, the question of the relation between money and prices, which had seemed closed with the Napoleonic Wars, was again an open one.
In this contest the four did as they usually did – cordially receive the modern innovation, while expressing respect for the past. None of the four took an extreme position. None of the four had a sharply defined doctrinal position.
Brigden, in a paper he submitted to the Economic Journal, took up a theoretical position imbued with the spirit of compromise. ‘The growing liquidity of ownership makes it more impossible to draw a line between promises to pay money on demand at some future date, and even other property rights virtually convertible into money at will’ (Brigden 1923, p. 22). Therefore, he concluded cautiously, ‘the quantity theory is somewhat attenuated’. He expressed his vision of this attenuation with a metaphor seemingly deliberately modelled on Tycho Brahe’s own attempt at compromise between Copernicus and Ptolemy. Whereas the classical view placed money at the centre of the solar system, with trade and banking orbiting about it, the new thinking would place trade at the centre, and would have money and banking doing the orbiting. Brigden would demote money, but not quite so radically: trade is the sun and money the orbiting planet – to this extent Brigden was the revolutionary Copernican. But banking itself was not a distinct planet charting its own course, but merely money’s moon.[12]
The contribution of the remaining three was not to affirm any strong theoretical proposition, but to give a measure of welcome to the tendencies of modern policy, and to investigate the alternatives empirically.
Copland’s contribution was a novel investigation of the relation between the outburst of inflation and monetary expansion that Australia had experienced since 1914. His main concern was to determine whether the Quantity relationship held between money and prices. He began by using a wide range of Australian economic data to calculate estimates of M, V and T for 1901–17. He then computed the magnitude of (V/T)M for 1901–17. If the ‘equation of exchange’ had held in Australia over the 1901–17 period, this computed magnitude should also have been the P series. So having produced the P series which would have been observed if the ‘equation of exchange’ had applied, he then compared it with the P series that was actually observed. His judgement was that the two P series – the hypothetical and the actual – displayed close agreement. This being so, he felt justified in concluding that ‘The equation of exchange may be regarded as true for Australia’ (Copland 1920, p. 505).
The exercise was an elementary one by later standards, but Copland maintained that it was entirely original: the hypothetical P series which he had generated was, he said ‘the first of its kind known to the writer’. And he seems to have been correct. The level of empirical investigation of the Quantity Theory still consisted of comparing percentage changes in actual M and actual P.[13] It was not until the mid-1920s that Holbrook Working initiated the calculation of coefficients of correlation between M and P (Working 1923).
The confirmation of Copland’s contribution was its acceptance – in no ordinary way - for publication in the Economic Journal by its editor, J. M. Keynes. Keynes wrote: ‘I am much obliged to you for sending me your masterly article on ‘Currency and prices in Australia’, and I gladly accept it for the Economic Journal. You have clearly taken great pains in the investigation, and the results are of high general interest.’[14]
Copland did not see his vindication of the Quantity Theory as vindicating the policy of a gold standard. As Copland claimed: ‘Modern theorists base their work on this distrust [‘of any standard based upon a commodity like gold’], and one of the principal aims of monetary theory in recent years has been to devise a means of escape from the gold standard’ (Copland 1920). At most, Copland and Giblin[15] would grant a benevolent nod to a flexible gold standard of the type favoured by Fisher – in this scheme, the gold value of money would be fixed by government, but its gold value would be periodically revised by government.
Copland himself did not fight the war against the gold standard. But as editor of the Economic Record he gave room to his old Tasmanian pupil Keith Isles to launch a Quantity Theory critique of the gold standard from Caius College, Cambridge (Isles 1931).
Isles began with the contention that the gold standard had been adopted in Australia with little or no consideration of its suitability to local circumstances. It was, regrettably, not suitable, as it left the money supply vulnerable to balance of trade shocks, since the world would use money balances in times of export booms to pay for Australian exports (and, conversely, Australia would use part of her money balances to pay for imports in times of import booms). Compounding the difficulty, the banking system spread throughout the economy (both secondary and primary) the impact of disturbances to the foreign exchange reserves, caused by such fluctuations in exports of primary products. An increase in sterling balances in London (due perhaps to improved wool prices) would induce banks to increase lending in Australia. As a consequence, ‘Rapid expansions and contractions in credit’ are the concomitant of the gold standard. ‘Monetary policy should be designed to prevent them [= reverberations of disturbances of primary products], but Australian monetary policy actually promotes them’.
In the next issue of the Economic Record, Isles’ paper was criticised by his old classmate from Economics II, Roland Wilson (Wilson 1931a). His studies since the two last met had prepared Wilson well to give Isles a lesson in careful empirical inquiry. He showed that a correlation Isles had prized – that between ‘net increase in banking funds abroad’ and the ‘excess of deposits over securities’ – was an accounting tautology. As for the hypothesised dependence of advances upon the excess of deposits over advances, Wilson showed the correlation between the two was negative. But Wilson was more interested in truth, than in proving Isles wrong. He also demonstrated, in support of Isles, a correlation of 0.44 of excess advances with prices.
Isles replied in the next volume of the Economic Record (Isles 1932). He conceded some errors. He perhaps need not have been so modest. In the last pages of his reply he noted the ‘considerable sympathy’ between a plotting of the annual rate of change in prices in Australia between 1913 and 1930, and the plotting of the (inverted) unemployment rate. Isles had stumbled on the Phillips Curve.