increase of credit also has been abandoned. It is one thing for
banks to provide the gold necessary to meet an internal drain,
and quite another to get the notes required in exchange for some
form of bankers' credit. It is one thing to keep a free market
for gold, and quite another for the government of a country to
meet the foreign demands for payment by borrowing abroad
instead of sending gold. It is one thing to control the move-
ments of gold by changes in the rate of interest, and quite another
to let the movements of gold depend on the governmental regu-
lations regarding import and export.
The World War Period. In tracing the progress of inflation during the World War, the case of the United Kingdom is the most instructive and important. It is also the most difficult, because the abandonment of the gold standard which opened the way for inflation was not definitely announced or admitted, and was only realized some time after the fact had been accomplished in practice. The first authoritative recognition that the gold standard was no longer operative in the United Kingdom was that made in the first report of the Cunliffe Committee issued Aug. 1918. It begins with an account of the currency system which had been effectively maintained in the United Kingdom before the war, and it points out that " under these arrangements the country was provided with a complete and effective gold standard." But the report goes on to state: " The course of the war has, however, brought influences into play in consequence of which the gold standard has ceased to be effective." The main steps in this practical abandonment are also well stated in the report. On the outbreak of war it was considered necessary by the Government not merely to give permission for a suspension of the Act of 1844, as had been done on some earlier occasions, but also to empower the Treasury to issue its own currency notes for i and IDS. as legal tender throughout the United Kingdom. It may be noted that before the war only Bank of England notes were legal tender (not the notes of other banks), and Bank of England notes were not legal tender by the bank itself. In the bank restriction (see above) full legal tender was only conferred on the notes in 1812, i.e. 15 years after the beginning of the restriction.
Under the powers given by the Currency and Bank Notes Act of 1914, the Treasury undertook to issue the new notes through the Bank of England to bankers, as and when required, up to a maximum not exceeding for any bank 20% of its liabili- ties on current and deposit accounts. The amount of notes issued to each bank was to be treated as an advance bearing interest at the current bank rate. Later on, certificates of larger denominations were issued to banks in lieu of notes, to save trouble, and it became the practice for the banks to pay for the notes in other forms of bankers' credit. In this way the principle of limitation as applied to the notes was practically abandoned. What ought to have been barriers to expansion became elastic bands that yielded at the slightest pressure. The reserves were adjusted to the liabilities and not the liabilities to the real reserves. In place of a limited amount of gold that could only be increased by being attracted from other countries, the real banking reserve was now a mass of notes which could be increased on the demand of the banks themselves. It must be said in justification of these very elastic provisions regarding the notes that it was never anticipated that the demand for internal currency would have necessitated extensive recourse to these provisions. At the beginning of Aug. 1914 an extended bank holiday was sufficient to restore confidence in the currency situation. The danger, as events showed, lay in another direc- tion. The banks were made so secure that they imposed no restraints on the demands of the Government. The inflation was made possible by the issues of the notes but the real infla- tion began with the expansion of credit. The credits created by the Bank of England in favour of its depositors, under the arrangements by which the bank undertook to discount approved bills of exchange, and other measures taken at the same time for the protection of credit, caused a large increase in the deposits of the bank. At the same time the needs of the Government for funds to finance the war in excess of what was raised by taxa-
tion and by real borrowing from the public made it necessary for the bank to create credits in favour of the Government in the shape of Ways and Means advances. The consequence was that the total amount of the deposits of the bank increased from about 56,000,000 in July 1914 to 273,000,000 in July 1915. The balances created by these operations passed, by means of payments to contractors and others, to the Joint Stock banks, and caused an increase in their deposits, which were also expanded by credits created in connexion with the various war loans. The consequence was that the total deposits of the banks of the United Kingdom other than the Bank of England increased from 1,070,681,000 in Dec. 31 1913 to 1,742,902,000 in Dec. 31 1917. This process of credit inflation is correctly described in the Cunliffe report (note, p. 4.) : " Before the war these processes if continued compelled the Bank of England to raise its rate of discount, but the unlimited issue of currency notes has now removed this check upon the expansion of credit."
The great increase in bank deposits represented a corre- sponding increase in purchasing power, which in conjunction with other causes (e.g. war demands, war obstructions, war scarcities, etc.) caused a rise in prices. The rise of prices in its turn brought about a demand for legal-tender currency for cash payments of all kinds (wages, transport, retail trade, etc.). The war contractors and others had to break up their large credits into smaller credits, and these again were transmuted into legal tenders. " The unlimited issue of currency notes in exchange for credits at the Bank of England is at once a conse- quence and an essential condition of the methods which the Government found necessary to adopt in order to meet this war expenditure." On June 30 1914 the fiduciary issue of the Bank of England was under 19,000,000, but by July 10 1918 there had been added 230,412,000 in Treasury currency notes not covered by gold.
Compared with the mass of purchasing power indicated by the growth of deposits, and still more effectively by the increase in the clearing-house returns, the increase of notes may seem of relatively small importance. The importance of the currency notes lies not in their mass compared with other forms of pur- chasing power but in their function as taking the place of gold. Before the war the Bank of England, with a smaller gold re- serve than those of other great European banks, supported a far greater mass of credit. Under certain conditions the move- ment of a few millions of gold was sufficient to threaten a crisis. Severe precautionary measures were taken to prevent the depletion of the ultimate metallic reserves. The quantity of gold was small, but it was necessary. Before the war, periodical warnings were given that the gold reserves were inadequate to bear the possible strain. By substituting currency notes for gold (and by amassing credits abroad), the quantity of gold held by the central bank became of relatively little importance.
The currency notes, as explained above, were never definitely made inconvertible. It was even provided that when they were presented at the Bank of England gold could be demanded. But since it was against the law to make any use of gold money except as currency i.e. it could lawfully be neither melted down nor exported -the presentation of currency notes for conversion in this way at the bank could only lead to unpleasant questions and possibly incriminating answers. The converti- bility was, in fact, only nominal or indefinitely suspended.
The legal prohibition of the melting of gold coin, the control both of the exportation and the importation of gold, and the consequent limitation of dealings in gold, severed the link that formerly existed between the values of coined and uncoined gold. Under normal conditions the market price of gold could only differ from the mint price of 3 1 75. io^d. by very small amounts, negligible so far as any premium on gold was concerned. Practically, in London before the war, gold coin and gold bullion were convertible to any extent at very short notice. The actual records of the price of gold in London show the stability of the price within these very narrow variations. Since there was never the least hesitation among the public in accepting the currency notes, the gold coins previously in public use were
