Młynarski vs Triffin

Although both Młynarski and Triffin considered the GES system a threat to the stability of the international monetary system, they perceived its nature differently. Młynarski was convinced that GES had a built-in inflationary mechanism (Młynarski 1929, p. 87):

Having inflationary effects and complicating the process of adjustment of prices, the gold exchange standard is responsible for a greater range of price fluctuations in the course of a year than was the case before the war. Price levels are at present more sensitive and unstable.

Thus, Młynarski expected that GES would lead to global inflation. He noted that in the years 1922-1927, the USA enjoyed a relative price stability with a relative stability of the money supply (understood as the amount of cash in circulation), which was dangerously accompanied by a rise in the volume of bank deposits and loans, as a source of future higher inflation (Młynarski 1929, p. 34):

Table 1. Changes in the monetary sphere in the United States of America in the years 1922-1927

Increase in the level of gold reserves	Increase in dollar supply	Increase in the volume of loans	Increase in the volume of deposits	Inflation*
11.45%	3.86%	35.51%	37.23%	6.5%

 Source: Author’s own elaboration based on [Młynarski 1929].

However, the problem was deflation resulting, for example,  from a drastic reduction in the money supply by the Fed for fear of losing gold reserves. The policy of sterilisation of gold pursued not only by the Fed, but also by European banks had an impact on the drastic course of the Great Depression (Młynarski 1931, p. 51). The supply of the dollar decreased by almost 30% between 1929 and 1933 due to the drastic increase in the interest rate by the Fed in 1931 (Friedman and Schwartz 1963, p. 299). This was the second rate increase, the previous one occurred in 1929, when it rose  from about 5% to 6% (Friedman and Schwartz 1963, p. 304).

The following years brought competitive devaluations. The Bank of England’s suspension of the pound-gold exchange and the devaluation of the pound from $4.86 to $3.40 initiated a cycle of devaluations in 1931-1932 in countries whose currencies were pegged to the pound, while the devaluation of the dollar against gold in 1934 reached 41% (C. Leszczyńska 2013, pp. 278-279).

As mentioned before, Młynarski noted in 1929 that  the GES system had an inflationary character (Młynarski 1929, p. 87). This was due to the fact that the balance of payments deficit of the country whose money returned to it (the US and the UK) doubled the world’s credit base and contributed to a boom in both the debtor and lender countries (Rueff 2012, p. 41).

However,  the demand factor that  caused deflation came into play. And Młynarski’s analysis of the deepening crisis in 1930 is partly Keynesian because of the  emphasis on the occurrence of an excessive supply of goods in relation to the demand for them. Although he indicated, as  the reason for this, excessively expansionary lending to production as a destabilising factor rather than a sudden decline in aggregate demand.

The volume of credit should be adjusted to the possibility of its use by economic entities (Młynarski 1931, p. 56). The number of purchase and sale transactions in the economy depends not only on the central bank gold reserves, the size of credit and production in various sectors of the economy, but also buying capacity of the home market, which, if followed with a delay in the increase in production,  leads to temporary relative overproduction and a decline in prices (Młynarski 1931, p. 56). Młynarski stressed that the central bank loan was not used to finance consumption, but production, so in the case of increase in production (stimulated by credit) exceeding the purchasing power of ultimate consumer, the balance between supply and demand was disturbed, which resulted in a fall in prices as well as economic stagnation (Młynarski 1931, p. 56).

Explaining the sources of crisis and the illusion that it was caused by a shortage of gold,  Młynarski returned to the foundation of economics, i.e. to Say’s law. In fact, we acquire goods thanks to the income we earn (the product made), and money only expresses income, which is not a monetary phenomenon (Młynarski 1931, p. 56). Buying on credit is also limited by income in the long run, because one cannot borrow indefinitely. Certainly, however, credit in itself does not increase income, but only burdens it (Młynarski 1931, p. 56). In addition, it may disturb the price mechanism, which restores the balance between production and consumption (Młynarski 1931, p. 61).  This is because credit gives entities liquidity before they make a product (income) that does not have to be created (Korczyk 2019, p. 96).

Młynarski cited data according to which in the years 1926-1928, the world population increased by 2%, the production of raw materials and food by 8%, and the volume of trade by 11%, with production and trade growing until October 1929 (Młynarski 1931, p. 58). In this connection, he concluded that oversupply, combined with widespread protectionist practices, must have led to a fall in prices and an economic slowdown. It was not the lack of gold, but long-term capital (obtained from exports, i.e. from the sales of the product)  that was responsible for the depth of the crisis due to protectionism (Młynarski 1931, p. 59). In this way, liquidity in GES countries was limited.

From a theoretical point of view, the production of a country is equal to the national income, i.e. our purchasing power is equal to production (Młynarski 1931, p. 59). This means that sooner or later there must be an adjustment of production and consumption (Młynarski 1931, p. 59). Although a long-term  general overproduction can never occur, sometimes there is some relative overproduction when the distribution of production, which is equivalent to the distribution of income, is carried out in a wrong way (Młynarski 1931, p. 59). As Młynarski enigmatically claimed, not only production, but also distribution takes place in accordance with certain laws. Market equilibrium or lack thereof is determined by whether the path leading from the producer to the final consumer is short or long and whether it takes place without obstacles, as shown by the year 1930, when millions of people in the United States and Europe were starving as a result of unemployment and food producers were struggling with low prices (Młynarski 1931, p. 59). Młynarski explained the reason for this situation in a clear way. Only a small part of a country’s national income is in the hands of consumers (Młynarski 1931, p. 59). [1]

In 1913, in most countries, production began to increase significantly, and per capita income also increased, but demand lagged behind the increase in production (Młynarski 1931, p. 60). The problem was that wholesale prices fell significantly, while retail prices hardly changed, which did not reduce the cost of living of consumers (Młynarski 1931, p. 61). For example, between 1925 and 1929 in Germany, wholesale prices fell by 6.1% with an increase in the cost of living of 11.5%; in France during 1929 wholesale prices fell by 10.9% and the cost of living increased by 1.9% (Młynarski 1931, p. 61). According to Młynarski, this situation was due to the development of a mass production system, which required mass sales to reduce unit production costs (Młynarski 1931, p. 61). Unfortunately, the real income of consumers did not increase at such a pace that would allow for an increase in spending, which was caused by excessive taxation (Młynarski 1931, p. 63):

Table 2. Increase in government spending in 1928 compared to 1913[2]

 

Country	Rise in spending
Great Britain	344%
France	82%
Germany	144%
Italy	130%
United States	434%

  Source: Author’s own elaboration based on [Młynarski 1931, p. 62]

 

Młynarski underlined that along with decreasing trade turnover and falling wholesale prices, there was no decrease in the inflow to state budgets, and  the state share in national income increased (Młynarski 1931, p. 64).

Since the state takes over a significant part of national income at the expense of private production, it must perform more and more functions that were previously reserved for the private sector (Młynarski 1931, p. 64). According to Młynarski, the state limits the accumulation of capital, the growth of national income, and then the possibilities of consumption of individuals. On the one hand, the government tried to consciously support domestic production (e.g. through protectionism), and on the other hand, it limited consumption with taxes (Młynarski 1931, p. 65). Contrary to J. M. Keynes, however, he believed that public spending should be cut and taxes lowered to help the economy out of recession. [3]

Młynarski justified this opinion by the fact that the government, through its expenditures, creates sectors of the economy that do not meet the needs of the private sector, but using its resources (taxation is the income of the public [4]sector). The growth of the state in the economy functioning within GES with the spread of customs barriers created, according to Młynarski, exceptionally favourable conditions for the crisis of the 1930s. The mechanism of relative overproduction is illustrated in Figure 2.

Figure 2. The impact of taxation and protectionism on the GES economy

The economy of a GES country received dollar loans ($), which were the reserves of the central bank converted into the national currency (M). Młynarski introduced a clear division of products in the economy of a country. Consumer and producer goods are produced for the private sector (Q1) and goods purchased by the public sector (Q2;  e.g. military equipment). Production is transformed into income (Y), which is partly saved (S) and then invested (I), consumed (C) and captured by the state in the form of taxes (T).  The private sector allocates I and C to the acquisition of Q1, and the public sector allocates T to the acquisition of Q2. As a result of improvements in mass production, Q1 exceeds total private sector spending, so in the absence of barriers to international trade, the surplus can be exported, enabling the repayment of dollar loans. Otherwise, there is a relative overproduction that cannot be absorbed by the private sector because its income is reduced by taxation. Therefore, Młynarski believed that focusing only on the removal of barriers to international trade would not solve the GES problem and it was necessary to reduce taxation and public spending.

In the GS countries (United States, United Kingdom), the reserves of the central banks were the basis for credit expansion, which allowed to finance production, with similar effects to those outlined above. Relative overproduction was a global problem, leading to deflation. Thus, Młynarski’s paradox referred to the reality in which the threat of the lack of convertibility of  key currencies into gold resulted from excessive lending to production, which was facilitated by depositing foreign exchange reserves of central banks operating within the GES in the accounts  of  foreign commercial banks. And the  threat of lower liquidity for the rest of the world was caused by  protectionist practices, in particular by  the United States. As mentioned before, the paradox of the system was that the United States, on the one hand, wanted to provide Europe with liquidity by flooding it with loans[5] and, on the other, reduced liquidity by limiting imports from Europe.

Młynarski perceived excessive customs burdens, limiting international trade, as a great threat to adjustment processes in the global economy. In particular, high tariff barriers applied by the United States to European goods raised concerns (Młynarski 1929, p. 97). As he claimed, in the interwar period, mercantilism dominated international economic relations. In the United States, this was justified by the protection of the standard of living of workers, in Western Europe by the lack of regulation on war reparations by Germany, and in the countries created under the Treaty of Versailles by the lack of gold reserves and currencies allowing participation in international trade on the principles of liberalism (F. Młynarski 1929. P. 106).

Młynarski surmised that GES hindered the return to liberalism in international trade, which required free trade in gold. It should also be remembered that there were no more gold coins in circulation, which were first used to regulate the balance of payments. In the GES system, central bank reserves were a means to this end. This change contributed to the strengthening of the mercantilist attitude among politicians (F. Młynarski 1929, p. 108). In a country with a deficit in the balance of payments, reserves flowed out and the interest rate was raised, which in the gold standard would contribute to falling prices and improving the competitiveness of exports, and then to improving the balance sheet. Unfortunately, in the GES system, the raising of the interest rate resulted in the inflow of foreign capital, which delayed the fall in prices, and sometimes prevented it (Młynarski 1929, p. 109). According to Młynarski, a necessary condition for returning to free trade was free trade in gold (central banks of GES countries bought gold, but did not sell it, while GS countries exchanged their currencies for gold).

Młynarski also believed that the GES system worked correctly only in the time of good economic situation, while any crisis could cause a massive exchange of gold reserves, therefore no political treaties can eliminate the risk and uncertainty of this system (F. Młynarski 1929, p. 90). He considered such a system absurd as it efficiently coordinated cooperation between GS and GES in “normal” times (good economic situation), but did not contain any safeguards in the event of crisis.

Młynarski was convinced that the system would be better coordinated if there were more gold centres than just in a few countries and if limits were introduced on the volume of currencies issued by the central banks of the GES system for the purchase of reserves.

He also believed that due to the lack of an international currency and the lack of equal purchasing power of gold around the world, the locally strongest currency is also the one that exerts the greatest influence on other currencies (Młynarski 1929, p. 64). Thus, even the gold standard could not free itself from dependence on the monetary system of the country with the most developed economy. After WWI, the American economy accounted for 53% of steel, 72% of oil (Młynarski 1929, p. 66). According to him, it was difficult to consider dethroning the dollar as the main reserve currency, so he thought that it became necessary to make the new GES system as effective as the gold standard had been until 1914.

In the spirit of classical economics, Młynarski emphasised that international exchange is in fact an exchange of goods and services. Under the GS system, bullion was only a technical means of facilitating exchange, being at the same time a product like all others in the economy. When a country recorded a negative balance of payments, gold as real wealth (equivalent to, for example, steel) covered the deficit (Młynarski 1929, p. 80). Receiving, within the GES system, a cheque in foreign currency as cover was not the same thing, since the bank receiving it did not receive the product, but the claim (Młynarski 1929, p. 80). The debtor did not pay with goods, real values, but with paper which was not worth much. Currencies did not replace gold in international settlements, because they were only credit, so the flow of currencies from country to country was not a transfer of wealth, but its illusion (Młynarski 1929, p. 81[6]).

A common element of Triffin’s dilemma and Młynarski’s paradox is the concern about the convertibility of the dollar into gold as a result of the increase in the supply of the dollar in relation to bullion (in the case of Młynarski, it concerned depositing reserves on interest-bearing accounts in foreign commercial banks, and in the case of Triffin it concerned a continuous increase of the balance of payments deficit by the United States).  It is worth emphasising that Młynarski also perceived the balance of payments deficit as a source of problems GS countries in the future. If a country wanted to attract gold, its balance of payments had to be positive, which required an adequate production capacity of the national economy (Młynarski 1931, p. 56). In a situation where the balance was negative, the inflow of gold was possible only by foreign loans, which, after all, had to be repaid in the future (Młynarski 1931, p. 56). The real problem of both gold exchange and gold systems, however, was the fixed official exchange rate of reserve currencies against gold, which is what constituted their essence.

The issue of rate rigidity needs to be put in a broader context in order to extract its significance and complete the arguments of researchers in the analysis of the flaws of the Bretton Woods system.

Already in the first decades of the nineteenth century, French economist J.-B. Say saw that government interference in determining the value of bullion in coins must have often failed, because it introduced an artificially constant ratio instead of a variable one (Say 1960, p. 385). As he noted, a certain amount of gold (always the same) had to be equal to, for example, 20 francs. In real terms, however, the value of a coin is determined solely by purchase and sale transactions, which are necessarily free (Say 1960, p. 391). According to J.-B. Say, monetary authorities should only denote the weight of bullion on coins in exchange for profits (seigniorage), but the ratio of bullion to other commodities should be determined by supply and demand. He considered giving a nominal value to a coin a mistake distorting the functioning of the price mechanism, which in the long run, contrary to the intentions of monetary authorities, would lead to the establishment of market price relations.[7]

Młynarski noticed this problem in relation to GES. He stated that the development of the world economy takes place within the framework of two contradictory tendencies: the first is the tendency of the exchange value of monetary bullions to constantly increase, and the second is the tendency to keep their prices constant by the monetary authorities (Młynarski 1938, p. 125). Młynarski put forward the thesis in the spirit of J.-B. Say, that ultimately in the long run the key influence on prices is always the real exchange value and with its increase comes the increase in prices (Młynarski 1938, p. 125):

The history of money shows tendency of a continuous and gradual devaluation, i.e. rise in the price paid in coins or notes per kilogram of bullion in question. This history is governed not by Cassel’s law of a 3% increase in bullion nor by any other mathematical formula, but by the law of fundamental contradiction between the tendency of the exchange value of monetary bullion to increase continuously, and the tendency of the prices paid for these bullions to remain constant.

After WWI, gold flowed into the United States, where prices in dollars doubled and the real value of gold halved (Mundell 1999, p. 227). With regard to the price level of 1930 (100), it was 78.4 in 1914; and 178.7 in 1920, with the gold standard unchanged (Mundell 1999, p. 227).  As can be seen, maintaining a fixed gold price deviated from changes in the general price level.

Reasoning by analogy, it can be noted that the post-war GES had a similar disadvantage. The Bretton Woods system was intended to be a system of currency managed with fixed parities but subject to modification in the event of fundamental imbalances (Bordo and Eichengreen 1993, pp. 28, 61). The first crisis of confidence in the dollar occurred in 1960, when the price of gold in London was pushed to $40 per ounce, while the official dollar parity was $35 per ounce (Bordo and Eichengreen 1993, p. 69). This means that the market indicated an overvaluation of the dollar against gold. However, parity was maintained thanks to the immediate creation of the so-called gold pool, i.e. an institution focused on the policy of supporting the dollar exchange rate (Rueff 2012, p. 165). The US intervention (delivery of gold to London) and the commitment of the G10 central banks to[8] refuse to buy gold above the official parity was effective (Bordo and Eichengreen 1993, p. 69). It seems that even then, it was necessary to devalue the dollar, which was not done for prestige and political reasons, mentioned on the occasion of recalling Triffin’s view on this issue.

The Bretton Woods system had to collapse due to the excessive issuance of the dollar in relation to gold reserves. The Fed began to pursue an expansionary monetary policy in 1961, setting the goal of seeking full employment over the goal of price stability (Bordo and Eichengreen 1993, p. 1970).  Inflation began to rise as early as 1964, and in 1965 it was strengthened by another increase in the dollar supply to finance the Great Society programme and the Vietnam War (Bordo, Eichengreen, p. 70).  It is reasonable to argue that the US violated the principle of the dollar standard by abandoning the care for a stable price level (Bordo and Eichengreen 1993, p. 82). However, Triffin argued  about the risk of deflation brought by the Bretton Woods system and opposed the devaluation of the dollar. Contrary to his expectations, it turned out that there was a sharp increase in the US money supply in 1965, which translated into inflation in 1966 (Bordo 1993, p. 70). In the last four months of 1965, the money supply increased by 6.8% year-on-year (Burger 1969, p. 16). Between 1965 and 1970, the money supply increased by 38% (Statistical Abstract 1977, p. 553).

Monetary developments were affected by factors from the real sphere, which deepened the gap between the market value of the dollar and the official one. On the one hand, in 1966, there was a decline in world gold production and an increase in demand for gold from the private sector, and on the other hand, differences in the productivity of economies appeared: a rapid increase in the level of durable goods production in West Germany and Japan, which showed the undervaluation of the currencies of these countries (Bordo, Eichengreen 61, 70).

Given the above, the US should have devalued the dollar. They did not do so for fear of losing confidence, although they had the opportunity to do so (Bordo and Eichengreen 1993, p. 87).

Despite the fact that both Młynarski and Triffin analysed the shortcomings  of the GES system, which in both periods (interwar and after WWII) was based on the use of gold-covered currencies as reserves of central banks operating within the GES (after WWII, only the dollar was left), fundamental changes occurred  in the monetary policy of the United States as a country issuing a reserve currency. In the interwar period, the restrictive monetary policy led to the collapse of the GES system, and the Bretton Woods system ceased to exist as a result of expansionary monetary policy.

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* Młynarski referred to data from the Bureau of Labour, in which 1913 was assumed as the base year (1913=100). The price level index for January 1922 was 138 and the index for January 1927 was 147. It should be remembered that in Młynarski’s time the category of monetary aggregates that we use today was not used.

[1] Młynarski’s reasoning can be linked to the division of consumers introduced by J.-B. Say into productive (producing useful goods and services) and non-productive (capturing the income of the former in the form of taxes that give them purchasing power), which means that in the sphere of consumption instead of a producer appears, for example, an official or a priest (Korczyk 2019, p. 44).  Ultimately, we pay for the product with the product, with unproductive consumers paying with someone else’s product.

[2] Although Młynarski does not indicate directly, the comparison probably concerns constant prices.

[3]Without a reduction of public expenditure, it will be impossible to lighten the excessive burden of taxation which hinders the domestic accumulation of capital and thereby checks the rate of increase in individual incomes.  As long as we do not accelerate the rate o f increase of individual incomes, we cannot accelerate the rate of growth of consumption capacity.  (Młynarski 1931, p. 65).

[4]Młynarski did not refer to Wagner’s law of 1883, according to which the state share in the economy increases with the enrichment of society, because the importance of the government as a provider of public goods increases (Bartkowiak 2013, p. 170).

[5] See: (Młynarski 1938, p. 121): America flooded the world with loans, but at the same time gradually raised its tariff barrier, although it had a constantly active trade balance. Under these conditions, the repatriation of gold could not develop, because new debts were incurred to pay installments and interest on old debts, or loans were used to cover import surpluses from America. Instead of repatriating gold, credit inflation developed. At the same time, the gold foreign exchange facilitated this inflationary process on an international scale, as the accumulation of foreign exchange increased from year to year and, as a supply of short-term money, spilled over from market to market, constituting an additional source of international credit.

[6] J. Rueff described the problem in a similar way: The Gold exchange standard created in this way a revolutionary change in world finance and gave birth to the mystery of “deficit without tears”. This mechanism allowed the countries issuing the most prestigious currency to “give without taking”, “lend without borrowing”, buy without paying”. (Rueff 2012, p. 38).

[7] To illustrate the phenomenon of J.-B. Say used the example of a change in the ore content in the medieval pound (Carolingian). During the reign of King Charlemagne, the pound contained 12 ounces of silver, but during the reign of Philip I, the pound contained 8 ounces of silver, or 2/3 of the original bullion content (Say 1960, p. 391). In the short term, before the participants of the transaction realised that they received 2/3 of the receivables expressed in silver, they lost. It was only when new contracts were concluded that the previous relations in settlements were restored (Say 1960, p. 392).

 

[8] Group of the most industrialised countries in the 1960’s: United States, Great Britain, Canada, France, West Germany, Italy, Netherlands, Belgium, Sweden, Japan (https://www.britannica.com/topic/international-payment/Special-Drawing-Rights#ref125847)